May 7, 2021
OECD releases Japan Stage 2 peer review report on implementation of Action 14 minimum standard
On 15 April 2021, the Organisation for Economic Co-operation and Development (OECD) released the Stage 2 peer review report of Japan relating to the outcome of the peer monitoring of the implementation of the Base Erosion and Profit Shifting (BEPS) minimum standard under Action 14 on improving tax dispute resolution mechanisms. Stage 2 focuses on monitoring the follow-up of any recommendations resulting from Japan’s Stage 1 peer review report.1 Japan requested that the OECD also provide feedback concerning their adoption of the Action 14 best practices, and therefore, in addition to the peer review report, the OECD has released an accompanying document addressing the implementation of best practices.2
Overall, the report concludes that Japan addressed almost all the shortcomings identified in its Stage 1 peer review report. Japan meets the Action 14 minimum standard with respect to the prevention of disputes, availability and access to the Mutual Agreement Procedure (MAP), resolution of MAP cases and implementation of MAP agreements. However, the report recommends that Japan take action with respect to a number of tax treaties, as detailed below.
In October 2016, the OECD released the peer review documents (i.e., the Terms of Reference and Assessment Methodology) on Action 14 which form the basis of the MAP peer review and monitoring process under BEPS Action 14.3
The Terms of Reference translate the minimum standard approved into a basis for peer review, consisting of 21 elements complemented by 12 best practices. The Terms of Reference assess a Member’s legal and administrative framework, including the practical implementation of this framework to determine how its MAP regime performs relative to the 21 elements in four key areas: (i) preventing disputes; (ii) availability and access to MAP; (iii) resolution of MAP cases; and (iv) implementation of MAP agreements.
The Assessment Methodology establishes detailed procedures and guidelines for a two-stage approach to the peer review and monitoring process. Stage 1 involves the review of a Member’s implementation of the minimum standard based on its legal framework for MAP and the application of this framework in practice. Stage 2 involves the review of the measures taken by the Member to address any shortcomings identified in its Stage 1 peer review. In light of the above, the OECD has also released a schedule for Stage 1 of the peer review and a questionnaire for taxpayers. The schedule catalogues the assessed jurisdictions into 10 batches for review.
Both of these stages are desk-based and are coordinated by the Secretariat of the Forum on Tax Administration’s (FTA) MAP Forum.4 In summary, Stage 1 consist of three steps or phases:
Input is provided through questionnaires completed by the assessed jurisdiction, peers (i.e., other members of the FTA MAP Forum) and taxpayers. Once the input has been gathered, the Secretariat prepares a draft Stage 1 peer review report of the assessed jurisdiction and sends it to the assessed jurisdiction for its written comments on the draft report. When a peer review report is finalized, it is sent for approval of the FTA MAP Forum and later to the OECD Committee on Fiscal Affairs (CFA) to adopt the report for publication.
For Stage 2, there are two steps or phases: (i) approval of Stage 2 peer monitoring report of an assessed jurisdiction and (ii) publication of Stage 2 peer review reports. More specifically, an assessed jurisdiction should within one year of the adoption of its Stage 1 peer review report by the CFA submit a detailed written report (Update Report) to the FTA MAP Forum. The Update Report should contain: (i) the steps that the assessed jurisdiction has taken or is taking to address any shortcomings identified in its peer review report; and (ii) any plans or changes to its legislative or procedural framework relating to the implementation of the minimum standard. Members of the FTA MAP Forum should also provide their comments on the Update Report provided by the assessed jurisdiction. Based on the Update Report submitted by the assessed jurisdiction and the input from the peers, the Secretariat will revise the Stage 1 peer review report of the assessed jurisdiction with a view to incorporate these updates in the Stage 2 peer monitoring report of the assessed jurisdiction. After adoption from the CFA, the Stage 2 peer monitoring report will be published.
Minimum standards peer review reports
The report is divided into four parts, namely:
Each part addresses a different component of the minimum standard.
Overall, Japan addressed almost all the shortcomings identified in its Stage 1 peer review report.
[A.1] Include Article 25(3), first sentence, of the OECD Model Tax Convention in tax treaties
Out of Japan’s 71 tax treaties, 70 contain a provision equivalent to Article 25(3), first sentence, of the OECD Model Tax Convention requiring the competent authority to endeavor to resolve by mutual agreement any difficulties or doubts arising as to the interpretation or application of the tax treaty.
Out of the 70 treaties, only 1 does not contain this equivalent and will not be modified by the Multilateral Instrument (MLI) to include such equivalent. However, Japan reported that under its domestic legislation and/or administrative practice there is no obstruction to enter into interpretative MAP agreements, although it has not experienced such a situation so far.
The report does not identify any areas of improvement or recommendations with respect to this section.
