A. Introduction

1. Necessity of Proper Administration

Proper administration of the income taxes is essential for their successful functioning in the Japanese fiscal system. These taxes form the backbone of the tax structure. They effect the greatest number of taxpayers. They have the largest impact on the business system. They extend to every variety of livelihood. At the same time, these taxes are the most difficult to administer. Simplicity of tax structure is necessary for application of the income tax to great numbers of taxpayers. At the same time, ten need for equitable distribution of the tax burden is a constant stimulus in the opposite direction.

This combination of the imperative need for proper income tax administration and the very real difficulties in the path of its achievement offers a constant challenge to the Government. Responsibility for the successful administration rests not solely on Government officials and employees, but also with the wage earner and the salaried employee, with the farmer and the fisherman, with the small business man and the corporation executive, with the professional man and the investor -- in short, with the entire nation. Fairness in the application of these taxes thus demands mutual cooperation on the part of all classes of taxpayers and the Government.

2. Obstacles to proper Administration

Great obstacles stood in the way of successful administration of the post-war income taxes in Japan. The individual income tax suddenly affected the great mass of citizens instead of being applicable only to a wealthy minority. The small independent farmer, the product of land reform, became a taxpayer as well as a farmer. The small wage-earner and the small business man, equally inexperienced in income tax matters, also joined the farmer as part of the new classes of citizens subject to tax. Accurate accounting and bookkeeping are essential to income tax administration; but instead there existed both an absence of books and records in some quarters and a deplorable multiplicity of books and records in other quarters and a deplorable multiplicity of books and records in other quarters.

The two professional groups that play an important role in tax administration, accountants and lawyers, were not prepared for the task. The accountants had not achieved the independent status and traditions that their profession demands; the lawyers were wholly un-versed in tax matters.

On the Government side, the entire tax service was in a disorganized and inefficient condition, partly as a result of the war. Tax officials were young, inexperienced, underpaid. They were inefficiently assigned and supervised. Tax Offices were located in inadequate, under-maintained, ill-lighted buildings. Office equipment, never approaching modernity in the past, was largely non-existent. Office routine was fearfully inadequate.

On top of this complete unpreparedness on the part of Government and taxpayer alike, there lay the serious fiscal situation. Severe inflation brought complete instability in prices and wages. Consequent Government economic controls meant extensive black markets. Income tax rates and exemptions, however, had been designed for non-inflationary conditions. Indeed, the entire concept of taxable income has presupposed a stable price level. The impact of inflationary events thus created a terrific impetus to tax evasion.

Under these conditions it is an achievement that revenues of large magnitudes have been collected. But basically such collection has been due to two factors -- Military Government pressure and Tax Office mass reassessment designed to achieve predetermined revenue goals. The income taxes have been collected -- but an objective measure of individual income, the cornerstone of a proper income tax has necessarily been sacrificed.

3. Prospects for the future

The basic question that must be faced today with respect to the income tax is thus the question of whether it can be properly administered. If it cannot be satisfactorily administered it should be discarded in favor of other taxes less difficult to enforce. This question cannot be answered with complete confidence. The obstacle stressed above largely remain, as formidable as ever. But despite the sheer necessity under those obstacles of resorting to the methods of collective and average assessment.

The development of a sound income tax administration has been started. Such steps are incompleted and uneven. But they are sufficiently defined to indicate that proper tax administration is a goal capable of achievement if the desire to reach it persists.

They are thus in the present confusion and disorganization sufficient indications that the challenge of successful income tax administration can be met in Japan. The experiment is not doomed to failure. On the contrary, on the record to date, the Japanese taxpayer and tax administrator are entitled to the opportunity of demonstrating that they are capable of successfully administering an income tax.

B. Voluntary Compliance and Self-Assessment

1. Ascertainment of Actual Income of Taxpayer

Since the income tax is levied on the income of the taxpayer, it is necessarily a personalized tax. The proper measure of the tax is thus not an arbitrary amount assigned to a taxpayer, nor an average of the income of many taxpayers of a particular class, but the actual income of the particular taxpayer. Hence any factors which make for arbitrary or average measurement of income are intrinsically opposed to the fundamental objective of the ascertainment of the precise amount of a particular taxpayer's income. Mass administration may, it is true, require some resort to factors involving average measurement if it is to succeed. But any reliance on these factors must be critically examined and their use justified only if the resulting individual inequity is clearly outweighed by administrative advantages and the inequity is not too great. Such factors, therefore, as the use of goals and quotas, the collective allocation of tax amounts among associations, the allocation by an association of a group amount among its members, any extreme reliance upon standards to measure income -- all these factors are initially suspect and fundamentally contrary to proper tax administration. Clearly, also, favoritism on the part of tax officials, or leniency in the application of the tax, are unjustified at any time. The objective to be kept uppermost is a fair ascertainment of the income of the particular taxpayer.

2. Self-Assessment

Successful income tax administration rests essentially on voluntary compliance by the taxpayer. He is the person best informed as to his taxable status, as to the amount of his income. The necessary voluntary submission of the data required to measure a taxpayer's income is called self-assessment. In areas where withholding does not operate, such self-assessment is vital to satisfactory tax administration. The business man, the farmer, the higher salaried employee, the corporation -- in short, all taxpayers require to file returns are through self-assessment reporting to their Government the amount of their incomes. On each such person so reporting falls a share of the administrative task facing the nation. The great majority of such taxpayers must voluntarily perform their proper share of that task if tax administration is to succeed. At the same time, the Government must assure such majority that the laws will be rigorously enforced against those taxpayers who fail in their trust and who report falsely or improperly.

