June 30, 2017
The Tax Treaties, Transfer Pricing and Financial Transactions Division
Centre for Tax Policy and Administration
The Organisation for Economic Co-operation and Development

International Tax Committee
Japan Machinery Center for Trade and Investment

Comments on the Discussion Draft of “Implementation Guidanceon Hard-to-Value Intangibles”

Japan Machinery Center for Trade and Investment (“JMC”) is a non-profit organizationthat was established in 1952 to promote sound development of foreign trade relating tomachinery in Japan by multi-national entities (“MNE”), and includes the major machinery
manufacturers, trading companies, and engineering companies. To enhance the international
competitive strength of the machinery industry in Japan, an international tax committee wasestablished in beginning of 1990 to study and encourage the developments of domestic andforeign international taxation systems.
URL：http://www.jmcti.org/jmchomepage/english/index.htm
Transfer pricing issues of intangibles discussed in BEPS Action 8 have very important
implications on the business of the member companies of the JMC, which deal in export andinvestment of machinery equipment including high-tech machinery. Thus, in addition to
fully supporting the comments by KEIDANREN to the OECD, we decided to submit our own
comments, which particularly related to the circumstances of the JMC member companies.

<General Comments>
The discussion draft provides some guidance for tax administrations regarding thetreatment of hard-to-value intangibles (HTVI) with a view to tackling information asymmetry
between the taxpayer and the tax administration. We hope that, based on this guidance,
common understanding among tax administrations of different countries is promoted.
The discussion draft discusses the possibility of considering the ex post outcome aspresumptive evidence on the appropriateness of the ex ante pricing arrangements.

While thetaxation based on the ex post outcome only is not permitted, some examples are indicatedregarding the estimates based on the ex post outcomes in case taxpayers cannot provide
explanation on the attainability and foreseeability at the time of the initial valuation. Fromthe viewpoint of taxpayers, it is important to have a clear understanding on the proof ofattainability and foreseeability.

However, as no clear guidance on the evidence for that proof

is indicated, taxpayers can be in trouble in the course of actual business. We believe thatfurther guidance has to be indicated clearly. That point is also important for avoiding too
broad interpretation by the tax administration.
It is likely that different tax administrations have different views on the ex post
adjustment, and taxpayers are concerned that it might cause the double taxation.

The

approach of the discussion draft should be implemented after the effective mutual agreement
procedure is established and the international agreement on the dispute resolution mechanism
is attained, as mentioned in paragraph 31-32.
The discussion draft provides some examples, making reference to the condition that theapproach to HTVI (“commensurate with income standard” in the subsequent part of ourcomment) is not applied. Thus, it can be useful for understanding the operation mechanismof “commensurate with income standard”.
We want to have clearer explanation on the following point:
As indicated in paragraph 6.193 of the Guidelines, “commensurate with income standard” isnot applied when the taxpayer provides:
1. Details of the ex ante projections used at the time of the transfer to determine the pricing
arrangements, including how risks were accounted for in calculations to determine theprice (e.g. probability-weighted), and the appropriateness of its consideration ofreasonably foreseeable events and other risks, and the probability of occurrence; and,2. Reliable evidence that any significant difference between the financial projections andactual outcomes is due to: a) unforeseeable developments or events occurring after thedetermination of the price that could not have been anticipated by the associatedenterprises at the time of the transaction; or b) the playing out of probability of occurrenceof foreseeable outcomes, and that these probabilities were not significantly overestimated2

or underestimated at the time of the transaction.
In the examples in the discussion draft, the operation mechanism of “commensurate withincome standard” is explained on the presumption that taxpayers cannot explain theunforeseeability at the time of the transaction. In practice, even if the taxpayer explains theunforeseeability, the tax administration might figure that the explanation of the taxpayer is notreliable.

We hope that the guidance is provided in the examples on the reason of thejudgement by the tax administration concerning the explanation by the taxpayer and on theconcrete conditions required for the sufficient proof by the taxpayer which can be judged as
being reliable by the tax administration.
<Introduction>
1. We appreciate the efforts made by the party concerned in that the implementation
guidance is arranged within the framework of the arm’s length principle. At the sametime, we would like to reassure that the arm’s length principle is fully esteemed. We
consider that it should be clearly indicated that the application of “commensurate withincome standard” is limited to the cases where the pricing of intangibles between
associated enterprises deviates from the arm’s length principle.
2. Paragraph 6.192 of Guidelines refers to “the determination of the arm’s lengtharrangements, including any contingent pricing arrangements that would have been madebetween independent enterprises at the time of the transaction”.

