Pointing Out  Evaluation of Stocks without Trading Market

Introduction

The Board of Audit of Japan* has pointed out that the valuation method for "stocks which don’t have exchanges for trading" (i.e., unlisted stocks) used for inheritance and gift taxation may have problems in terms of fairness and reflection of actual conditions. Since there are no trading markets for unlisted shares, and it is difficult to evaluate share prices objectively, certain valuation methods based upon valuation notifications　have been used. However, due to changes in social and economic conditions and the diversification of corporate realities, it has been pointed out that in some cases the current method does not always provide fair valuations. The points raised by the Board of Audit may lead to tax system revisions in the future.

Problems and Background of the Principle Valuation Method

The value classifications for unlisted stocks are mainly “the principle valuation method" and “the special valuation method". The principle valuation method includes the following two types:

Comparable industry method: This method calculates the valuation amount based on indicators such as the stock price of a listed company in a similar industry, or the level of profits, dividends, and/or net assets of a stock-issuing company.

Net asset value method: A valuation method based on the subject company's net assets (total assets minus liabilities).

According to an investigation by the Board of Audit, it was confirmed that the larger the share-issuing company, the lower the calculated valuation value tends to be relative to the size of the company. The Board of Audit pointed out that this may be due to the calculation methods of comparable industry value, as well as the revisions of the valuation guidelines, not properly reflecting the actual situations of share-issuing companies.

Periodic Divergences Between the Special Valuation Method and theDesignatedRate of Return

On the other hand, in some cases, the "dividend capitalization method" is used for the special valuation method, in which the capitalization rate is uniformly set at 10%.

This method is applied to certain cases in family-owned companies, such as for unlisted shares owned by non-family shareholders. It was established with reference to the level of interest rates at the time the Basic Notice on Property Valuations was enacted in 1964.

At that time, Japan was in an era of high interest rates, with long-term deposit interest rates hovering around 6-7%, so there was a certain rationality in setting the rate of return at 10%. However, in recent years long-term interest rates have remained very low - at less than 1% - for a long time, and the cost of capital and expected rate of return have changed significantly. Continuing to use a high capitalization rate of 10% without taking into account these changes in the historical background may result in an appraised value that is far from the actual situation.

What the Board of Audit Pointed Out

In light of these issues, the Board has urged the National Tax Agency (NTA) to consider the following points regarding the valuation method for unlisted stocks.

• Fairness of valuations among acquirers of unlisted shares issued by share-issuing companies in different size categories
• Consideration of socio-economic changes

In response to this suggestion, the NTA has stated that it will work to ascertain the actual situation regarding the valuation method for unlisted stocks. It is possible that the valuation method will be reviewed and improved in the future, and the trend of such  possible changes is attracting attention.

The valuation methods for unlisted shares are important factors that directly affect the taxation of inheritance and gift taxes. The findings of the Board of Audit indicate that the current valuation method may not always reflect fairness and reality; this may result in future tax system revisions.

Owners of family-owned businesses need to think about the succession of their shares in anticipation of such tax reforms.

The National Tax Agency has Published FAQs Regarding Invoices, for New Business Operators

Introduction

Many existing businesses are already familiar with the invoice system to a certain degree. However, for those businesspeople who have recently started a business, or are planning to start one in the near future, there are many cases in which they do not fully understand the system. For this reason, the National Tax Agency (NTA) has set up a specific page for new business operators on its special invoice website. The page summarizes points to keep in mind for new business operators, who account for the majority of businesses that apply for invoice registrations.

Overview of Specific Page for New Business Operators

In light of the current situation, the NTA has released a special webpage on the invoice system for new business operators. The page explains registration as an invoice-issuing business operator, related procedures, and points to note in an easy-to-understand manner, so that even those new to the system can smoothly understand the system. The following information is organized on the special website:

Registration Basics

It carefully explains the basic rules related to registration, such as key points when a tax-exempt business transitions to being an invoice-issuing business, what to do if registering during a taxable period, registering from the date of opening of business, and whether it is possible to apply for registration retroactively back to the first day of a taxable period. This allows new business owners to understand the correct procedures in regards to their situation.

Conditions for “Newly-Started Businesses”

The criteria for determining whether a business is a "new business operator" are clearly indicated with specific examples, such as a case in which a business that leased out residential real estate from the previous year shifts to leasing commercial real estate this year, or a situation in which a sole proprietorship that once closed its business reopens it. In addition, practical questions such as the applicability of the purchase tax credit for capital investment prior to the start of business are also answered.

