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(c) 2014 Grant Thornton Taiyo Tax Corporation. All rights reserved. Japan tax bulletin – October 2014 1
Japan tax bulletinNewsletter on important tax and business developments in Japan
October 2014
In this issue
New rules for the taxation ofPermanent Establishments andmeasures planned for consumptiontax on electronic sales including the“reverse charge” mechanism.
This edition of our newsletter contains details ofchanges to the taxation of PermanentEstablishments in Japan under the AOA(Authorised OECD Approach) and details of newmeasures being planned by the government tocorrect an imbalance in the consumption taxtreatment on electronics sales for domestic andoverseas companies.
Taxation of PEs and new proposed consumption tax measures
(c) 2014 Grant Thornton Taiyo Tax Corporation. All rights reserved. Japan tax bulletin – October 2014 2
Taxation of PEs
Taxation of a Permanent Establishment
under the Authorised OECD Approach
(AOA) approach
The AOA (Authorised OECD Approach) rule fortaxation of Permanent Establishments (PEs) wasintroduced in the 2014 tax reform and will comeinto force for fiscal years beginning after March 312016. The new rule includes changes to the sourcerule, introduction of transfer pricing to intra-company transactions and the introduction of newdocumentation requirements for incomeattributable to PE.
Source rule
According to the current source rule, domesticsource income for business income is differentfrom income attributable to a PE. Currently, aforeign corporation operating in Japan through aPE is liable to corporate income tax on thedomestic source income of the PE. Therefore, anyforeign source income that is attributable to the PEis out of the scope of corporate income tax.
Under the new rule, domestic source income forbusiness income will be the income attributable tothe PE. A foreign corporation is subject tocorporate income tax as long as the definition of itsincome follows Art 138(1)(i) of the CorporationTax Law (“ CTL”). According to the revised Art138(i), domestic source income for business incomewill be defined as:
“Where a foreign corporation conducts businessthrough a PE, domestic source income will beincome attributable to PE with reference tofunctions performed by the PE, assets employed bythe PE, intra-company transactions etc. assumingthat the PE is a separate enterprise conductingbusiness independently from the foreigncorporation.”
In addition, new rules were introduced forcalculating the income attributable to a PE.
Disallowance of interest expenses on equityattributable to a PEIn situations where the equity (net assets) of a PEis lower than the equity of the foreign corporationwhich is attributable to that PE, any interestcharged that corresponds to the difference is non-deductible.1.
Disallowance of head office expense allocationIn order for a PE to take a tax deduction forallocated head office expenses, sufficientdocumentation on how the expense was allocatedmust be maintained. If the documentation isinsufficient the expense will be disallowed for taxpurposes.
Foreign tax creditsWhere a PE pays foreign tax on foreign sourceincome, the PE is allowed to take a foreign taxcredit against its Japan corporation tax. Themaximum credit available is capped at the amountof Japan corporation tax due on the foreign sourceincome2.
Intra-company transactionUnder the current rule, certain intra-companytransactions such as intra-company licenses, intra-company loans etc, are not recognized3. Afterimplementing the new rule, intra-companytransactions will be recognized. Intra-companytransactions are transactions with the head office orother offices in the same entity which would bemade between independent enterprises, such as thetransfer of assets, provision of services etc.4
Transfer pricing rule
The Japanese transfer pricing rule is applied totransactions between separate legal entities whichare related in terms of ownership and othersubstantive control5. Although the arm’s length
1 Art 142-4 of CTL2 Art 144 of CTL.3 Art 176(3)(ii) of Corporation Tax Law Enforcement
Ordinance (“CTLEO”)4 Art 138(2)5 Art 66-4 of the Special Taxation Measures Law (“STML”)
Taxation of PEs and new proposed consumption tax measures
(c) 2014 Grant Thornton Taiyo Tax Corporation. All rights reserved. Japan tax bulletin – October 2014 3
principle is applicable to intra-companytransactions, Art 66-4 of STML does not apply tothem. From a transfer pricing perspective there aredifferences between intercompany transactions andintra-company transactions in terms of the statuteof limitation, presumptive assessment anddocumentation requirements. In connection withthe tax reform, the transfer pricing rule will beapplied to intra-company transactions in the sameway as it is applied to intercompany transactions.
