Tax

Audits abound

April 2020 In Committee / Text by Geoff Botting

What’s worse than a tax audit? “Nothing” might be the response from companies and individuals who have been subjected to the ordeal.

In Japan, the prospect of tax inspectors poring over one’s financial records should be a concern for everyone, according to Hans-Peter Musahl, chair of the EBC Tax Committee. The reason has to do with the country’s self-assessment system — audits are the only way for the tax authorities to review a case.

“You not only file on your own, but you also calculate the tax and the assessment of the tax,” Musahl explains.

That’s in contrast to his home country, Germany, where the tax authorities are the ones who determine how much you owe.

But in Japan, Musahl says, “at a certain point in time, the authorities want to make sure that things are generally in line with what they want.”

And that is when an audit — and potential troubles — begin.

Foreign residents of Japan need to be aware of all this, especially since the recent rollout of an OECD initiative aimed at giving the authorities a clearer picture of overseas financial accounts held by taxpayers. Under Common Reporting Standards (CRS), introduced in 2018, signatory countries gather account information from their financial institutions and then automatically exchange it with tax authorities in the other member countries.

The agreement works hand-in-hand with another recent initiative: My Number, which is Japan’s tax and social security ID system. Financial institutions in CRS member countries are now required to record the ID numbers of their customers living in Japan.

In the eyes of the institutions, failing to report your number to your overseas bank or brokerage is tantamount to hiding taxable assets. They will thus cut their dealings with customers who refuse to cooperate.

Japanese tax authorities have indicated that CRS is already leading to an increased number of audits of individuals.

“All of a sudden, the tax authorities have more sources, due to this exchange of information,” Musahl says.

He stresses that there is nothing unfair about Japan’s self-assessment system or its audits and that foreign residents need to be fully compliant with their tax obligations.

Transfer pricing, an area of corporate taxation that refers to the charging of prices among companies within the same group (e.g. for goods and services), is coming under particular scrutiny. Audits concerning this practice can be particularly onerous. While transfer pricing can help to reduce a company’s tax burden, tax inspectors also believe it can be used by companies to unfairly shift profits out of Japan to jurisdictions with lower tax rates.

“It’s not like the traditional audit many people imagine, where you show your books and your tax return and it’s just numbers,” says Keith Thomas, another committee member.

Rather, the inspectors often dig deep to gain an understanding of the company’s operations. A wide range of office staff, not just the accountants, can be subject to interviews that include ad-hoc meetings. These ordeals can last a month if no problems are found.

“But if they find significant issues, then they can go on for one to two years, or more,” Thomas says.

So, what should companies do?

“It’s important to manage the process,” he says.

Have documentation ready, try to determine the specific areas the auditors are looking for and support colleagues being interviewed.

The number of transfer-pricing audits are rising sharply in Japan. According to the National Tax Agency, a total of 257 took place in the year ending in June 2019, compared with 178 a year earlier.

To an extent, the increase reflects a heightened zeal among Japan’s tax collectors to rake in more revenue, in light of the country’s massive national debt.

“The police and hospitals have to be financed,” Musahl says. “And someone has to pay for it.” •

Advocacy issues

• Filing period

The tax filing period for individuals should be extended to May 30 to improve the quality of filings and the working and family lives of those preparing returns.

• Income and inheritance taxes

Only foreign nationals residing permanently in Japan should be subject to taxation on global assets.

• Tax treaties

Japan should increase the number of tax agreements with other countries.