Business Succession or Incorporation through Inheritance

Information is also provided for special situations, such as how to proceed with the registration process for an invoice-issuing business when a business is taken over by inheritance, and who will actually be in a position to conduct the business if there are multiple heirs.

It also introduces the procedures necessary for a sole proprietorship to incorporate, as well as the procedures related to registration as an invoice-issuing business on the corporate side, to meet a wide range of needs.

Steps Taken for Ease of Understanding

The NTA also uses visual tools to promote understanding. For example, the "Learning with Manga (comics): Points New Business Operators Should be Aware of Regarding the Invoice System" explains the main points of the invoicing system in a storybook style. The catchy themes, such as "Leaving the workforce...it's a new start" and "Inheritance...it comes out of the blue," depict specific situations that are easy to visualize.

A substantial 19-page FAQ’s section is also provided, providing detailed answers to frequently-asked questions.

Usage and Application Recommendations

All of these materials can be downloaded free of charge from the special page. They would be a very useful resource for those who are starting a business for the first time or considering registering as an invoice-issuing business.

Through this special website, the NTA is supporting many businesses in understanding the invoice system correctly, and to operating smoothly within it. We hope you will make effective use of the webpage to help resolve any concerns or questions your company may have about the system.

<Reference: Page for New Business Operators>
https://www.nta.go.jp/taxes/shiraberu/zeimokubetsu/shohi/keigenzeiritsu/invoice_sinkijigyousha.htm

AI-based Tax Audits

Introduction

Artificial Intelligence (AI) is now being used for tax audits. The National Tax Agency (NTA) has released its corporate tax and individual income tax audit report for the fiscal year 2023, showing that effective, accurate tax audits are being conducted through the usage of AI. The NTA is trying to achieve efficient and fair tax administration with its limited manpower and time by continuing to improve its audit methods utilizing AI.

AI-based Selection of Audit Targets

Tax audits have traditionally required large amounts of manpower and time to verify the appropriateness of tax returns. However, with the use of AI, it is now possible to quickly and accurately analyze tax return data and information from various documents, and efficiently identify taxpayers who are highly likely to have committed tax fraud, as well as cases in which there is a discrepancy between the tax return and the actual status of the taxpayer. This has improved the efficiency of investigations, and has enabled the NTA to accurately allocate resources to high-priority cases.

Enhanced Data Analysis

The introduction of AI seems to be having an impact on the audit work process itself.

Automation of the collection and organization of data
AI automatically collects and organizes e-filing and digital transaction data, reducing the manual input work of investigators. This allows investigators more time for advanced analysis and decision-making.

Rapid selection of audit targets
AI refers to past audit results and tax returns to immediately screen for audit targets. This enables focused audits while still maintaining the overall number of audits, and has allowed fair, appropriate audits to be conducted on a larger number of taxpayers.

Examples of Audits of Companies

In the 2023 fiscal year, a wide range of corporate tax and consumption tax (corporate) audits were conducted. Based on AI-based analysis, audits/investigations focused on companies suspected of large-scale, maliciously fraudulent accounting. As a result, examples of fraudulent accounting was corrected, proper taxation was ensured, and the efficiency of audits was also improved. In addition, through detailed analysis focusing on specific industries and sizes, efforts to detect at an early stage corporate failures to declare income, as well as fraudulent activities, have progressed.

Notably, the amount of undeclared income? for corporate and consumption taxes was approximately 9.2 billion yen, an increase of 17.9% from the previous fiscal year, and the amount of additional taxes due from audits of non-filing corporations was approximately 21.9 billion yen, the highest since fiscal year 2007. These results indicate that AI is contributing to the extraction of targets for investigation, and improvement of audit/investigation efficiency.

Examples of Audits of Individuals

AI is also playing an active role in personal income tax audits. AI can effectively identify ‘high-risk activities’ that were difficult to detect in the past, such as overseas investments, Internet transactions, and non-filing of tax returns, and can efficiently identify cases of undeclared income and fraudulent tax refunds.

Especially in crypto asset (virtual currency) trading and new digital trading areas, the scope of data analysis by AI is expanding, making it easier to track transactions that were previously difficult to follow.

Effects of the Application of AI, and Future Prospects

Amidst huge numbers of documents, etc., the introduction of AI is making significant contributions to improving the efficiency and accuracy of tax audits. Continued advances in AI technology are expected to further enhance the sophistication of tax audits, and the National Tax Agency has indicated a policy of actively adopting this technology.