Japan Tax Bulletin
Revision of the Administrative Guidelines on Operation of Transfer Pricing

July 2023
On June 10, 2022, the National Tax Agency revised theAdministrative Guidelines on Operation of Transfer Pricing.
The revision is intended to clarify Japan's transfer pricing tax
treatment of related party transactions in light of the revisionof Chapter Ⅷ (Cost contribution arrangement) and Chapter
X (Transfer pricing aspects of financial transactions) of theOECD Transfer Pricing Guidelines for Multinational
Enterprises and Tax Administrations.
In particular, the revised Japanese Administrative Guidelines
on financial transactions will replace the previous Japan-specificprovisions for financial transactions with the global standard(based on OECD transfer pricing guidelines) provisions. This
revision will lead to the start of full-fledged scale transfer
pricing taxation enforcement for financial transactions betweena corporate taxpayer and foreign related parties, and will beapplied to investigations for fiscal years beginning on or after
July 1, 2022.
First of all, the "Administrative guideline 3-7; Particulars toNote when conducting investigations regarding financialtransactions" has been revised to provide basic ideas on
considerations regarding money loan transactions, debt
guarantee consignment transactions, and cash pooling.
Among the revisions, this commentary focuses on transfer
pricing risks related to interest rate setting in the case of loans
to foreign affiliates, considerations for debt guarantee
consignment transactions, and allocation of mutual benefits incash pooling in the "Administrative Guideline 3-8; Particulars toNote when conducting an arm's length price study on financialtransactions" .
The amendment removes the use of methods which weretreated as methods equivalent to Comparable Uncontrolled
Price Method in the previous Administrative Guidelines when
determining arm’s length interest rates in monetary loantransactions with made to foreign affiliates. Prior to the revision,
it was clearly stated that for money loan transactions, theapplication of a method equivalent to Comparable
Uncontrolled Price Method had been assumed as a matter ofcourse, and the application of the comparable transaction isexamined in the order of the borrower's funding interest rates
from third party financial institutions, then the lender's funding
interest rates from third party financial institutions and finally

the investment interest rate on government bonds and otherinterest rates. In the revised Administrative Guidelines, the"most appropriate method" prescribed in Article 66-4,
paragraph (2) of the Act on Special Measures Concerning
Taxation need to be selected in calculating an arm’s length pricefor financial transactions.
Specifically, it can be interpreted that the creditworthiness ofthe borrowers is assessed, comparable transactions are thenselected based on this creditworthiness, and then the arm’s
length interest rates are calculated.
Since there are very few cases where there are comparable
transactions of the same timing and duration in the same
currency, it is expected that the calculation of the rate will
require some adjustments to the terms, currency, other factors
in which the financial transaction is executed.
There was no clear provision for debt guarantee transactionsin the previous Administrative Guidelines prior to the revision.
When a Japanese parent company provides a debt guarantee tothe third party financial institutions for the loan that foreign
affiliates obtained from the financial institutions, the foreign
affiliates pay guarantee fees to the parent company. The
guarantee fees must be set at a rate consistent with the arm'slength principle.
The new cash pooling rules also require careful attention to theallocation of common intra-group benefits among parties
involved, and broad conditions and circumstances need to betaken into account.
In the Reference Case Studies on Application of Transfer
Pricing Taxation”, case study 4 was revised in terms of loantransactions and a new case study on consignment of debt
guarantees has been added to reflect this revision. A new casestudy on cash pooling has also been added to case study 7 toreflect this revision.
The amendments were divided and indicated in the following
sections:
3-8(1) Use of market interest rates, etc.
It is now clearly stated that so-called "market interest rates" areto be used for comparative transactions.

3-8(2) Policies on credit rating
Credit ratings can be used to evaluate the creditworthiness ofborrowers, and specifically, they should be equivalent to ratings
published by external rating agencies. Superior credit ratingscannot be guaranteed because the borrower solely belongs to a
multinational enterprise group. Meanwhile, it is also stated thatincidental benefits based on belonging to a multinational
enterprise group should be considered.
3-8(3) and (4) Use of risk-free interest rate
When lenders do not have risk management functions nor
perform decision-making functions in lending, notionaltransactions using risk-free interest rates such as swap rates orgovernment bonds may be used as comparable transactions.
3-8(5) Use of interest rates estimated by financial institutions
The standard also states that interest rate quotations obtained
from financial institutions do not correspond to market interest
rates. Therefore, interest rates estimated by financial institutions
cannot be used as comparable transactions in calculating arm's
length prices. The new Administrative Guidelines, however,clearly states that this fact alone does not constitute transfer
pricing taxation.
3-8(6) Calculation methods of debt guarantee fees
The "yield approach," the "cost approach," and the "credit
default swap approach" are exemplified as approaches tocalculate the debt guarantee fees.
3-8(7) Views on allocation methods of common benefits
It is now clarified that common benefits arising from cash
pooling should be allocated to the parent companies and foreign
related parties in accordance with the arm's length principle.
It may be said that the treatment of interest on loans to foreign
affiliates in Japan prior to the revision was quite taxpayerfriendly. However, the amendments require a new type ofanalysis for setting inter-firm interest rates between foreign
related parties, and new calculation approaches might also berequired for debt guarantee transactions to set the debt
guarantee rates or fees in accordance with the arm's lengthprinciple. For loans to loss-making foreign affiliates that havenot been performing well, higher interest rates may be requiredcompared to companies with excellent business performance. Achange of mindset might be required when analyzing theinterest rates setting, and practical responses and approacheswith consideration of changing the loan contracts with theforeign affiliate might be needed.
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