[A.2] Provide roll-back of bilateral APAs in appropriate cases
Japan allows roll-back of bilateral APAs. A roll-back will be granted where the application to previous fiscal years is considered to be appropriate. The report does not identify any areas of improvement or recommendations with respect to this section.
Availability and access to MAP
[B.1] Include Article 25(1) of the OECD Model Tax Convention in tax treaties
Of Japan’s 71 tax treaties, 6 do not contain a provision that is equivalent to Article 25(1), first sentence.
Two of these six treaties have been or are expected to be modified by the MLI to include the equivalent of Article 25(1), first sentence.
Four of these six treaties will not be modified by the MLI to include the required provision. For these treaties, the report recommends that they are modified through bilateral negotiations.
The second sentence of Article 25(1) provides that the taxpayer can present the request for MAP assistance within a period of no less than three years from the first notification of the action resulting in taxation not in accordance with the provisions of the tax treaty.
Out of 71 tax treaties, 12 do not contain a provision equivalent to Article 25(1), second sentence. Of these 12, 11 have no filing period for a MAP request. Where a tax treaty does not contain a specific filing period for MAP requests, Japan reported that its domestic legislation and administrative practice does not provide for such a filing period either and its competent authority would not apply a specific timeframe within which a MAP request should be filed.
Only one treaty contains a filing period less than three years for a MAP request (two years). This treaty will be modified by the MLI to include the equivalent to Article 25(1), second sentence.
[B.2] Allow submission of MAP requests to the competent authority of either treaty partner, or, alternatively, introduce a bilateral consultation or notification process
The minimum standard requires that: (i) tax treaties shall contain provisions which provide that the taxpayer can request MAP assistance to the competent authority of either contracting party; or (ii) where this is not permitted under the treaty and the competent authority who received the MAP request does not consider the taxpayer’s objection to be justified, the competent authority should implement a bilateral consultation or notification process which allows the other competent authority to provide its views on the case.
Japan reported that where its competent authority considers that the objection raised in a MAP request is not justified, or where a MAP request does not include the required information or documentation as set out in its MAP guidance, it will apply a consultation process with the competent authority of the relevant treaty partner.
The report does not identify any areas of improvement or recommendations with respect to this section.
[B.3] Provide access to MAP in transfer pricing cases
The minimum standard requires that jurisdictions should provide access to MAP in transfer pricing cases.
Japan reported that it is in favor of including Article 9(2) in its tax treaties where possible and that it will seek to include it in all future tax treaties.
The report does not identify any areas of improvement or recommendations with respect to this section.
[B.4] Provide access to MAP in relation to the application of anti-abuse provisions
The minimum standard requires that jurisdictions provide access to MAP in cases in which there is a disagreement between the taxpayer and the tax authorities making the adjustment as to whether the conditions for the application of a treaty anti-abuse provision have been met or as to whether the application of a domestic law anti-abuse provision is in conflict with the provisions of a treaty.
None of Japan’s 71 tax treaties allow competent authorities to restrict access to MAP for cases when a treaty anti-abuse provision applies or when there is a disagreement between the taxpayer and the tax authorities as to whether the application of a domestic law anti-abuse provision is in conflict with the provisions of a tax treaty and Japan has reported that it will provide access to MAP in such cases.
[B.5] Provide access to MAP in cases of audit settlements
The minimum standard requires that jurisdictions should not deny access to MAP in cases where there is an audit settlement between tax authorities and taxpayers.
Under Japan’s domestic law, there is no process available allowing taxpayers and the tax administration to enter into a settlement agreement during or after ending of an audit. Nor is there an administrative or statutory dispute settlement/resolution process in place, which is independent from the audit and examination functions and which can only be accessed through a request by the taxpayer.
[B.6] Provide access to MAP if required information is submitted
The minimum standard requires that jurisdictions do not limit access to MAP based on the position that insufficient information was provided if the taxpayer has provided the required information based on the rules, guidelines and procedures made available to taxpayers on access to and the use of MAP.
Where a taxpayer has not included all required information in its MAP request, Japan‘s competent authority will request the taxpayer to supplement the missing information and/or documentation. Where taxpayers ultimately do not submit the required and requested information, even after repeated requests, Japan’s competent authority may decide not to initiate MAP discussions with the other competent authority concerned.
[B.7] Include Article 25(3), second sentence, of the OECD Model Tax Convention in tax treaties
The minimum standard requires that tax treaties contain a provision under which competent authorities may consult together for the elimination of double taxation in cases not provided for in their tax treaties.
Out of Japan’s 71 tax treaties, 8 do not contain a provision that is equivalent to Article 25(3), second sentence. Of these eight treaties, five concern tax treaties with a limited scope of application.
One of the three remaining treaties is expected to be modified by the MLI to include the equivalent of Article 25(3), second sentence, and two of the three remaining treaties will not be modified by the MLI to include the required provision.