Even for incomes subject to withholding, there exists some aspects of self-assessment and taxpayer compliance with duties. The individual employee subject to withholding must correctly inform his employer of his taxable status, such as the number of his dependents. The employer, entrusted with the task of tax collection on wages and salaries, must rigorously apply the withholding rates to the entire wage or salary, whatever its nature or form. He must promptly pay over to the Government the taxes so collected. Employer and employee thus also carry a share of the task of proper tax administration.

3. The Goal System

Such voluntary self-assessment is directed toward ascertainment of the accurate income of a taxpayer. Its basic principles are in direct contrast to practices of the "goal system". Under this system a tax collection goal is assigned to, or computed by, each Tax Office. The total of these goals is the budget figure of expected income tax collections. With this goal constantly before the Tax Office, the individual's accurate income is largely forgotten. The goal is subdivided among various groups and associations, as the Tax Office strives to reach and often to exceed its goal, and those who pay after the goal is achieved are treated less severely. Such a goal system was perhaps initially necessary to prevent total collapse of income tax collection. But sound tax administration will not appear until it is abandoned. This is true whatever the system be called, whether it be goals descending from the Finance Ministry or expected quotas ascending from the Tax Offices. It is proper and necessary for the Finance Ministry to estimate the total revenue expected from the income tax. It is not necessary to allocate those revenues among the various Tax Offices as targets to be attained. Likewise, proper measures may be devised to check the efficiency of Tax Offices without resort to the goal system. Use may be made of a variety of factors to ascertain whether a particular Tax Office is properly performing its duties -- number of returns field, degree of reassessment required, volume of taxpayer protests, number of investigations made, extent of record-keeping in the area, etc. Competent supervisors should be able to gauge the efficiency of a Tax Office. While the task will not be easy, it can be accomplished. Consequently, the goal system should be abandoned as a step toward objective tax assessment.

Against this background, we may consider in sequence the various steps in the process of administering the income taxes. Both individual and corporate income taxes will be considered together.

C. Procedural Steps in the Administration of the Income Tax

1. Declaration of Estimated Tax

a. Basing Declaration on Previous Year's Income

The first step under the self-assessed income tax is the filing of a declaration of estimated income and tax for the current year. Its purpose is to place the taxpayer on a fairly current pay-as-you-go basis -- one-third of the tax under the present system being paid on June 30, when such provisional declaration is filed, one-third October 31, and the balance, corrected to reflect the actual tax, being paid when the final return is filed January 31. In practice, however, taxpayers in their declarations generally estimate their income far below the actual amount. As a consequence, tax collections during the year fall well below these one-third and two-third levels. Collections then rise sharply at the beginning of the next year, under the pressure of reassessments. The pay-as-you-go system is thus defeated and tax collections are completely unbalanced.

To remedy this situation, the law should provide that the declaration be based on the income of the preceding year. While the taxpayer may, if he desires, declare more than that amount, he should be required to declare at least the amount of his past year's income as stated in the January 31 return. One-third of the tax so computed would be payable with the filing of the declaration, and another one-third on October 31. The law should authorize the same measures to enforce collection of such declared amounts as now exist with respect to the tax due on the final return. At the same time, the Tax Office would not reassess the amount of such a declaration. Such use of last year's income is, however, only a mechanical method of establishing the estimated tax for the purpose of the declaration and the first two payments. When the January 31 final return if filed, the actual income for the preceding year will be indicated and the final tax payment made accordingly. Such final return would be subject to reassessment as at present. In some cases a refund will be due the taxpayer.

In order to take account of material changes in the national economy, the law should authorize the Finance Ministry to prescribe blanket percentage adjustments respecting the income of the previous year. Thus, if incomes are rising, the amount that must be included in the declaration can be last year's increased by say, 10% or any other such figure named by the Ministry, and conversely, if incomes are dropping. To accommodate special individual situations, the Tax Offices should be authorized to permit use of an amount lower than last year's income upon application of a taxpayer who, in advance of the filing of the declaration, can readily demonstrate on the basis of the first part of the current year, especially from adequate books and records, that his income for the current year will be materially below last year's income.

Such a declaration system would (1) smooth out the collection of taxes and thereby avoid the bunching that now exists at the beginning of the next year; (2) lessen the work load of the tax officials, since only the final return need be investigated for reassessment; (3) provide a definite tax figure which the taxpayer can use to measure the adequacy of his saving for tax payment; (4) afford the Tax Offices more time within which to reassess the January returns, since as a result of the larger prior collections they will no longer be under the pressure of completing the reassessments by March 31, when the fiscal year ends; (5) permit use of a simple declaration form, showing mainly last year's income, current tax status (number of dependents, etc.) and amount of tax. While perhaps the declaration filing could be omitted and bills prepared by the Tax Office on the basis of last year's income could be sent to the taxpayer, it is desirable to retain the requirement of declaration filing. It permits current adjustment to be made for changes in dependent status, tax rates, etc., and avoids throwing on the Tax Office the burden of preparing bills.

b. Corporations

For corporations, a previous recommendation suggests the adoption of a twelve month accounting period for tax purposes. Corporations, therefore, should, as at present in the case of corporations now having such a twelve months period, file a provisional declaration at the end of six months and a final return after the twelve month period. Such declaration could be based on last year's income as in the above recommendation under the individual income tax.

c. Farmers

A change in the method of collection taxes on farm income is suggested later which will eliminate the need in most cases for declarations to be filed by farmers with the Tax Office, and will in other cases change the filing date.

d. Withheld Wage and Salary Earners

The requirements for declaration filing in the case of taxpayers subject to withholding on wages and salaries should be reexamined to see of simplification is possible ( this is tied up with co-living family and other substantive changes).