Art 66-4-3 of STML was introduced as a set oftransfer pricing rules to be applied to intra-company transactions. Art 66-4-3 is identical toSTML 66-4 and has the same rules for the statuteof limitation, presumptive assessment anddocumentation requirements as those that areapplied to intercompany transactions.
Transfer pricing documents must be submittedwithout delay when requested. When the companyfails to meet the deadline, the tax authorities areauthorized to tax the company by presumptiveassessment. Transfer pricing documents includesdocuments describing both intra-companytransactions and the arm’s length price for intra-company transactions.
Documents describing intra-companytransactions6
Documents describing details of assets andservices in intra-company transactions.
Documents describing functions performedand risks assumed by a PE and head office etc.
Documents describing intangible assets andtangible assets utilized by a PE and head officeetc.
Contracts or equivalent documents thatdescribe the transfer of assets, provision ofservices or other facts.
Documents describing the method ofdetermining the intra-company transactionprice as well as the negotiation process onhow the price was reached.
Documents describing profit/loss on theintra-company transaction between the PEand head office etc.
Documents describing the market analysis ofthe intra-company transaction.
Documents describing the business policy of
6 Art 22-10-3(1) of Special Taxation Measures Law
Enforcement Regulation(“STMLER”)
the foreign corporation, and the businessactivities of the PE and head office etc.
Documents describing other transactions thatare (including other intra-companytransactions) closely connected to the intra-company transaction, along with the contentsof the transaction.
Documentation requirements for the PE
A PE is required to prepare and maintaindocuments relating to both intra-companytransactions and its transactions with third parties.7.
Documentation for third party transactions8
A PE is required to prepare the followingdocuments: Documents describing the contents of
transactions attributable to the PE (“ PEattributable intercompany transactions”)
Documents describing the details of assets andliabilities utilized by the PE and head officesetc for PE attributable intercompanytransactions.
Documents describing the functions and risksperformed and controlled by the PE and headoffice etc in PE attributable intercompanytransactions. The functions include labourfunctions and other functions in relation toassets attribution and risks involved.
Documents describing the departmentsengaged in the functions performed in PEattributable intercompany transactions and thedepartment’s business description.
Documentation for intra-companytransactions9
A PE is required to prepare the followingdocuments: Orders, contracts, invoices, receipts, price
estimates or equivalent documents describingintra-company transactions such as transfer ofassets, provision of services etc and otherfacts.
Documents describing the details of assets andliabilities utilized by the PE and head officesetc for intra-company transactions.
Documents describing the functions and risksperformed and controlled by the PE and head
7 Art 146-2 of CTL8 Art 62-2 of Corporation Tax Law Enforcement
Regulation(“CTLER”)9 Art 62-3 of CTLER
Taxation of PEs and new proposed consumption tax measures
(c) 2014 Grant Thornton Taiyo Tax Corporation. All rights reserved. Japan tax bulletin – October 2014 4
office etc in intracompany transactions. Thefunctions include labour functions and otherfunctions in relation to assets attribution andrisks involved.
Documents describing the departmentsengaged in intra-company transactions,together with the department’s businessdescription.
Documents that provides evidence of the factsrelated to intra-company transactions (theseinvolve asset transfers, provision of services orother intra-company transactions).
Actions required
Under the new AOA rules, the compliancerequirements for a PE of a foreign corporationhave increased significantly. Therefore it isrecommended that foreign corporations reviewhow the new rules would affect their Japan PEs andthat appropriate steps are taken in order to preparefor the requirements before they come into force.
Taxation of PEs and new proposed consumption tax measures
(c) 2014 Grant Thornton Taiyo Tax Corporation. All rights reserved. Japan tax bulletin – October 2014 5
Consumption tax proposals
On 26 June 2014 the international taxationdiscussion group of the Japanese government’s TaxCommission released the current status of itsdiscussions on consumption tax relating to cross-border services.
It proposed to extend the scope of taxabletransactions under the consumption tax law forcross-border services rendered by foreignenterprises.
Current law
Under the current law, purchases of digital servicesfrom domestic enterprises are subject toconsumption tax, while those from foreignenterprises are not subject to consumption tax.This is because for cross-border services when theplace of service provision is unclear the services aredeemed to be rendered at the location of thesupplier’s office or address.
The government wants to achieve fair competitionbetween domestic and overseas service providersby implementing its proposal.
