Archive 09
Tax ruling involving Amazon illustrates problem common to US businesses operating in Japan |
| 10 August, 2009 - Permanent establishment and Transfer Pricing issues highlight need for clarity between "cost-plus" and "buy-sell" entities A recent tax ruling involving high profile Amazon illustrates a problem common to US businesses operating in Japan. The Permanent Establishment (PE) and Transfer Pricing issues raised highlight the need for all US businesses to analyze their own "cost-plus" or "buy-sell" entity models. High Street Partners has prepared the following document and recommendations for clients operating in Japan. Background In July 2009, the Tokyo Regional Taxation Bureau concluded that Amazon.com had underpaid local income taxes on sales to customers in Japan, and assessed the company with a nearly $120M charge, related to the tax years 2003 through 2005. The issue arises from the fact that every time Japanese customers purchase books and other products from Amazon’s Japanese website, the sales revenue and related income are booked and taxed completely in the US. Although Amazon has local employees working for either of two subsidiary companies in Japan, neither of these local entities have been involved in the sales transactions with Japanese customers. Instead, the local subsidiaries, focused on sales operations and distribution, have been remunerated by the US parent on a “cost-plus” basis for these support services, versus setting either of them up under a “buy-sell” model which, depending on the transfer pricing position taken, would have left at least some level of taxable income related to actual customer sales eligible for taxation in Japan. While Amazon is currently in negotiations with the Japanese tax authorities to decrease or even eliminate the amount asserted, many experts believe that their prospects for success are bleak. Japan has long been known as one of the more aggressive countries when it comes to asserting that a cost-plus model is not appropriate once in-country operations have matured, especially where there is a meaningful level of sales activity to customers in Japan. In the Amazon decision, the authorities concluded that since computers at the distribution center were supplied by the US affiliate booking the sales to local customers, that permission from the affiliate was required before plant design changes could be made, and because e-mail instructions were made by the affiliate to the local staff, that the Japanese distribution company is in effect a branch of the US sales affiliate. Impact of Japan’s Buy-Sell assertion on HSP Clients For many HSP clients, the establishment of operations in Japan via a cost-plus “Kabushiki Kaisha” (or “KK”) support subsidiary is the preferred and appropriate approach for those just starting out. However, where after one or two years this cost-plus structure has not been changed, and where meaningful sales to local customers have been generated or are expected, there is absolutely a risk that the local tax authorities could challenge the propriety of not utilizing a buy-sell structure, as they did with Amazon. This risk needs to be anticipated and addressed in order to avoid an unexpected, and potentially significant, adverse tax liability. Suggested action HSP clients with employees in Japan who are using a cost-plus model should routinely, on at least an annual basis, refresh their analysis for whether a buy-sell approach would be more appropriate. This is especially true where sales revenues to customers in Japan are in excess of $1.0M annually. This analysis should include the participation of the international tax experts who advise the company on such matters, as well as the company’s auditors to the degree that there could be FIN 48 or deferred tax valuation and disclosure ramifications. |
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