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Introduction of Stringent Transfer Pricing Documentation Requirement
September, 26th 2016

A recent 2016 tax reform in Japan ("Reform") has introduced stringent Japanese Transfer Pricing Documentation Requirements, which require the preparation/filing of: (i) a Master File, (ii) a Country-by-Country Report, and (iii) a Local File, as well as (iv) a "Notification of the Ultimate Parent Entity." Any ultimate parent company ("Parent Co") of a multinational enterprise with group consolidated revenues of JPY 100 billion (approximately USD 1 billion) or more ("MNE") having a Japanese subsidiary should pay due attention to the new requirements.

The Reform notably requires any MNE with a Japanese subsidiary ("Sub Co") to prepare and file a Master File with the Japanese tax authorities through Sub Co. As long as the MNE meets the JPY 100 billion threshold, Sub Co will have to file the Master File with the Japanese tax authorities regardless of how small Sub Co is and whether or not Parent Co's home country has introduced the same or similar Master File documentation requirements. It should be especially noted that a failure to file the Master File would be subject to a sanction by criminal penalty (i.e., a criminal fine ranging up to JPY 300,000).

The Master File itself must be prepared in accordance with Parent Co's fiscal year starting on or after April 1, 2016. Following the end of the Parent Co's fiscal year, the Sub Co must submit the Master File to the appropriate Japanese tax authorities by the applicable submission deadline, which is one year after the end of the Parent Co's relevant fiscal year. For example, if the fiscal year of Parent Co is a calendar year, the rule will be first applied to the fiscal year beginning on January 1, 2017, and the relevant submission deadline will be December 31, 2018. If there are two or more Sub Cos, any one Sub Co may submit the Master File on behalf of all Sub Cos.

The Master File may be prepared in either the Japanese or English language and must be submitted electronically. The Master File must contain: (i) the MNE's organizational structure chart; (ii) the MNE's description of businesses with a brief written functional analysis of individual entities in the group; (iii) relevant information about the MNE's intangibles (including the MNE's overall strategy, list of intangibles and owners thereof, list of important intercompany agreements relating to intangibles, and transfer pricing policies relating to R&D and intangibles); (iv) the MNE's intercompany financial activities; (v) the MNE's annual consolidated financial statements; and (vi) the MNE group's existing unilateral APAs and other tax rulings.

In addition, the same rules pertaining to the Master File are applicable to the filing of a Country-by-Country Report, which must contain tax information for each jurisdiction where the MNE operates. Sub Co will, however, be exempt from filing the Country-by-Country Report, provided that the Japanese government may obtain a copy of the Country-by-Country Report from the relevant treaty partner through the exchange of information provisions of its tax treaties.

Further, any Sub Co that is subject to the filing obligation of a Master File also will have to submit the "Notification of the Ultimate Parent Entity" with the Japanese tax authorities by the end of Parent Co's applicable fiscal year. The Notification describes only the name, the registered address or the place of control, the name of the representative, and the corporate number of the Parent Co. Sub Co is required to submit the Notification to the pertinent Japanese tax authorities by the end of each fiscal year of the Parent Co beginning on or after April 1, 2016 (i.e., the first deadline is one year earlier than the Master File deadline).

Finally, if Sub Co's annual transaction amount with any of its foreign affiliates equals JPY 5 billion (approximately USD 50 million) or more, or Sub Co's annual transaction amount for intangibles with any of its foreign affiliates equals JPY 300 million (approximately USD 3 million) or more, then Sub Co will be required to prepare a Local File (i.e., documents necessary for calculating the arm's-length prices for the above transactions) by the filing deadline for its corporate tax return and to keep all Local Files created within a seven-year rolling period. In the event of a tax audit, Sub Co will be required to submit the Local File within 45 days upon request from a tax auditor. While Sub Co's failure to prepare or submit the Local File will not be sanctioned by criminal penalty, a failure to submit the Local File will likely result in the receipt of unfavorable transfer pricing assessments (i.e., using so-called secret comparables) by the Japanese tax authorities. The rule is applicable to the Sub Co's fiscal years beginning on or after April 1, 2017.

In view of the above, it is advisable for any entity affected by the Reform to prepare for the forthcoming implementation of the above Japanese Transfer Pricing Documentation Requirements by assessing the potential cost and burden of future compliance with the Reform. Depending upon the particular facts and circumstances, we may be able provide a cost-effective simplified transfer pricing solution to those entities affected by the Reform.

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