2. Withholding

a. In General

The great bulk of the income tax on wages and salaries is collected through withholding of the tax by the employers. Such withholding system appears to be functioning successfully as respects its basic aspects. Employees appear to know their wages and the amount of tax withheld with reasonable accuracy. Employers as a group are performing their withholding duties in generally satisfactory fashion. As a consequence, of the three broad groups of taxpayers -- businessmen, farmers, and employees -- the last-named is the group reached most effectively under present tax administration.

b. Changes Recommended

Improvements, however, are possible in the withholding process. It is suggested:

(1) Employee Information - The law should require the employer to notify the employee in writing at the time of each wage payment of the amount of tax withheld. This would be in addition to the notification presently required at the end of year. Employers should post withholding tables and other withholding information in places where general employee information is displayed. Such information should explain the withholding computations. It would be desirable for the Tax Administration Agency to prepare explanations for this purpose. Unions should inform their members of the withholding requirements and rates.

(2) Withholding on all Forms of Wages and Salaries - Investigations should be conducted to see that all forms of wages and salaries are actually withheld upon. Allowances, compensation disguised as loans to employees, compensation in kind, bonuses, etc.

(3) Prompt Payment by Employers - Investigations should be conducted to ensure that employers (and others withholding on dividends, interest, and royalty payments) are promptly paying to the government the amount of taxes withheld. Employers should be required to display in their place of business monthly receipts showing that the withheld tax on wages and salaries has been paid to the Government.

(4) Minimization of Year-End Adjustment - The withholding system should be carefully examined and improved to minimize the amount of adjustment required at the end of the year. The withholding rates on wages and salaries should be such as to tend to a slight amount of over-withholding rather than under-withholding. Where under-withholding has occurred, the consequent adjustment should be spread over several pay periods if necessary to prevent hardship.

(5) Shifting Year-End Adjustment to Tax Offices - As the year-end adjustment is now handled by employers, most employees have no contact with the Tax Offices. At the present time the load on the Tax Offices is such that this adjustment must continue to be carried out by the employers. The process should be shifted, however, to the Tax Offices as soon as such a shift is possible. This would simplify the return filing requirements. Every employee subject to tax would file a return, attach a statement from his employer as to withheld tax, and pay the balance due or obtain a refund of overpaid tax.

(6) Notification to Tax Offices of Amounts Withheld - While employers and other persons withholding on income payments are required to notify their Tax Office of the amount so withheld, coordination of such information with the Taxpayer's return is a difficulty for the tax office, particularly where the employee's tax office is other than that of his employer. Consideration should be given to requiring such withholding agents to send a similar notice in addition to the Tax Office in which the payee files his tax return. This requirement could be limited to cases where the annual payment is greater than a certain amount, since the procedure is important chiefly as an aid to the collection of tax from the larger taxpayers.

c. Withholding for Farmers

There is recommended later a complete revision of the income tax procedure applicable to farm income. A part of the new procedure is the institution of a withholding system on Government payments for delivered crops.

3. Returns and Final Payment of Income Tax

The taxpaying public appears to have developed considerable familiarity with the mechanics of filing the final January 31 return. The task here is to steadily improve the present situation. The following suggestions are to that end:

a. Simplification of Return Form

The present return form is too complex for the average taxpayer. This is equally true of the accompanying instructions. s considerable portion of this complexity arises, of course, from the complexity of the law itself. Basic substantive changes have been recommended which will materially simplify the income tax structure, and permit considerable simplification of the return form and instructions. In addition, attention should be given to simplifying the return and instructions from the standpoint of form, language, printing, method of presentation, arrangement, etc. Different types of returns could be printed in different colors to permit case of identification by taxpayers and tax officials.

The return form for farmers should be simplified. At present, farmers must deal with the regular return form and a separate form or schedule showing farm income. These forms should be revised and simplified and then combined into one return form suitable for farmers prepared in accordance with the method of collection on farm income discussed later. Consideration should also be given to the feasibility of separate return forms for other groups of taxpayers, as fishermen, small business enterprises, and employees.

b. Assistance in Filing Returns

All proper agencies should be enlisted to assist the taxpayer in filing his return. Each Tax Office should maintain at filing time a group of officials, readily accessible, to help the taxpayer. Tax officials could be sent to department stores, schools, banks, post offices and other places where large numbers of taxpayers may gather to offer their assistance. Unions, chambers of commerce, and farmers cooperatives should continue to assist their members. Village office s may be utilized in rural areas.

c. Balance Sheet Filed by Higher Income Groups

To assist the Tax Offices in their investigations, the law should require higher income individual taxpayers to file a balance sheet with their final return. Such a balance sheet should be filed by all taxpayers with incomes over, say, one-half million yen or net assets overt two million yen. The balance sheet should contain a list and valuation of all assets held by the taxpayer and all liabilities owed by him. Criminal penalties applicable to the return should also apply to such balance sheet. In addition, a civil penalty should attach for omission of assets or undervaluation of assets.

d. Confidential Nature of Returns

At the present time, returns are not confidential, since on payment of a nominal amount anyone can examine another taxpayer's return. This practice is intended to assist in enforcement by enlisting the aid of informers. It would seem that on balance, however, secrecy of the information contained on the return would result in greater overall compliance. It would be advisable, therefore, to keep the return data confidential. As an aid to enforcement, it would still be desirable to acquaint the public with the names and incomes of the larger income taxpayers, so that substantial underreporting may be noticed by persons having information as to such incomes. This could be accomplished by posting for public inspection at each Tax Office a list of its larger income taxpayers, say those with incomes over 250,000 yen, and the amount of their net incomes.

