Navigating Japanese transfer pricing reforms
In response to the Organisation for Economic Co-operation and Development (OECD) revisions to transfer pricing of financial transactions, the Japanese transfer pricing administrative guidelines have been reformed in Japan effective 1 April 2023. The latest revisions clarify the application of transfer pricing to financial transactions and give more precise guidance on intercompany transactions related to loans, cash-pooling and guarantees.
The reforms will impact all companies conducting those transactions, regardless of any Japanese transfer pricing thresholds, resulting in increased importance for the alignment of the transfer pricing documentation on financial transactions with the group transfer pricing policy.
Demonstrating an arm’s length approach
A distinct challenge for those undertaking financial transactions, particularly the financial services sector, is how to manage and ensure that intercompany transactions are conducted at arm’s length during periods of economic volatility. For global financial services groups, the ability to develop a consensus on pricing related to financial transactions is more complex during such periods. For example, Japan’s central bank has maintained a low interest rate strategy to stimulate economic growth. The Bank of Japan (BoJ) went as far as to adopt negative interest rates from 2016 onwards. In contrast, US and European Central Bank key interest rates have risen to a level of 4% or 5%, following a long period of low interest rates.
As Japan and global tax authorities strengthen their approach to transfer pricing, it will be essential for financial services groups to demonstrate that pricing mechanisms in place for financial transactions accurately reflect how decisions were made and their expected impact on outcomes. This is particularly important during times of economic volatility when results can differ from what was originally anticipated.
Questioning transfer pricing accuracy
In light of OECD revisions and Japan’s own transfer pricing reforms, there are signs that Japanese tax authorities will use reforms to take a harder line on the accuracy of transfer pricing policy applied to intragroup financial transactions. This suggests that Japanese tax authority challenges will increase going forward.
Demonstrating how the actual outcome complies with the arm’s length principle demands a practical analysis of current economic events. At its core, it requires international transfer pricing expertise and strong audit capabilities. Such capabilities are particularly crucial in the current tax environment where the number of tax audit cases is increasing following the return to normal operations in the post Covid-19 era.
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