Business to Business (B2B) transactions
The proposal introduces a reverse chargemechanism for B2B transactions. B2B transactionsare cross-border service transactions establishedthrough telecommunication lines such as internetor telephone lines, where the recipients of theservices are identified as enterprises with referenceto the nature of service or trading terms etc.
Under the reverse charge mechanism, recipients ofthe service will be required to report a “reversecharge” output tax in their consumption tax return.The reverse charge means that the business willrecognize an output tax credit for the service (as ifit had provided the service to itself). For mostenterprises this output tax will be equal to the inputtax paid by the enterprise for the service provided.
Foreign enterprises that provide cross-borderservices that are subject to the reverse chargemechanism will need to notify the recipients of theservice so that they can report the consumption tax
correctly The timing of this notification has not yetbeen decided, although the reverse chargemechanism will apply regardless of whether therecipient has been notified or not.
Business to Consumer (B2C) transactions
B2C transactions are cross-border servicetransactions provided both inside and outside ofthe country through telecommunication lines suchas internet or telephone lines, which do not fallunder the definition of B2B transactions withreference to the nature of service or trading termsetc.
Foreign enterprises engaging in B2C transactionswill be required to file a consumption tax return,which is also currently a requirement for domesticenterprises. The current exemption from tax filingwill also be applicable to foreign enterprisesengaged in B2C transactions, and so foreignenterprises whose taxable sales are JPY 10 millionor lower will not be required to file a consumptiontax return. For B2C services such as online musicdistribution or electronic books purchased bydomestic enterprises, the input tax credit on theB2C services will be disallowed as there is a risk theforeign enterprise providing the B2C services maynot file a tax return to pay over the sales tax. If taxreturns are not duly filed, the Japanese governmentwill take action in accordance with the informationexchange clause or tax collection cooperationclause under the tax treaty established with theforeign enterprise’s home country.
Other points
The proposed change will be applied to cross-border services (not limited to digital services) aslong as services are provided throughtelecommunication lines. Therefore, intra-groupservices within multinational corporate groups maybe subject to consumption tax unless it is clear thatthe services are rendered overseas. The followingexamples are given in the discussion paper as cross-border service transactions subject to consumptiontax:
Taxation of PEs and new proposed consumption tax measures
(c) 2014 Grant Thornton Taiyo Tax Corporation. All rights reserved. Japan tax bulletin –October 2014 6
In-house training services provided by a parentcompany to its subsidiaries
Provision of common system infrastructurepurchased by a parent company to subsidiaries.
Summary
The new proposal, if implemented, will ensure alevel playing field for Japanese businesses engagedin providing cross-border digital services. Aconsequence of this is that foreign businesses willendure increased administrative burden whenproviding these types of service. The full extent ofthis burden will be known more clearly once theproposal has been debated further and therequirements and mechanism of the reverse chargeare further refined.
Contact us for any enquiry on our services;
Yoichi Ishizuka
Managing Partner, Tax ServicesTel: 03-5770-8870 email: [email protected]
Hideharu Tanaka
Partner, International Tax ServicesTel: 03-5770-8871 email: [email protected]
Kumiko Miyajima
Partner, International Tax ServicesTel: 03-5770-8914 email: [email protected]
Yuka Iizumi
Manager, International Tax ServicesTel: 03-5770-8892 email: [email protected]
Tosh Kamii
Manager, Corporate ServicesTel: 03-5770-8935 email: [email protected]
Takashi Kurematsu
Manager, International Tax ServicesTel: 03-5770-8938 email: [email protected]
Michiko Shinohara
Manager, International Tax ServicesTel:03-5770-8896 email: [email protected]
Adrian Castelino-Prabhu
Assistant Manager, International Tax ServicesTel: 03-5770-8882 email: [email protected]
Disclaimer
The aim of this newsletter is to provide information relating to recentJapanese tax and business. The information is general in nature and it isnot to be taken as a substitute for specific advice. Accordingly, GrantThornton Japan accepts no responsibility for any loss that occurs toany party who acts on information contained herein.
Grant Thornton Taiyo Tax Corporation is a member firm within Grant Thornton International Ltd ('Grant Thornton International').Grant Thornton International and the member firms are not a worldwide partnership. Services are delivered by the member firms independently.