e. Payment of the Tax -- Savings Plans

The Government should encourage and publicize a variety of methods by which taxpayers can save to meet tax payments. Postal Saving deposits and bank accounts are examples. In rural areas especially, saving associations might be permitted. Such savings associations should be organized and operated under rigid restrictions designed to prevent their becoming vehicles for "boss domination" and the like. Their activities should be limited to savings, their funds should be deposited in reliable depositories such as post offices or banks, a countersignature plan might be developed under which an official of the association and the particular member must both sign to obtain funds for the latter, the organization should be cooperatively run and full disclosure should be made of its activities.

f. Payment of the Tax -- Coordination with Banks and Post Offices

The present method of payment of taxes to banks and post offices should be examined in the interests of improving the coordination between such depositories and the Tax Offices. Thus, prompt notification of payment to the Tax Office would prevent the latter from billing the taxpayer for taxes already paid, as occurs at present.

4. Procedure Applicable to Farm Income

The income tax procedure applicable to farm income is at present based almost entirely on the use of standards. The various Tax Offices have, under coordination by their Regional Bureaus, determined the standard gross receipts and expenditures per tan for various types of agricultural land in their area. The standards for any particular village are prepared by checking several families in the village, by obtaining data regarding preplanting and production quotas and price estimates, by checking in some instances with agricultural cooperatives as to expenditures, by obtaining actual production per district and averaging it among the farm land in the district, etc. These standards are made available to the farmers in advance of their filing declarations and returns. The farmers in turn incorporate these standards in their tax forms.

Individual variations from the average income per tan in either direction are thus largely disregarded. Such use of standards has enabled the Tax Offices to assess the great bulk of farm income and sometimes to overasses it. As a consequence, farmers as a group are second only to wage-earners in the extent to which their income is covered by the tax. As a result of withholding in the one case and fairly accurate averages in the other, the income of these two groups is reached with far more effectiveness than that of the business group.

While the standards may be fairly accurate as averages, they are no better than averages and hence represent either considerable unfairness or considerable leniency in individual cases. In keeping with the goal of an objective individual measurement of net income, this system of standards should, therefore, be replaced by methods that take account as far as possible of differences in income productivity per tan among individual farmers. Such a system is quite feasible for considerable data are available with respect to actual individual deliveries of staple crops and actual individual expenditures for fertilizer and other articles. Returns based on such data would materially improve the equity of the income tax on farmers by subordinating to a marked degree the use of averages.

The income tax procedure applicable to farm income would also be improved if income tax payments by farmers were adjusted to seasonal farm income patterns. Such adjustment would lessen the need for borrowing to meet tax payments and would permit the farmer to be realistically current in his taxes.

These two objectives - individual measurement of net income and coordination of tax payments with farm receipts may readily be achieved through the following plan:

a. Taxes will be withheld from payments for staple food crops and tobacco. If more than 70 per cent of a farmer's estimated net income is from such crops subject to withholding, he need not file any declaration with the Tax Office. Withholding shall be made by the bank or cooperative from whom the farmer receives his crop payments, each farmer being restricted to one place of payment throughout the entire year. With respect to those farmers required to file declarations, the filing and payment dates should be changed to July 31, November 30 and February 28 in two-crop areas, and to November 30 and February 28 in one-crop areas.

b. On summer crop deliveries in two-crop areas a flat percentage of the gross delivery payments shall be withheld for taxes. It may be advisable to permit low-income farmers who paid little or no income tax for the preceding year because of exemptions and dependent credits to file with the withholding agent a certificate to that effect obtained from the Tax Office and thereby be exempt from summer crop withholding.

c. In October a statement would be filed by the farmer with the withholding agent showing gross income estimates based on the estimated value of home consumption and of the delivery quota for that farmer (the preplanting quota would be used if the adjusted quota had not been set) less a standard percentage for expenditures determined by each Tax Office. In cases of farmers also having uncontrolled crop and other income, wherever possible actual production data shall be used. The withholding statements would also show the exemptions and the dependent credits of the farmer and the amount of summer crop withholdings. Most of the data might in practice be filled in by cooperative or village authorities. On the basis of these statements, the withholding agents would calculate the withholding rate for the particular farmer. The rate would be determined from a table showing the deduction per bale on the basis of the tax to be paid and the number of bales to be delivered. For convenience a number of classes of rates would be established and the farmer allocated to a particular class on the basis of such statement. Such withholding rate would then be applied to each bale actually delivered by the farmer.

