One of the most commonly asked questions in Japanese tax due diligence or risk assessment (including FIN48) is how the statute of limitations operates for Japanese tax purposes. There are some important differences between the Japanese system and the US and UK or UK based approaches, with some key points being as follows:
Comparing Japan to US and UK
In contrast to the US, where failure to file certain tax returns (such as those required by a permanent establishment of a foreign company in the US) can leave an open ended exposure that will not expire with time, in Japan the expiration of the statue of limitations over time will in due course mean that historic liabilities will fall out of the period allowed for assessment, although the timing is extended for failure to make filings when due.
In contrast to the UK or similar assessment based systems such as Hong Kong, in Japan audit followed by the issue of an assessment makes little difference to the tax authorities right to make further assessments. In practice however, assuming correct disclosure and fact finding during the audit process, it is rare for years subject to audit to be re-opened. What maybe somewhat more common is for an issue identified in a later year to be rolled back to an earlier year that has already been audited, although this is still somewhat unusual.
To get a better understanding of the Japanese system it helps to look at the audit and assessment process in Japan.
Kousei/更生 and kettei/決定 – assessment and determination
When a Japanese corporation tax return has been submitted, if it is recognised that the amount of income or the amount of tax due in the return is not reported in accordance with the tax law or when, further to a tax authority audit, it is clear that these amounts are different from those found correct on audit then the auditors will amend the income or tax amounts concerned to the appropriate amount. This is a referred to as kousei, and is equivalent to the issue of a tax assessment.
In cases where there is an obligation to submit a corporation tax return but such a return has not been submitted, then based on an audit the tax authorities may proceed with the calculation of the income and taxes due. This is referred to as kettei, translated here as “determination”. If, through this process, a tax liability is found not to arise at the conclusion of the audit then such a determination is not carried out.
If, sometime after a kousei or kettei process is completed, it becomes apparent that the income amount or tax amount is either to large or too small then, based on further audit, the tax authorities can adjust the amount concerned (i.e. issue a saikousei/再更生 or re-assessment).
When either a kousei or kettei procedure (including saikettei) is carried out the tax authority is required to transmit a notice of kousei or kettei (i.e the assessment notice). If the assessment notice is issued to a “blue form” filing or consolidated tax filing entity then the tax authority is requried to state the reasons for the kousei. Given most subsidiaries of foreign groups will be blue form tax filers this requirement has little practical impact, although one exception may be a foreign entity that is found to have a PE in Japan – as such an entity may not be treated as a “blue form” tax filer (it would have missed the deadline to elect such treatment).
Time limits for kousei and kettei
In principle kousei cannot be made from the day five years or more from the day on which the relevant tax filing was due (or five years from the day that a request for repayment of tax was submitted). However for cases under (1) and (2) below, kousei can be made up to seven years after the date the relevant tax filing was due.
(1) A kousei which increases the amount of net loss or increases a tax repayment or one which reduces the amount of net loss for the year end concerned.
(2) In circumstances where due to falsification or other unlawful action the amount of tax is exempted or an amount of tax has been repaid.
Kettei or kousei post kettei cannot be made after five years or more have passed from the date that the relevant tax filing was due (or where falsification or other unlawful action occurse, seven years). Special rules apply where a tribunal appeal or court case are persued in relation to the kousei or kettei.
For transactions with related parties (i.e. transfer pricing transactions) the five year time limit above is extended to six years when looking to tax earlier years.