In a decision issued on March 10, 2022 the Tokyo High Court upheld a 2020 decision from the district court and ruled mostly in favour of NGK INSULTATORS, LTD. in an appeal filed against a transfer pricing correction issued in 2012 by the Japanese tax authorities.
The case
At issue was whether the royalties received by NGK Insulators, the HQ of a Japanese group, from its Polish subsidiary, were lower than the arm’s length price.
Due to the tightening of European emission regulations, only two companies at the European market, the Polish subsidiary and IBIDEN (Ibigawa Electric Power Co., Ltd.), were able to provide parts that complied with those regulations. This resulted in an oligopoly situation and excessive profits in the subsidiary.
In regards of the residual profits the tax authority had argued that the split should be based on NGK Insulators’ research and development costs on the one side and the Polish subsidiary specific departmental research and development costs the other side.
Judgement of the Court
The court adopted the tax authorities’ method for calculating the basic profit, but decided that the split of residual profits should be based on NGK Insulators’ research and development costs on the one side and the Polish subsidiary specific departmental research and development costs + depreciation costs on the other side.
The 2012 tax assessment resulted in additional taxes in an amount of yen 6.2 billion (USD 48 million) for FY 2007-2010, but as a result of the judgment approximately 5.8 billion yen (USD 45 million) in corporate taxes paid by NGK following the tax assessment will now be refunded.
JAPAN NGK Insulators March 2022
The NTA applies residual profit split method for determination of arm’s length of the transaction of royalty received by a Japanese parent from its subsidiary located in a foreign jurisdiction. The methodology is adopted when the subsidiary earns a profit more than normal. There might be local factors for earning more than normal profits by the subsidiary as in this case.
The determination of residual profit and division of the same based on intangibles contributed by both entities to the transaction is a difficult exercise. It is not always that the adopted method results into reliable and realistic outcome.