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Tax Compliance

Katsuhiko Sakai
Professor, Faculty of Commerce, Chuo University
Areas of Specialization: Tax Law and Tax Accounting

This work was supported by JSPS KAKENHI Grant Number 15K03220. (Public Relations Office)

1. Introduction: Awareness of corporations and citizens in regards to compliance with tax law

As awareness is being raised towards corporate compliance, discussion regarding corporate governance has truly blossomed. Without a doubt, the idea that legal compliance will lead to enhanced corporate value will attract even greater attention in the future.

However, among laws which are discussed in the same vein of legal compliance, how much emphasis is placed on tax law? For fields such as those related to the Companies Act, the Financial Instruments and Exchange Act, the Antimonopoly Act, and the consumer laws, there is a high level of legal compliance realized through internal controls. However, the same awareness does not exist for tax law.

Every day, there are news reports regarding tax evasion and unreported income by corporations. However, for the majority of such incidents indicated by the tax authority, a spokesperson for the company involved will make a statement such as “we have finished amending our tax statements in accordance with indications from authorities, and have paid the required tax” or “although we had a different opinion from tax authorities regarding the indicated items, we have implemented processing necessary for correction.” Upon making such comments, it seems that the companies manage to avoid any problems. In my view, I have almost never heard of any cases in which shareholders expressed strong anger at violation of tax law by a corporation and ultimately forced management to resign. Unreported income by politicians is one case in which anger is expressed by the general public; but even so, such scandals hardly ever mark the end of a political career. Considering diatribe against politicians at least temporarily in case of violation of the Political Funds Control Act, this is something that should be addressed immediately.

With regard to other countries, on the other hand, I’m sure that you have heard of how citizens (consumers) boycotted Starbucks after the company was accused of large-scale tax avoidance, although the accusations never escalated to full-scale tax evasion. Tax evasion is a clear violation of tax law, while tax avoidance cannot always be said to constitute a violation. Nevertheless, attention must be given to how citizens are taking action against tax avoidance. Moreover, media reports on tax avoidance by Google, resulted in the creation of what is known as the Google tax, a tax law which applies to multi-national corporations that conduct advertising businesses via the internet. Furthermore, David Cameron (former Prime Minister of the UK) and other people who had their name listed in the Panama Papers have resigned. Compared to the situations in other countries, Japanese citizens have a very low level of awareness towards tax law compliance.

The tax environment is becoming increasingly complex due to factors such as corporate internationalization and implementation of ITC, increasing the difficulty of tax investigation. Furthermore, due to personnel limitations at tax authorities, it is impossible to secure the required number of investigation days or to keep the number of investigations being started at the current level. In response, recent steps have been taken to enhance the taxpaying environment. For example, an additional tax system as penalty have been strengthened and requirements for providing tax information have been expanded. Put simply, attempts are being made to maintain appropriate reporting through deterrence and collection of materials.

In that respect, the National Tax Agency of Japan is showing interest in fostering compliance awareness of corporations. Recently, the tax agency implemented a project for corporate governance for taxes. The agency is also preparing a system which grants benefits such as exemption to tax audits for corporations which are recognized as having constructed corporate governance in relation to taxes.

2. Corporate governance for taxes as espoused by the National Tax Agency

The National Tax Agency 1) evaluates corporate governance systems for taxes at corporations, and then 2) based on the results of that evaluation, 3) holds meetings with top executives; 4) based on the results of those meetings, if it is judged that the condition of corporate governance for taxes is favorable, the investigation did not indicate significant or malicious items requiring correction, and there is a low need for tax audits, 5) urges the corporation to engage in voluntary disclosure of transactions, etc. for which, generally speaking, there is a high possibility of a difference of opinion with the tax authorities (hereinafter referred to as “voluntary disclosure”), and 6) extends the interval until the next tax audit based on the condition that the tax agency can confirm appropriate processing for said voluntary disclosure.

During this process, when the tax authorities hold meetings with top executives of corporations which have been judged as having favorable conditions for corporate governance for taxes, agency officials seek to obtain agreement for voluntary disclosure as a condition for extending the interval of tax audits. Voluntary disclosure is performed to prevent the administrative load of audits from becoming overwhelming as a result of extending the interval of auditing. If confirmation by the tax authority indicates a mistake in tax processing, voluntary correction is requested in the form of administrative guidance. Corporations which agree to voluntary disclosure (corporations eligible for extensions) receive an extension for the next audit which is calculated by adding one additional year to the interval from the previous audit to the current audit. This treatment just recently came into effect on July 1, 2016.

If such programs take root, the perspective of corporate governance for taxes at corporations will be shared through general society, and there will most likely be a change in the way in which corporate tax compliance is viewed by shareholders. In other words, if an illegal item is indicated by a tax audit and a large amount of additional tax or overdue tax is charged to a corporation, shareholders will hold management responsible for negative effects such as excessive penalties which should have been avoided and a decline in corporate image. If this happens, corporations will no longer be able to salvage the situation simply by making comments like “although we had a different opinion from tax authorities regarding the indicated items, we have implemented processing necessary for correction.”

3. Tax compliance and corporate social responsibility

If a corporation is notified of an illegal item discovered during a tax audit, the corporation can either file an amended tax return in accordance with instructions from the tax authority, or can dispute the matter by filing a lawsuit after being subjected to corrective action. When considering what course of action to take, it is necessary to consider the odds of winning the lawsuit. Of course, upon receiving an order to issue an amended return, it goes without saying that the chance of winning a lawsuit is not the only issue at hand; it is also necessary to consider whether it is appropriate to file a lawsuit based on interpretation of tax law. It can also be argued that the principle of management responsibility should be considered in such cases.

Ultimately, the corporate governance for taxes being advanced by the tax authorities is only meaningful if it affects compliance awareness among taxpayers. When advancing this program, it is vital to consider if a discussion of corporate governance is required for tax compliance, if corporations will only view that program as a way to reduce the frequency of tax audits, or if corporations will simply feel that the program is being forced on them by the government.

How should corporate governance for taxes be positioned to realize its ideal form? When discussing this issue, we must consider to what extent corporations can achieve independence as subjective taxpayers.

Katsuhiko Sakai
Professor, Faculty of Commerce, Chuo University
Areas of Specialization: Tax Law and Tax Accounting
Katsuhiko Sakai was born in Tokyo. He completed the doctoral program at the Chuo Law School in 2006. He is a Doctor of Law (Chuo University).
He started his current position in 2014 after working as a professor in the Faculty of Law, Kokushikan University. His current research topics include the intertwining of tax laws and private laws, and tax avoidance theory.
Major publications include Follow Up – Tax Laws (published in 2010), Step Up – Tax Laws; Study of Issue of Income Tax Act; and Brush Up – Tax Laws (all published in 2011), Close Up –Tax Requisition Facts (4th Edition) and Start Up – Tax Law (3rd Edition) (both published in 2015), Close Up – Tax and Administrative Laws (2nd Edition) (published in 2016) (books listed above published by Zaikeishohosha), Administrative Case Litigation Act and Tax Suit (published in 2010), Looking from Trial Example – Corporation Tax Law (published in 2012), and Looking from Trial Example – Income Tax Law (published in 2016) (these three books above published by Okura Zaimu Kyokai), Progressive Theory of Tax Accounting I and II (published by Chuokeizai-sha in 2016), Lecture - Introduction to Tax Law Interpretation (published by Koubundou Publishers in 2015), Access - How to Read Tax Notices (published by Dai-Ichi Hoki in 2016), and many more.