Priority in Japanese transfer pricing methodologies

February 28, 2011  |  Transfer Pricing

Flowchart showing priority among Japan's transfer pricing methodologies pre 2011 tax reform.

Japan’s 2011 tax reform proposals include the abolition of priority among the different approaches allowed under the transfer pricing regulations to price controlled transactions (‘TP Methodologies’). The proposals are intended to be effective from 1 October 2011 if passed by the Japanese Diet in early 2011.

This article introduces a flow chart outlining the priority in which different TP Methodologies should be applied.

Three basic methods

As shown in the flow chart, when determining which TP Methodology to apply a taxpayer should first address whether or not the relevant transaction is an inventory transaction.

For inventory transactions preference is given to the three basic transactional TP Methodologies – Comparable Controlled Price, Resale Price or Cost Plus Methodologies. When one of these three methods cannot be applied then either a method corresponding to them, a profit split or transactional net margin (‘TNMM’) TP Methodology can be applied.

Non-inventory transactions

For non inventory transactions – for example, service transactions, financial transactions, transactions in intangible assets – taxpayers should, where possible, use a method equal to one of the above three basic methods.

Where application of one of the three basic methods is not possible, the profit split method or a method equal to the TNMM method can be applied. Finally when no other approach is possible a method corresponding to the TNMM can be applied.

In practice this prioritisation would seem to limit the circumstances under which a TNMM methodology can be applied to non-inventory transactions, such as those involving intangible assets.

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