As an alternative to items b and c, the Tax Office would calculate such a rate on the basis of the return for the previous year and notify the farmer and the withholding agent of such rate. While this would eliminate the need for filing the October statement with the withholding agent and would afford an individual rate for summer crop withholding, it would involve a considerable amount of work for the Tax Offices and would lessen the general accuracy and currency of the withholding.

d. To encourage familiarity with the process of record keeping, each farmer could be provided with a tax data book in which the following illustrative information would be included: amount of tax withheld, amount and value of delivery quota for each crop, record of deliveries and payments, record of tax payments, record of allowable expenditures, etc. This information could readily be obtained from the appropriate local sources.

e. A final tax return would be filed at the end of February after crop deliveries had ended. For such return the gross income would be calculated on the basis of actual production data furnished the farmer by village offices. Home consumption income would be based on the retention figures allowed under the delivery quota system. The income amount of such retention would be calculated at the producer price prevailing for the current crop period. Expenditures would be based as far as possible on the records of individual expenditures kept in the village offices and cooperatives, for fertilizer, implements, etc. and on other expenditures substantiated by receipts. If necessary, expenditure standards compiled cooperatively for each village by the Tax Office, village office and cooperative may be used. Uncontrolled crop income and livestock and other income should be based on actual data as far as possible. Where necessary, however, standards may be utilized. Withholding amounts would be obtained from the withholding agents. These procedures would not reach black market income, so that the Tax Office may have to act independently if such income is to be taxed. In those areas where the quota proves too low for the entire area, some overall percentage adjustment worked out cooperatively with the agricultural authorities may be helpful. While efforts to reach black market income are necessary to protect over-quota legal deliveries, it seems likely that the problem may gradually diminish as the food situation improves.

This tax return would be certified by the appropriate local officials as to the relevant data obtained from the village offices and cooperatives and as to the number of dependents and family status of the taxpayer. The return form for farmers would be revised in accordance with this plan.

The farmer would at the same time pay any tax due if his withheld tax fell below the actual tax so determined on the return. If excess tax had been withheld, the return would constitute a claim for refund which should be promptly paid by the Tax Office or at the taxpayer's election be available as a credit.

The above system would accomplish the following:

a. Permit a fairly accurate individual measurement of former net income, far more accurate, in any case, than the present averages resulting from complete reliance on standards;

b. Coordinate tax payments with income receipts;

c. Reduce seasonal fluctuations in currency issue by eliminating the lag between Government crop payments and farmer tax payments;

d. Tend to prevent excessive expenditures on the part of farmers during the period of fall crop payments;

e. Eliminate the one-third initial payment that would otherwise be due in June under the system of basing the declaration on the previous year's income, and defer any tax payment until income was obtained for delivered crops;

f. Considerably reduce the work load on the Tax Offices, through the elimination of declarations from most farmers and through the substantiation of the data on the return by local officials.

The details of this system should be worked out cooperatively by the various groups involved, such as the Finance Ministry, Ministry of Agriculture and Forestry, village officials, cooperatives, etc. Its application is of extreme importance to equitable and efficient administration of the income tax as it effects farm income. Consequently, all interested groups must strive for its successful operation.

5. Re-assessment of Returns

a. Investigations

Once a taxpayer's return is filed, the voluntary task of self-assessment is ended and the task of the Tax Office commences. To the extent that taxpayers properly carry out the responsibilities of self-assessment, the burden on the Tax Offices will be lessened. But it is the experiences under any income tax that constant vigilance in checking and investigating returns is necessary to prevent deterioration of taxpayer compliance. Prompt and efficient investigation of returns, backed by enforcement of penalties fro violations, will be rewarded by a high degree of taxpayer self-assessment. An extensive investigatory program is thus an absolute necessity for proper income tax administration. But the methods and results of such investigations must be genuinely directed toward an objective ascertainment of the proper tax. The honest taxpayer needs assurance that the dishonest person will not profit by such dishonesty. He needs assurance that the investigators will sooner or later ferret out the tax evader and make him pay his full share of tax, plus penalties for his misdeeds.

The groundwork of an investigatory system is now in the process of establishment through the formation of the Investigation and Inspection Division of the Tax Administration Agency. Under supervision of this Division, an investigation staff is to be built up at the Regional Bureau level to handle the cases of the larger taxpayers. These basic plans must be steadily pushed and the program constantly improved and enlarged. It must extend to investigations at the Tax Office level as well as the Bureau level. Particular attention must be paid to the following:

(1) Selection of Cases to be Investigated - It is clear that every return cannot be investigated. Consequently, efficient use of investigatory personnel is imperative. One aim should be to assign adequate personnel to investigate the taxpayers, corporate and individual, with the largest amounts of income. Compliance from the average taxpayer will be increased if he is assured that the wealthier groups are paying their share. Thus, all returns above a certain income should be investigated. At the same time, a small but adequate portion of the cases to be investigated should be selected on a random sampling basis applicable to each of the various classes of taxpayers. Such selection would be entirely at random, without any regard for suspicion as to the need for investigation in the particular case. Thus, no taxpayer should be able to feel that his return would not be investigated, regardless of how small the income or how plausible the return might be on its face. An analysis of the results of this randomized investigation would tend to determine which types of returns should be selected for more frequent investigation. In addition, standards may be utilized, as discussed below, to aid in the selection of cases to be investigated. As the entire investigatory system develops, efforts should be made to see that as many taxpayers as possible are visited by a tax official -- not necessarily every year, but often enough to indicate that any lapse on the taxpayer's part will eventually be detected.

(2) Personnel - Competent personnel in adequate numbers must be assigned to investigatory work. This personnel must be carefully trained in the methods and techniques of investigation. Manuals must be prepared to assist them in their activities. Such personnel should be properly utilized; for example, only one or two should be assigned to a particular case unless it is of an exceptional nature.

(3) Utilization of All Sources of Information - The investigators must utilize all possible sources of information. They must be alert and imaginative in the development of new techniques. The task does not end with a fruitless search for the second set of books. Information should be sought from customers and suppliers of a business. Bank deposits should be checked; the rules governing Tax Office access to bank records should be changed to permit more extensive examination. Data filed with the Securities Exchange Commission and other public bodies should be examined. An individual's transactions is real estate and his purchases of large amounts of insurance or other assets should be checked to see if his reported income matches such expenditures. The use of net worth investigations as a check on reported income should be developed.