With respect to these three treaties, the report recommends that Japan should modify through bilateral negotiations.
[B.8] Publish clear and comprehensive MAP guidance
The minimum standard requires that jurisdictions publish clear rules, guidelines and procedures on access to and use of the MAP and include the specific information and documentation that should be submitted in a taxpayer’s request for MAP assistance.
Japan has included basic information on its MAP process in Article 12 of the Ministerial Ordinance on the Enforcement of the Act on Special Provisions of the Income Tax Act, the Corporation Tax Act and the Local Tax Act regarding the application of Tax Treaties. The competent authority also provides specific MAP guidance online.
[B.9] Make MAP guidance available and easily accessible and publish MAP profile
The minimum standard requires that jurisdictions should take appropriate measures to make rules, guidelines and procedures on access to and use of the MAP available and easily accessible to the public and should publish their jurisdiction MAP profiles on a shared public platform pursuant to the agreed template.
The Japan MAP guidance is published online in both Japanese and English. The MAP profile of Japan is published on the website of the OECD.
[B.10] Clarify in MAP guidance that audit settlements do not preclude access to MAP
The minimum standard requires that jurisdictions should clarify in their MAP guidance that audit settlements between tax authorities and taxpayers do not preclude access to MAP.
Under Japan’s domestic law, it is not possible for taxpayers and the tax administration to enter into audit settlements. In that regard, there is no need to address in Japan’s MAP guidance that audit settlements do not preclude access to MAP.
Resolution of MAP cases
[C.1] Include Article 25(2), first sentence, of the OECD Model Tax Convention in tax treaties
Article 25(2), first sentence, of the OECD Model Tax Convention, provides that the competent authority shall endeavor, if the objection appears to it to be justified and if it is not itself able to arrive at a satisfactory solution, to resolve the case by mutual agreement with the competent authority of the other Contracting State, with a view to the avoidance of taxation which is not in accordance with the tax treaty.
Out of the 71 tax treaties, 2 do not contain a provision that is equivalent to Article 25(2), first sentence. Of these two treaties, one is expected to be modified by the MLI to include the equivalent of Article 25(2), and one will not be modified to include the required provision. With respect to this treaty, no actions have been taken nor are any concrete actions planned to be taken. The report recommends that for this treaty, Japan should initiate bilateral negotiations for the inclusion of the required provision.
[C.2] Seek to resolve MAP cases within a 24-month average timeframe
The minimum standard requires that jurisdictions should seek to resolve MAP cases within an average time frame of 24 months. This time frame applies to both jurisdictions (i.e., the jurisdiction which receives the MAP request from the taxpayer and its treaty partner).
The average time needed to close MAP cases during the Statistics Reporting Period was 27.02 months. The average time needed to close 71 pre-2016 cases was 35.56 months. The average time needed to close 44 post-2015 cases was 13.25 months.
[C.3] Provide adequate resources to the MAP function
The minimum standard requires that jurisdictions should ensure that adequate resources are provided to the MAP function.
MAP cases were closed in 27.02 months on average, which is above the 24-month average (which is the pursued average for resolving MAP cases received on or after 1 January 2016). This particularly concerns attribution/allocation cases, as the average time needed for such cases is 27.95 months while for other cases the average is below the pursued 24-month average (17.27 months). Although there was a substantial reduction in Japan’s caseload in 2017-18, the average time taken to resolve cases in 2018 increased as compared to 2016-17, which was higher than the pursued 24-month average as well. Therefore, there is a risk that post-2015 cases are not resolved within the average of 24 months.
The peer review report notes that as additional personnel have been assigned to Japan’s competent authority function in recent years and successful organizational steps have been taken to be able to increase the number of cases closed and reduce the average completion time and as Japan has provided comprehensive clarifications explaining the additional time taken to resolve some cases. The report recommends that Japan should continue to closely monitor whether the addition of new staff and the organizational steps taken will further contribute to the resolution of MAP cases in a timely, efficient and effective manner.
[C.4] Ensure staff in charge of MAP has the authority to resolve cases in accordance with the applicable tax treaty
The minimum standard requires that the staff in charge of MAP processes have the authority to resolve MAP cases in accordance with the terms of the applicable tax treaty, in particular without being dependent on the approval or the direction of the tax administration personnel who made the adjustments at issue or being influenced by considerations of the policy that the jurisdictions would like to see reflected in future amendments to the treaty.
Japan reported that staff in charge of MAP in practice operate independently and have the authority to resolve MAP cases without being dependent on the approval or direction of the tax administration personnel directly involved in the adjustment at issue. Furthermore, since only the MAP office is competent to handle and resolve MAP cases, and as this office is placed within the National Tax Agency and not within the Ministry of Finance, Japan reported that the process for negotiating MAP agreements is also not influenced by policy considerations.
