TT-514 -- Tax Crackdown Looming? Ebiz in Japan

* * * * * * * * * T E R R I E 'S T A K E * * * * * * *
A weekly roundup of news & information from Terrie Lloyd.
(http://www.terrie.com)

General Edition Sunday, Apr 19, 2009 Issue No. 514

+++ INDEX

- What's new
- News
- Candidate roundup/Vacancies
- Upcoming events
- Corrections/Feedback
- News credits

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+++ WHAT'S NEW

When the G20 met at the beginning of this month, most of us
in Japan thought it would be a ho-hum affair. The
impression was that it was yet another coordinated effort
to get governments around the world to do stimulus packages
so as to ensure that the U.S. financial implosion was
shared by all. And in so doing, the trade relationships
that have developed over the last 30 years or so would be
sustained for another 30.

However, there was one item on the agenda which is now
showing up as direct Japanese government action. This was
the issue of tax havens and how to bust them. The G20
placed a number of countries on a tax haven black list,
eventually removing Uruguay, Costa Rica, Malaysia, and the
Philippines after they subsequently committed to meet
international standards and be good tax wise.

Among those countries noted as tax havens, yet not put on
the black list, were Macau and Hong Kong, both of which
were vigorously defended by their relevant local
governments as well as China when the subject of inclusion
came up. France in particular wanted both countries named
to the black list and it took Obama's intervention to cool
down tensions between the French and Chinese. Hong Kong of
course is a natural target for the G20, given that so much
of China's trade flows through the territory, thus making
it an ideal point for companies to engage in tax-favorable
trading arrangements, transfer pricing, and straight-out
tax evasion.

The corporate tax rate in Hong Kong is 16.5% and for
individuals it is just 15%, while here in Japan for
companies the upper rate is around 45% or more (if you
consider Social Insurance as a "tax"). This fact is not
lost on Japanese companies, and it is probably no accident
that there are approximately 2,100 of them operating from
the territory, versus operating directly in China.

[Continued below...]

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[...Article continues]

In 2005, Hong Kong received US$16.9bn of Japanese
investment, the fourth highest level of foreign investment
(excluding tax havens) after China, the Netherlands, and
the U.S. Whereas in the 1980's a company incorporating in
Hong Kong would have raised a red flag to the National Tax
Agency (NTA), today so many companies operate in and out of
Hong Kong that the territory has become normalized from a
tax point of view and you hear very little about tax
evasion cases emanating from there these days.

However, it looks like that situation is about to change...

This last week, Japan announced that it would crack down on
tax evasion involving overseas tax havens, and noted that
it plans to revise or "update" tax treaties with
Switzerland and Singapore, while angling for first-time tax
treaties with locations such as Hong Kong, Monaco, and
Macao. The main objective, according to the Nikkei, is for
the NTA to gain better cooperation from the tax authorities
of those reciprocating countries, so that they can ask for
banking information and tax filings of companies that deal
with the Japanese firms under investigation. In the past
such cooperation was almost non-existent, requiring
high-level governmental requests to get it.

Compelling a bank in another country to give up customer
information is not easy. However, it's important in proving
criminal cases back here in Japan. Although the prosecution
protected the witness, a classic situation would have been
the LiveDoor case. In this, the LiveDoor CFO, Miyauchi,
admitted that he used company and CEO Horie's accounts in
both Hong Kong and Switzerland to conduct both tax evasion
and insider trading. Interestingly, in their zeal to nail
Horie, the government (i.e., including the NTA) never
sought to charge Miyauchi on these wrongdoings, perhaps
proving that getting even is sometimes more important than
collecting taxes! Who would have thought?

So just how many cases of tax evasion are there involving
Japanese companies doing business off-shore? We were unable
to come up with any recent overall numbers, however, the
trend is that both more companies are succumbing to the
need to restore profits by hiding it from the tax man, and
the Japanese National Tax Agency (NTA) is getting better at
finding those companies.