However, contingent

pricing arrangements are not usually used, or only used very rarely in transferring
intangibles between independent enterprises.

Because ex post adjustment of prices ofintangibles is seldom implemented between independent enterprises, the scope of theapplication of “commensurate with income standard” on associated enterprises should belimited strictly.
3. In the examples in the discussion draft, a pharmaceutical compound is illustrated.
However, use of a pharmaceutical compound does not necessarily seem be useful as a
guidance for machinery industries where a lot of patents and other intangibles are used for
one product.
4. We understand that one product is protected by one or several patents in the case ofpharmaceutical compound. In the case of machinery, including electric or transportation
machinery, thousands or even ten thousands of patents are used for one product. When
only one or several of these numerous patents are transferred, it is virtually impossible toevaluate the profit produced by the transferred patents.
5. Therefore, we think that the application of “commensurate with income standard” should
be limited to the following cases of large-scale or important transfers of intangibles: (i)3

So many patents for one product are transferred to overseas associated enterprises that thetransfer of these patents has an important influence on the sales of that product. (ii) The
scope of regions where the transferred patents are protected is so wide that the amount ofsales of the product using the patents in these regions is large and important. (For example,
while the parent company keeps the right to sell the product within the resident country of
the company, the right to use the patents in any other counties or regions is transferred toan overseas associated enterprise.)
6. In other words, “commensurate with income standard” should not be applied in thefollowing cases unless they involve large scale and important transactions indicated in 5.
above.

Instead, the pricing based the cost of research and development for the invention(cost plus method) should be admitted. (i) The case in which the inventions by overseas
subsidiaries on consignment development are transferred to the parent company based on
the policy to concentrate intellectual property to the parent company. (ii) The case inwhich the parent company buys the patent developed independently by an overseas
subsidiary.
<Example 1>
1.

In Example 1, the reason why the tax administration corrects the price from 700 to 1,000
is the sales are realized earlier than anticipated, but it seems that this fact alone is not
sufficient to conclude that the price should be corrected upwards retroactively. It might
be the case that the efforts by the patent buyer made the earlier sales possible.

Moreexplanation is needed on the conditions of this example.
2. If the Phase III trial was completed earlier because of the efforts by the company thatpurchased the patent, it is more reasonable from an economic point of view to allocate theincreased profits to that purchasing company.
3. Paragraph 19 (and also 24) refers to the explanation by the taxpayer on theproperly taking account of the possibility at its original valuation and on theunforeseeability of the development. We would like you to provide us with clearer
guidance about the expected level of proof.

<Example 2>
1. In Example 2, the timing of correcting the price does not retroact to the time of transaction(Year 0) as in Example 1, but only to Year 3. However, there is no essential difference
between them because the price correction retroact to previous years from the audit period
in both examples.
2. “The successful completion of development phases or regulatory approvals in a particular4

market” (in paragraph 28) might due to the efforts made by company that purchased thepatent. Therefore, it is not reasonable to conclude that the price should be corrected
upwards retroactively based on that fact only.

More explanation on the factual

background is needed.
3. Paragraph 28 reads that “this paragraph in not intended, and does not, imply thatmodification of the payment form can only occur when there is a common practice in therelevant business sector regarding the form of payment for the transfer of a particular typeof intangible.” However, we cannot agree to the notion that the concept of “additionalcontingent payment” is applied regardless of the common business practice.
4. Example 2 seems to imply that the tax administration can construct a contract that include
contingent payment clause, which did not exist in the original contract, and can tax at thetime of contingent payment, regardless of the actual price setting practice in the relevantbusiness sector. To dare to take that approach, although the same result can be achievedby taxing at the time of the initial transaction, seems to imply to virtually abolish thestatute of limitation and to come close to introduce the income recalculation after the all
actual data are available. From the viewpoint of taxpayers, the statute of limitation isuseful in mitigating the tax risk and constructing a contract by the tax administration goes
too far.
<Example 3>
1. In deciding the royalty payment rate during the contract period, it might be common in thepharmaceutical patent to determine the rate by dividing the value of the intangible (700)by the present value of sales over the contact period (3,500); in this example,
700/3,500=20%.