(4) Investigate All Tax Activities - The investigators should check all tax activities of the taxpayer. If an employer, is he properly fulfilling his withholding duties? Is the taxpayer sending in the necessary information returns? Is he paying the other taxes?

(5) Educational Activities - The investigators should indicate to the taxpayer the deficiencies in his books and records and accounting procedures, and explain the improvements that are necessary.

(6) Fraud Cases - A procedure has recently been instituted under which possible fraud cases are concentrated in a special group of inspectors. This arrangement is sound and should be pushed. Investigation and prosecution of such fraud cases are highly important, both to reach actual criminals and to deter future evasion.

(7) Substantive Changes to Aid Investigation -

(a) Sworn Statements Taken by Tax Officials: While tax officials are permitted to examine persons and inspect records in connection with the investigation of income taxes, they do not have authority to take sworn statements. That right is reserved to the courts. In order to expedite tax investigations, authorized tax officials and procurators should have the authority to administer oaths to which the appropriate penalty would attach.

(b) Bank Deposits: A large number of bank deposits are held at present in fictitious or dummy accounts. This procedure presents a distinct obstacle to effective tax investigation. There is no justification for this procedure. Consequently, it is recommended that a bank should not be permitted to accept any account if it has knowledge or reason to believe that the account is not in the real name of the individual for whose benefit the account is utilized. Such a provision, enforceable by appropriate penalty, would, when coupled with changes permitting ready inspection of bank records by tax investigators, materially increase compliance with the income tax. While it might temporarily affect the volume of bank deposits, such a consequence does not outweigh the advantage to be obtained from this requirement.

(c) Registration of Corporate Securities: At the present, there is no effective system of registration of corporate stock or debentures. It is recommended that a registration system be made applicable to all corporate securities, including both equity and debt securities, under which the tax officials could ascertain who is or was the owner of any particular share or bond.

(d) Notification of Business Changes: Any individual or corporation engaged in business should be required to notify the appropriate Tax Office of such matters as commencement of the business, change in business location, and discontinuance of business activity.

b. Standards

(1) Use of Standards

(a) In general, actual investigation of a particular taxpayer is the only method whereby his real income can be checked. Anything short of such investigation cannot produce accurate reassessment of the tax. Ideally, investigation of the individual should, therefore, precede reassessment in every case. But the present low state of taxpayer compliance with self-assessment makes this ideal practice impossible. The fact must be faced that at the present time the great majority of returns require reassessment, and resources are inadequate to permit investigation on such a wide scale. Resort to a system of standards is still needed to bridge the gap between the investigated cases and those uninvestigated cases in need of reassessment . These standards are of two general forms - standards indicating the expected amount of net income for the enterprise in question on the basis of various external factors (the size of the business and its location, number of employees, materials utilized, etc.), and standards indicating the rate of profit (also based on external factors) for the enterprise, so that once gross receipts are known net income can be obtained. Essentially, such standards are averages based on the experience of the group in question. Refinement exists only with respect to the number of classifications utilized and the extent of the data on which the standard for each classification is based.

Such standards have two principal functions:

((1)) To Guide Investigation: Given a very large number of returns that can bear investigation but facilities for investigating only a portion of this number, the problem is to ascertain which returns should be investigated. Standards may properly be used to assist in separating those returns showing the greatest departure from the standard as the returns most likely to warrant investigation. Such use of standards, as discussed below, will be a necessary corollary to the plan recommended to encourage the keeping of books and records, since the essential of such plan is that a taxpayer agreeing to keep books on a prescribed form is assured that investigation will always precede assessment.

((2)) To Determine Re-Assessment: Standards can also be utilized directly to determine the amount of tax to be reassessed. Under this procedure, the income tax becomes a tax not on the actual income of a taxpayer but on the average income of the group in which he is classified. The taxpayer may even be notified of the standard income that he is expected to report, and self-assessment then ceases to be a reality. As the present time, the vast majority of returns and reassessments are determined by such use of standards.

This second use of standards is not an ideal sense compatible with a sound income tax law, since such a tax should be primarily geared to actual income of the individual, not the average income of a group. At the same time, it will take a considerable period of steady development before the stage is reached in which the level of taxpayer compliance under self-assessment is such that the resources available for actual investigation can adequately cover the cases calling for reassessment. Until then, the tax administration must bin self-defense resort to standards for reassessment purposes. But the defensive justification for their use must always be recognized. The goal must be a steady shift away from the use of standards for direct assessment purposes end in the direction of the use of standards only as an aid in charting the course of actual investigations. The rapidity of such shift will be a true measure of the degree to which proper income tax administration is being realized.

(b) Preparation of Standards - Since standards will be an important part of tax administration, either properly as an aid to investigation or defensively as a means of obtaining revenue until administration and compliance reach a higher level, it is imperative that the standards be carefully prepared. The number of cases utilized as the basis for the standards should be increased. The data obtained from actual investigations conducted primarily for reassessment purposes may be secondarily used for this purpose. Available sources of information within the Government, as the Ministry of Agriculture and Forestry, should be consulted regularly. Data possessed by villages and farmers cooperatives should be checked as respects farm income. Careful supervision by Regional Bureaus and in turn by the Tax Administration Agency is necessary to see that the diversity among standards set by different Tax Offices is limited to that demanded by variations in local conditions. The classifications utilized should be sufficiently detailed so that all major sources of systematic variation in particular occupations and activities are recognized.