One area that the NTA is really getting its claws into is
pricing transfer tax -- the practice of a multinational
loading up a high-tax jurisdiction like Tokyo with costs,
while liberating all the profits in a low-tax jurisdiction
like Hong Kong. From July 2007 through June 2008 the NTA
issued 133 tax assessments to companies about transfer
pricing and sought adjustments and penalties, a 32%
increase over the previous fiscal year. The problem for
companies now is knowing where creativity and reality cross
over. Unfortunately there are no published guidelines on
what constitutes an objectionable transaction to the NTA,
and thus companies have to guess or use expensive
professional help to figure out what their liabilities are
going to be.

Deloitte have a page on the web on Japan-related transfer
pricing red flags, and their list reads (slightly edited):
* Transactions with related parties in low-tax jurisdictions
* Transactions involving intangible property
* Fluctuations in profits (i.e., reduced profits) in Japan
* Persistent losses in Japan
* High profits in Japan and/or abroad [Ed: not sure why
they care about high profits in Japan.]
* Changes in Transfer Pricing methodology
* Failure to submit Tax Schedule 17.3, which requires
companies to give transfer pricing methodology

As far as we can see, parts of this list apply to almost
all companies doing business here or abroad, especially
with the vagaries of the global economy at present -- so
we're not sure how the NTA is going to sift through what
has to be a huge number of companies that fall into the
"fluctuating profits" or "persistent losses" category.

The good news is that while there is a big unknown
surrounding this kind of tax, there is also a limit to the
number of tax auditors and the work they can do. From the
stats we've seen, there seems that there are only about 200
or so serious cases brought before the courts every year
(of which the international tax cases would be a very small
number), and so presumably the rest are settled in some
amicable fashion. These stats come from a presentation from
a tax professor at the National Tax College (yes there is
one!) who also consults for the NTA. As he also shows, there is
a lot more tax evasion happening here at home than anything
going on with Japanese companies overseas.

According to the good professor, in 2004, there were 210
cases of severe tax evasion -- appearing to mean there was
more than JPY100m involved, of which 152 went to court and
were charged. 100% of those charged were convicted --
perhaps not unsurprising considering Japan's legal system.
The average amount found to have been evaded was JPY133m.
In case you're interested, in order of frequency of
industry of the transgressors was: 1) Food and Beverage
Retail -- 11 cases, 2) Machinery Retail -- 8 cases, 3)
Pachinko -- 8 cases, Medical -- 8 cases, Cabaret and
Restaurant -- 7 cases, and Construction -- 5 cases. Good
old Pachinko parlors... some things never change.

It is often said that the Japanese Tax authorities are much
more reasonable than their counterparts abroad, and
providing there is a reasonable explanation, they are more
willing to listen to tax-payer mistakes and let you rectify
them. Yes, incorrect tax means penalties and embarrassment,
but it's good to know that you have to have done something
fairly serious to wind up in court, and of those convicted,
only about 5% actually did prison time.

********************

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+++ NEWS

- New Nintendo game title indicator of problems?
- Pioneering bio-med deal for U.S. company
- Subaru Stella ev due out soon
- SDF helps out Canadian ship off Somalia
- Big Hello Kitty sublicence

-> New Nintendo game title indicator of problems?

Following the recent drop in Wii hardware sales, a new Wii
title that was expected to sell in the millions has also
suffered from poor sales, leading gaming experts to wonder
if Nintendo is losing its luster. The Deca Sports 2 sequel
game sold just 2,000 copies on its first day, far less than
the 30,000 sold when the original version was released.
Nintendo's stock has fallen 7.5%, and the Impress Watch
newsletter is apparently saying that they are expecting
Nintendo to experience a slowdown in the near future,
unless of course they have some new and impressive Wii
replacement product to release at the E3 show in June this
year. (Source: TT commentary from escapistmagazine.com, Apr
16, 2009)

