Audit trends and scope
The number of inheritance tax audits in Japan have been gradually increasing in recent years. Checks on inheritance tax returns have become increasingly detailed and the value of assets that are typically included in the scope of audit examination has also been lowered. Tax reforms awaiting adoption in 2011 also propose widening the scope of persons and assets subject to inheritance tax, further increasing the level of audit scrutiny.
Recent audits have also focused on confirming the value of taxable assets that should be included in the estate by examining in detail gifts made prior to the deceased’s passing away as well as looking for other undeclared assets.
Frequency of inheritance tax audit
Compared with other taxes, the frequency of inheritance tax audit is high. Omissions from tax returns are common and in contrast to income tax which can be audited from year to year, inheritance tax will only be audited once. In 2009 approximately 110,000 returns were filed in a year when around 1,100,000 passed away. Of those returns, approximately 40,000 were subject to audit. Accordingly the audit rate is approximately 30% of returns submitted and audits found approximately 85% of tax returns audited to be deficient.
The Nikkei article reported that the time between submission of the tax return and the commencement of a tax audit had shortened and that the number of items examined in an audit had increased. In recent years tax audits had commenced from about between one year to one and a half years from the time of submission of the return.
Assets subject to audit
The article also observed that audits of capital games on the disposal of land had recently decreased while the tax authority’s focus on inheritance tax audits had increased. This trend may reflect the decline in asset values following the 2008 financial crisis and a subsequent decrease in the number of disposals of assets.
In the past if an estate did not included land or financial assets worth more than a couple of hundred million yen then generally they would not be subject to inheritance tax audit. However more recently estates worth between JPY100-200 million (a little over USD1-2m) may still be subject to audit.
Items examined on audit
The Nikkei article listed a number of check points that were often the subject of an inheritance tax audit. These items included the following:
Whether assets reported in the inheritance tax return were consistent with the income, assets and occupation of the deceased
Whether, prior to the passing away of the deceased, significant amounts of deposits or similar withdrawals were made from the deceased’s account.
Whether accounts were maintained in the name of family members but which included, in substance, the assets of the deceased
Whether gifts made in the lifetime of the deceased were properly reported on the return
Whether assets were transferred to persons other than those identified as the inheritors of the deceased’s estate.
How funds used to settle inheritance tax liabilities at the time of filing the return were raised
Whether deposits made with old people’s homes that were returned on death were actually repaid and declared
Whether loans or deposits made by the deceased were properly declared
Whether access liabilities and access funeral expenses were improperly declared
Whether a deduction for the decline in value of small-scale residential property was inappropriately claimed
The article also reported statistics concerning which assets were most commonly under-declared on an inheritance tax return.
Given related legal registries, the reporting of land and property was generally the most complete, comprising only around 17 per cent of under-reporting cases. 30 per cent of under reporting arose in relation to other assets such as insurance monies, loans, deposits, valuables, with the remaining approximately 53 per cent relating to cash securities and similar liquid financial assets.
Advice to inheritors
The article included advice for inheritors in relation to the tax.
One trend in recent audits was for the tax authorities to examine the accounts held by inheritors to identify whether any such accounts were really under the control of the deceased or included assets gifted from the deceased. Accordingly, care should be taken to manage the seals and passbooks or other formal authorities over such accounts in order to prevent them being included within the estate of the deceased and subject to tax.
The article included some additional points of advice in relation to preparing for an inheritance tax audit, which were as follows:
Maintain evidence around gifts made during the lifetime of the deceased, such as related contracts, returns and evidence of payment of gift tax
Keep records explaining reasons for withdrawing money from accounts
Keep the past tax returns of the deceased in order to demonstrate their level of income
Consider employing a qualified tax accountant to participate in the audit process
One point to take away from the above advice is that preparation for an inheritance tax audit begins in day to day management of an individuals financial affairs. Given the uncertain world we live in, this is good advice in any circumstances.