(c) Other Matters - The reassessment process can be improved in other ways:

((1)) More time for Re-Assessment: Under the recommended change in the declaration procedure, an amount of tax at least equal to that on the previous year's (or even greater if a percentage adjustment in prescribed) will have been collected by January 31. As a result, the collection of tax revenues will be stabilized. It should no longer be necessary to finish all reassessments within a month, as is now the practice, in an effort to obtain the required revenues before the fiscal year closes on March 31. Enough time can then be taken for the reassessment process so that it can be conducted in an orderly and careful manner. This does not mean that the pace may become leisurely - for each year inexorably furnishes a new set of returns to be reassessed. But the pace should be more rational than that which prevails at present.

((2)) Informing Taxpayer of Reason for Reassessment:

The taxpayer should be as fully informed as possible of the reasons for the reassessment. Where the action is based on actual investigation, the Tax Offices are in a position fully to explain the reasons and the computation of the new tax amount. Where the reassessment is based on standards, the information is necessarily more limited. But in either case, the taxpayer is entitled to know why he has been reassessed and how his additional tax was computed.

6. Taxpayer Protest of Reassessed Amount

a. Nature of Protest and Payment of Tax

The next step in the administrative process is the right of the taxpayer to protest the reassessment and the method of considering his protest. While not all taxpayers will so protest, it may be expected that protests will be filed in large numbers in the period ahead. Normally such protests should initially be considered in the Tax Offices. If the investigation, however, has been handled by the investigators of the Regional Bureau because of the amount of income involved, the protests should also be considered at that level.

The protest should be in writing, with the reasons specified. It may be desirable to extend the present 30 day period for filing the protest to 45 days, or as an alternative, permit the Tax Offices to extend the time for good cause shown.

At present, the taxpayer is required to pay the reassessed tax even though he files a protest. To be sure, this procedure may have elements of hardship, especially where the reassessment is later found to be improper. But for the present at least, such requirement of payment is a necessary safeguard to maintenance of the revenues. The Tax Offices should continue to have discretionary authority to waive all or a part of such payment in cases where genuine hardship is demonstrated. Consideration should also be given to the feasibility of a procedure under which a bond may be accepted in lieu of tax payment.

For the longer run, however, taxpayers should have better protection against improper or arbitrary action of examining agents. When conditions become more stabilized, interest charges and other expenses involved should sufficiently inhibit frivolous appeals. Consideration should then be given to permitting appeals without payment of tax.

b. Handling of Protest - Conference Groups - The basic question respecting this stage of tax administration is the procedure for acting on such appeals or protests. If the case has previously been investigated, the taxpayer should be able to discuss the entire matter with the investigator in an effort to reach a settlement. Any such settlement should have the approval fo some supervisory official if it differs appreciably from the reassessed amount. In cases where investigation did not precede the reassessment, if the facts so warrant an investigation should be made and the above procedure followed. Every effort should be made to settle the protest as speedily and as informally as possible, especially where the amounts involved are not significant.

If such discussion with the investigator does not settle a case, further resort to administrative consideration is necessary. It is suggested that a Conference Group of tax officials should be formed whose function would be to consider and decide the protests still unsettled. The conferees would be chosen from the abler, older and more experienced tax officials. In view of present personnel shortages, it might be possible to designate the investigators to act part of the time as conferees. Any investigator who has personally handled the particular case previously in the investigatory or preliminary settlement stage should not act as a conferee on that case. However, as far as is feasible the Conference Group should probably consist of personnel other than investigators, as assurance to taxpayers that their appeals are being considered y an entirely different group of officials having no connection with the original reassessment or investigation processes. The taxpayer would present his case to one or more Conferees, the matter would be fully discussed and considered, and the Conferee would then decide the issues involved. Experimentation might be undertaken to determine whether a Conference Group should be maintained at each Tax Office, or whether it is preferable to have a Conference Group for a Prefecture which would travel to the Tax Offices in the Prefecture. The former is more consistent with overall unitary management of a Tax Office; the latter may offer the taxpayer a feeling of great impartiality.

If the decision of the Conference Group in the Tax Office is still unsatisfactory to the taxpayer, he may in certain cases be entitled to a further appeal to the Regional Bureau. Here also the Conference Group technique would be utilized in much the same fashion. The Regional Conferee could either consider the case at the Regional Bureau or travel to the Tax Office to hear the matter. In either event, the taxpayer would have the opportunity of appearing before such conferee to present his case. This procedure would similarly be followed in cases in which the protest is handled by the Regional Bureau in the first instance.

It may be desirable to provide that the decision of the Tax Offices be final in certain cases, without any further possible appeal to the Regional Bureau. Thus, a taxpayer who has not kept books and records might be denied appeal to the Bureau. Also, cases involving incomes below a certain figure could be confined to the Tax Office. Discretionary authority might be given the Chief of the Tax Office, and possibly the Director of the Regional Bureau, to permit an appeal in either case if he thought the situation exceptional.

At present a taxpayer has the right to petition the Finance Minister, so that a method of administrative appeal from the Regional Bureau exists. Consideration should be given to eliminating this avenue of appeal, especially if it becomes frequently used. Otherwise, the administrative process will be unduly lengthened and the Tax Administration Agency may be presented with an excessively large number of cases to be heard and decided.

The activities of the Regional Bureau Conference Groups should, however, be checked and supervised by the Tax Administration Agency through audits of representative cases decided by such Groups. Such an auditing procedure would also maintain uniformity of approach on the part of the various Bureaus. Also, the Regional Bureau could request advise from the Tax Administration Agency in cases involving new or unusual features, in advance of decision at the Bureau level.

c. Handling of Protest - Citizens Committees - The use of Citizen Committees has been suggested as an alternative procedure to the Conference Group. There are considerable variations in the different suggestions as to the manner in which such Committees would be chosen and function.