http://tinyurl.com/daezpt

-> Pioneering bio-med deal for U.S. company

A Massachusetts company called BioSphere Medical has just
signed a distribution deal with pharma firm Nippon Kayaku,
to distribute its unique treatment which involves the
insertion of polymer microspheres to starve fibroids and
cancerous growths of blood supply and thus cause them to
shrink or die. Although BioSphere's U.S. doctor base mainly
uses the technology to treat uterine fibroids and vascular
tumors, in Japan the primary target will be the treatment
of liver cancer. There were about 75,000 transcatheter
arterial embolizations performed in Japan in 2008 and most
if not all where reimbursed by the government. ***Ed: Since
BioSphere's treatment is much quicker and cheaper, the
partners think they have a good chance to pulling in most
of the liver cancer treatment market.** BioSphere gets
US$1m up front, and another US$3m once the product is
registered and starts to sell. We presume there are also
ongoing royalties on top of that. (Source: TT commentary
from smalltimes.com, Apr 16, 2009)

http://tinyurl.com/ctg5b4

-> Subaru Stella ev due out soon

The second Japanese-made plug-in electric vehicle due out
this year is from Subaru. Although the company has kept to
its promised schedule of releasing the Stella to buyers
from June, in fact, it has announced that only 15 vehicles
will actually be available -- and these will be operated by
the government for verification testing. Apparently the
actual consumer version of the product will be available
later this year. Fuji Heavy Industries says it hopes to
deliver about 170 units through to next March. No pricing
has been set yet. ***Ed: OK, so it's not going to be cheap,
then. Shame. Maybe we'll all end up waiting for the Nissan
Cube EV after all.** (Source: TT commentary from
edmunds.com, Apr 17, 2009)

http://www.edmunds.com/insideline/do/News/articleId=146270#3

-> SDF helps out Canadian ship off Somalia

Although the SDF sent their two destroyers to the Middle
East to protect Japanese ships and those carrying cargo
bound for or coming from Japan, in fact they have been
responding to distress calls from other nations as well.
The latest event was when they dispatched a helicopter to
ward off a suspicious vessel attempting to approach a
Canadian merchant ship last week. Last month, the Japanese
also assisted ships flying Singapore and Maltese flags.
***Ed: Certainly this is a great way for the Japanese to
earn global goodwill.** (Source: TT commentary from
nikkei.co.jp, Apr 19, 2009)

http://www.nni.nikkei.co.jp/e/ac/tnks/Nni20090418D18JF464.htm

-> Big Hello Kitty sublicence

Sanrio appears to be hitting a great groove in licencing
out its Hello Kitty character. Apparently the company has
just signed a deal with the world's 2nd biggest apparel
retailer, Industria de Diseno Textil of Spain, which also
operates the Zara brand. Hello Kitty will appear from this
month in over 1,200 Zara stores around Europe. Licencing
accounts for about 30% of Sanrio's income, or about
JPY23bn. ***Ed: Did you know that Hello Kitty was invented
by Sanrio staff member Ikuko Shimizu in 1974? She (Kitty)
first appeared on a vinyl coin purse sold in 1975.***
(Source: TT commentary from nikkei.co.jp, Apr 18, 2009)

http://www.nni.nikkei.co.jp/e/ac/tnks/Nni20090417D17JFA11.htm

NOTE: Broken links
Many online news sources remove their articles after just a
few days of posting them, thus breaking our links -- we
apologize for the inconvenience.

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+++ CORRECTIONS/FEEDBACK

In this section we run comments and corrections submitted
by readers. We encourage you to spot our mistakes and
amplify our points, by email, to editors@terrie.com.

=> In TT513, we wrote about the sale of Oak Lawn Marketing,
a fantastic success story for foreign entrepreneurs living
and building a business in Japan. We assumed that Robert
Roche, the founder, was leaving the firm, but as we heard
back, that's not quite the case.

--> Feedback: Robert Roche is still an outside director and
chairman of Oak Lawn Marketing, as well as remaining on as
the second largest shareholder after DoCoMo. So while he
certainly sold shares, he by no means fully exited from the
firm. Rather, Robert will continue to be very much
involved, particularly on the strategic growth and
investment side, which is what he is exceptionally good at
and where his main interests are.

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+++ ABOUT US

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Written by: Terrie Lloyd (terrie.lloyd@japaninc.com)

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