Tax Controversy Trends amid the COVID-19 Pandemic

Tax audits amid COVID-19 pandemic

The number of field audits of corporate taxpayers in FY 2020 dropped by 22.9% from FY 2019, an apparent impact of the COVID-19 pandemic. As COVID-19 started to spread across Japan from January 2020 and the state of emergency was declared in April 2020, Japan’s tax authorities refrained from doing field audits in the first half of 2020. This helps explain why the number of field audits dropped.

In addition, the total amount of income found by tax audits of corporations in FY 2020 decreased by 43.5% from FY 2019, and the total amount of corporation tax imposed by tax audits in FY 2020 decreased by 15.4%. These decreases are considered to be due to the drop in the number of field audits in FY 2020 largely as a result of the COVID-19 pandemic.

Despite these statistics, the amount of corporation tax imposed by tax audits per case in FY 2020 increased by 9.7% from FY 2019. This may reflect the trend that the tax authorities now tend to focus more on cases where a taxpayer’s misconduct is suspected and the tax amount at stake is large, by systematically selecting target cases through the use of a database of taxpayer information. In addition, the tax authorities continue to focus on international transactions, actively examining issues regarding Japan’s controlled foreign company tax regime and transfer pricing, which tend to be unchanged by the COVID-19 pandemic.

With respect to individual taxpayers, the number of field audits in FY 2020 dropped by 18.9% from FY 2019, and the total amount of individual income found by tax audits in FY 2020 decreased by 6.4%. These decreases are considered to be due to the COVID-19 pandemic.

However, the total amount of individual income tax imposed by tax audits in FY 2020 increased by 3.2% from FY 2019, with that per case jumping by 26.7% from FY 2019. This may be mainly because the tax authorities tend to focus on wealthy individuals, in particular those having international investments, frequently utilizing information obtained from foreign counterparts under the Common Reporting Standard (CRS) regime. This trend has continued regardless of the COVID-19 pandemic.

Tax appeals and litigation amid COVID-19 pandemic

The number of tax appeals initiated by taxpayers to the National Tax Tribunal in FY 2020 dropped by 17.6%, and the number of tax appeals completed in FY 2020 decreased by 2.6% from FY 2019. These numbers, however, are not very different from the previous five-year average, and so may not be due to the COVID-19 pandemic. On the other hand, the number of successful tax appeals to the National Tax Tribunal in FY 2020 jumped by 73.6% from FY 2019, such that the successful tax appeal ratio for taxpayers in FY 2020 increased by 78.4%.

The year over year changes with respect to tax litigation are larger. Tax litigation initiated by taxpayers in FY 2020 increased by 23.2% from FY 2019, and completed litigation in FY 2020 increased by 22.0%. Further, the number of cases successfully litigated in FY 2020 jumped by 250.0%, such that the successful tax litigation ratio for taxpayers increased by 185.3% from FY 2019.

These positive changes imply that tax appeals and litigation have not been negatively affected by the COVID-19 pandemic. Although Japan used to be a country where tax controversy was not prevalent, the fact that there are at least 375 successful tax appeal cases and 21 successful tax litigation cases gives a sense of assurance to a taxpayer facing an erroneous assessment notice and seeking for it to be overturned through one of these processes.

The taxpayer success ratio in FY 2020 increased from FY 2019 but is still lower compared with most other countries. However, this ratio itself is not a decisive factor for determining whether a country executes tax laws fairly, as it would be expected to be lower if most assessment notices challenged by taxpayers are in fact issued based on accurate facts in accordance with tax laws. Rather, what matters is whether an erroneous assessment notice is actually overturned through tax appeals or litigation.