Japan’s coalition leading parties released the 2019 tax reform proposal. The proposal includes some important items following the base erosion profit shifting (BEPS) plans recommendations to counter multinational tax avoidance. Besides updating the transfer pricing rule, the proposal also encompasses earning stripping rule.
Under the proposal, the scope of intangibles subject to the transfer pricing rules is clarified and defined, following the BEPS final report, as “something which is not a physical asset or a financial asset and whose use or transfer would be compensated had it occurred in a transaction between independent parties in comparable circumstances.”
In addition, the discounted cash flow method suggested by the BEPS final report also would be added to the list of transfer pricing methods. This method will be useful to the extent hard-to-value intangibles (HTVI) involved where comparable could not be found to use another transfer pricing method.
Under 2019 tax reform, the tax authority will allow to assess and determine the transfer price of “specified intangibles” based on the best method taking into consideration ex-post outcomes derived from the transferred HTVI. However, Japan’s tax authorities will not be able to exercise this power if the assessment of the compensation for the transferred HTVI does not cause deviation by more than 20 percent from the taxpayer’s projected compensation.
The proposal will categorize intangibles as specified intangibles if all the following conditions are satisfied: the intangible is unique and has significant value; the transfer price would be calculated based on projected future outcomes; and the projections are highly uncertain.
Apart from the intangible extension, the proposal also plans to extend the current six-year statute of limitations for transfers pricing to seven years. This revision will apply to taxable years beginning on or after 1 April 2020 and calendar years beginning 2021 for corporations and individuals, respectively.
The earnings stripping rules will be amended by reducing the current 50% of adjusted taxable income (ATI) to 20% in computing interest expense disallowance to comply with BEPS action 4 (interest deduction limitation) recommendation. To the extent net applicable interest payments exceed 20% of adjusted income in a taxable year, a deduction of the excess amount would be denied. The disallowed interest can be carried forward for seven years in the same manner as the current rules.
Moreover, the proposal also revises the scope of interest subject to the earnings stripping rules and the de minimis exceptions to address Business associations opposition to extending the earning stripping limitation to third-party loans.
The revision will apply to taxable years beginning on or after 1 April 2020.