[C.5] Use appropriate performance indicators for the MAP function
The minimum standard requires that jurisdictions should not use performance indicators for their competent authority functions and staff in charge of MAP processes based on the amount of sustained audit adjustments or maintaining tax revenue.
Japan has emphasized that none of the objectives for government officials relate to the amounts of sustained audit adjustments or the amount of tax revenue that is maintained. The same applies to the objectives set by the National Tax Agency for the MAP office.
[C.6] Provide transparency with respect to the position on MAP arbitration
The minimum standard states that jurisdictions should provide transparency with respect to their positions on MAP arbitration.
Japan reported that it has no domestic law limitations for including MAP arbitration in its tax treaties and that its policy is to include a mandatory and binding arbitration provision in its bilateral tax treaties. Japan’s position on MAP arbitration is included in its MAP profile published on the OECD website.
Implementation of MAP agreements
[D.1] Implement all MAP agreements
The minimum standard requires that jurisdictions should implement any agreement reached in MAP discussions, including by making appropriate adjustments to the tax assessed in transfer pricing cases.
Article 70 of the Act on General Rules for National Taxes contains Japan’s rules for amending a taxpayer’s taxable income. There are different rules for upward and downward adjustments to a taxpayer’s taxable income. Japan operates a self-assessment system for filing of tax returns and determining the amount of tax to be paid. Concerning the implementation of MAP agreements, a distinction is therefore made between the situation where the taxation subject of MAP discussions is levied by Japan or its treaty partner.
Japan reported that in the periods 1 January 2014 to 31 December 2017 and 1 January 2018 to 31 August 2019 all MAP agreements were implemented.
[D.2] Implement all MAP agreements on a timely basis
The minimum standard requires that agreements reached by competent authorities through the MAP process should be implemented on a timely basis.
Japan reported that in the periods 1 January 2014 to 31 December 2017 and 1 January 2018 to 31 August 2019 all MAP agreements were implemented on a timely basis.
[D.3] Include Article 25(2), second sentence, of the OECD Model Tax Convention in tax treaties or alternative provisions in Article 9(1) and Article 7(2)
The minimum standard requires that jurisdictions shall either: (i) in their tax treaties provide that any agreement reached through MAP shall be implemented notwithstanding any time limits in domestic law; or (ii) be willing to accept alternative treaty provisions that limit the time during which a contracting party may make an adjustment pursuant to Article 9(1) or Article 7(2), in order to avoid late adjustments with respect to which MAP relief will not be available.
Of Japan’s 71 tax treaties, 17 do not contain a provision that is equivalent to Article 25(2), second sentence, nor the alternative provisions to Article 9(1) and Article 7(2). Of these 17 treaties, 8 have been, or are expected to be, modified by the MLI to include the equivalent of Article 25(2) second sentence, and 9 will not be modified by the MLI.
The recommendation included in the peer review report is that Japan should initiate or continue bilateral negotiations to modify the treaties.
Best practice peer review reports
Each assessed jurisdiction can provide information and request feedback from peers on how it has adopted the 12 best practices contained in the Action 14 final report. Japan has provided information and requested feedback on how it has adopted best practices. In that regard, the FTA MAP Forum agreed on an optional best practices feedback form that peers have used to provide feedback on Japan’s adoption of the best practices.
Several peers provided input on Japan’s bilateral Advance Pricing Agreement (APA) program. Peers noted Japan’s well-developed bilateral APA program, Japan’s long-standing commitment to APAs and their positive experiences with Japan’s competent authority.
One peer provided input in relation to development of global awareness of the audit and examination functions. They appreciated the willingness of Japan’s competent authority to discuss the use of “reference sets” of comparable companies in cases presenting common fact patterns and transfer pricing issues.
One peer provided input on the best practice of publishing explanation of the relationship between the MAP and domestic remedies. This peer shared the view that taxpayers and competent authorities would benefit from enhanced efforts by Japan’s competent authority to provide guidance to taxpayers concerning those situations where, in its view, the application of Japan’s domestic law forestalls reliance on MAP to eliminate cases of double taxation.
Peers did not provide any feedback on the remaining best practices.
In a post-BEPS world, where multinational enterprises (MNEs) face tremendous pressures and scrutiny from tax authorities, the release of Japan’s Stage 2 peer review report represents the continued recognition and importance of the need to achieve tax certainty for cross-border transactions for MNEs. While increased scrutiny is expected to significantly increase the risk of double taxation, the fact that tax authorities may be subject to review by their peers should be seen by MNEs as a positive step to best ensure access to an effective and timely mutual agreement process.
For additional information with respect to this Alert, please contact the following:
Ernst & Young Tax Co., Tokyo