However, this method is not generally used in the machinery industry,where so many patents are used for one product.
2. In the machinery industry, it is next to impossible and unrealistic to evaluate each patent
one by one.

Thus, in many cases, low royalty rate as a ratio of sales of patented products

or small amount of royalty per one unit of patented products are set in the pricenegotiation between the licenser and the licensee, taking the “industry standard” intoaccount.

In these cases, it is virtually impossible to reevaluate each patent even ex post.

Thus, it seems to be difficult for the tax administration to implement transfer pricing
taxation by correcting the royalty rate ex post.
3. However, to the case of large-scale or important transactions of intangibles as explained in<Introduction>5, the approach presented in Example 3 might be applicable. Therefore,in examining the applicability of “commensurate with income standard”, the scope should
be limited to these cases as indicated in <Introduction> 5.

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4. Example 3 illustrates the situation where the received royalty is corrected upwards in casethe income or cash flow increase more than expected and that the taxpayer cannot
demonstrate that it was unforeseeable. We wonder if there can be a case in which royalty
payment is corrected downward (denial of inclusion in expenses of the royalty payment)
when the income or cash flow is lower than expected in the application of “commensuratewith income standard”.
<HTVI and the Mutual Agreement Procedure>
1. Whether “Commensurate with income standard”, which is to be applied to “hard-to-value”
intangibles, works in practice or not critically depends on the effective function of theadjustment of double taxation through the mutual agreement procedure. Therefore, theimportance of the effective function of the mutual agreement procedure cannot beemphasized too much.
2. From the view point of taxpayers, we request that the tax administration, which is to start
to apply transfer pricing taxation based on “commensurate with income standard”, goes
into the mutual agreement procedure with the other tax administration and that the upward
correction by the tax administration is implemented simultaneously with the downward
correction by the other tax administration, after the agreement is reached between these
tax administrations to avoid the double taxation.
3. The discussion draft does not examine the relationship between “commensurate withincome standard” and mutual agreement procedure in details, and indicates that this issue
is to be discussed in the framework of BEPS Action 14.

We hope that the tax

administration which applies transfer pricing taxation based on “commensurate withincome standard” is strongly requested to resolve the double taxation issue, without delay,
through the effective mutual agreement procedure.
4. In case the implementation guidance on “commensurate with income standard” ofhard-to-value intangibles are published as the final report, the double taxation adjustment
through the mutual agreement procedure should be included in the final report as a set of
the implementation guidance.
5. On the adjustment of double taxation through the mutual agreement procedure should
become effective as the binding implementation guidance, even if it is not a part of theGuidelines itself. Otherwise, we are concerned that the risk of double taxation might
further increase than before

6The topic discussed in the discussion draft is very relevant and important for many
Japanese exporting companies, and the JMC would like to thank the OECD for providing uswith the opportunity to comment on the discussion draft.

Japan Machinery Center for Trade and Investment
Kikai-Shinko Kaikan
3-5-8 Shiba Koen, Minato-ku, Tokyo 105-0011, JAPAN
Tel: +81-3-3431-9348 / Fax: +81-3-3436-6455
E-Mail: taniguchi@jmcti.or.jp / tanii@jmcti.or.jp

7Japan Machinery Center for Trade and Investment
International Tax Committee
Member Companies

Chair : Canon Inc.
Vice Chair : Hitachi, Ltd.
Committee members as follows ;Itochu CorporationKawasaki Heavy Industries, Ltd.
KUBOTA Corporation
Komatsu Limited
Sharp Corporation
SINFONIA TECHNOLOGY CO., LTD.
Sumitomo Corporation
Seiko Epson Corporation
Sony Corporation
Toshiba Corporation
Nikon Corporation
NSK Ltd.
NEC Corporation
Pioneer Corporation
Panasonic Corporation
Fujitsu Limited
Fujitsu General Limited
Marubeni Corporation
Mitsubishi Heavy Industries, Ltd.
Mitsubishi Electric Corporation

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