The Tokyo Regional Taxation Bureau (TRTB) decided that HP Japan had not declared ¥47 billion in taxable income between 2004 and 2006 which it had transferred to its US parent for administration and human resources services , Kota Funahashi and Nobuyoshi Nakamura reported in the Asahi Shimbun newspaper reported on August 11

“The Tokyo Regional Taxation Bureau (TRTB) pointed out that it is not clear what services were provided for these payments and determined that these payments cannot be deemed to be consideration for services by the US parent company,” said Akihiro Hironaka, a tax partner at Nishimura & Asahi.

As such, the TRTB treated the payments as donations and ordered HP Japan to pay taxes on them. Donations from one company to another within the same group are not exempt from taxation.

Complicating matters, the money was routed through a Swiss subsidiary. Switzerland is widely considered to be a tax haven by non-governmental organisations.

“It is possible that the authorities thought that the payments were made to reduce taxable income in Japan,” said Yushi Hegawa, a tax partner at Nagashima Ohno & Tsunematsu.

While the tax authorities have chosen to treat HP Japan’s payments as a donations issue, advisers note a strong transfer pricing element.

This is absolutely a transfer pricing issue, but the assement was made using the donations clause under Japan's rules,” said Kai Hielscher, head of transfer pricing at Ernst & Young in Japan. “We have seen the tax authorities make such assessments in the past and argue that they are not transfer pricing cases. By global standards, the cases are clearly transfer pricing cases, and there are instances where such cases have been resolved from double taxation through treaty procedures and analyses normally used for transfer pricing cases.”

Hegawa speculated that the authorities may have chosen to treat this as a donations issue because such cases are easier to win than transfer pricing ones, which give companies the opportunity to appeal on the grounds of double taxation agreements.

Advisers are hedging their bets as to whether an appeal by HP Japan will be successful.

“HP has centralised its worldwide administration function, such as management of human resources, in the US since 2005,” said Eiki Kawakami, head of tax at Kojima Law Offices - Taxand. “Whether HP stands a good chance [in their appeal] or not depends on how it can substantiate the cost incurred in the US.”

Hironaka notes that a series of large disputes have recently been reported in Japan involving information technology companies such as IBM, Yahoo and HP Japan.

Japan’s high corporate tax rate, which stands at 30%, has made the authorities increasingly wary of income being shifted to lower tax jurisdictions.

“In the 2009 tax reform, 95% of the dividends from foreign subsidiaries have become exempt from Japanese tax, and it is a natural response for the Japanese tax authorities to enforce tax law more strictly to avoid illegitimate transfers of income from Japan to foreign countries,” said Hironaka.

Advisers believe that the Japanese tax authorities have become more aggressive about international taxation.
 
“It seems that the Japanese tax authorities have become remarkably aggressive these days in the area of international tax, including transfer pricing,” said Kawakami.