But it is believed that Conference Groups composed of regular, trained, full-time tax officials clearly offer a better method of deciding taxpayers' protests than does any feasible scheme based on part-time Citizens Committees. The tax laws are technical and hence technically competent officials will reach results more in accordance with such laws than will untrained citizens. Under Citizens Committees responsibility for proper tax administration becomes diffused, with the tax official and the Committees each pointing to the other as being responsible for inefficient administration. The tax official will be inclined to pass the burden of decision along to the Committee. The latter in turn will tend to decide cases on factors extraneous to the tax laws. Such an approach tends to impair objective tax assessment. Even these criticisms assume at least honest functioning by the Committees. But in many cases, and perhaps most cases, it is to be expected that the Committees will exhibit favoritism to certain taxpayers, or become "boss-dominated", or be subject to manipulation by certain elements.

Certainly as a long-run proposition, such Committees would not seem a desirable part of the tax machinery. They can be supported, if at all, only as a stop-gap measure, defended on the ground that administration will continue to be so weak and inept in the next few years that the taxpayers are entitled to a buffer against inexperienced and arbitrary tax officials. Such a stop-gap is also tinged with considerations of political expediency, since the Committee is a device to shift criticism away from the Tax Offices. This justification assumes a defeatist attitude respecting the improvement of tax administration which is entirely inappropriate alongside the strenuous efforts being made toward such improvement. Moreover, if such Citizens Committees are established, energy will necessarily be spent in developing and supervising the Committees which could far better be utilized in direct improvement of tax administration. Reliance on such Committees will make for slower development of the Conference Group system, if it can develop at all under such conditions, so that the stop-gap Committees may become a permanent device.

It would, therefore, be clearly inadvisable to introduce the Citizen Committee into the present administrative process. Instead, every effort should be directed toward the building of a competent Conference Group system which can obtain the confidence of the taxpayers.

7. Litigation

a. In General - The administrative process will not resolve every dispute between taxpayer and tax official. It is to be expected that some cases will require resort to the courts before they are concluded. But the vast majority of disputes must be settled at the administrative stage. The courts exist only as a safety valve, guaranteeing an impartial arbiter between tax official and taxpayer in those cases that don not yield to administrative solution.

In the past the judicial process has been almost completely free of tax litigation. But already, through prosecutions for tax evasion and suits by taxpayers, tax cases are beginning to grow in number and importance. As a consequence, the rules regarding litigation and the methods of handling the cases in the courts will require reexamination as resort to the courts increases.

b. Refund Suite - The provisions governing the filing by taxpayers of suits for the refund of taxes should be clarified. The taxpayer should be permitted to file a suit after adverse decision by the Tax Office or the Regional Bureau, as the case may be. To prevent stalling or delay in administrative decision, he should also be permitted to bring suit as of right if his protest is not decided within a fixed period of time, of such duration that reasonable administrative action is possible. A taxpayer should not, as a general rule, be permitted to go to the courts unless he has attempted to secure relief through resort by protest to the administrative process. He may be afforded the right, however, to petition the courts for relief if improper functioning of the administrative process has resulted in serious hardship. In the event of a suit for refund, the Government should be permitted to offset the suit by any claim it might have for additional taxes arising from facts disclosed in the course of the litigation.

In such litigation, as well as in any suit to collect taxes excepting one where fraud or criminal conduct is involved, the taxpayer should have the initial responsibility of coming forward with evidence to show that the Government's administrative decision is erroneous.

As the number of tax cases brought by taxpayers increases, consideration must be given by the Government to the manner in which the Government's representation in theses cases will be handled. At present, while tax prosecutions are conducted by the special tax procurators, the defense of taxpayer's suits is handled by the Attorney General's Office, and the tax officials generally acting jointly, but with the ultimate direction resting with the Attorney General's Office. The number of suits against the Government, at present about 150, is still too few in number to permit a definite decision at this time as to the best plan for handling the Government's defense. One possible plan appears to be to develop a litigation staff in each Regional Bureau, subject perhaps to overall control by the Attorney General. Such handling of civil tax litigation by the Regional Bureaus would permit the Tax Administrations Agency to maintain unitary control over and thereby coordinate the administrative and litigation phases of tax collection. Another possibility would be to develop a tax unit in the Attorney General's Office, as part of the decentralized Regional Branches now being formed by that Office. Such a tax unit would have to work in close cooperation with the tax officials. Other alternatives may appear as the volume of cases increases and as both the tax officials and the Attorney General's Office gain experience in the handling of those cases. Undoubtedly, at all times and under whatever system is adopted, close cooperation between the two will be essential. It would not appear proper, except perhaps as a very temporary expedient, to reply upon a system of engaging private lawyers to handle particular cases.

Representation of the Government's interest in civil tax litigation is part of the general problem of how to conduct litigation growing out of administrative action. It is understood that considerable thought is being given to this broad problem. Consistent with progress in this general area, the Attorney General's Office and the tax officials should commence now, as tax litigation is increasing in importance, to work in close cooperation to develop as rapidly as possible a practicable method of defending the Government's interests.

c. Tax Prosecutions. A procedure has recently been instituted to govern the investigation and prosecution of tax evasion cases. This procedure involves: (1) careful preparation and screening of the cases by inspectors in the Regional Bureaus; (2) cooperation between the tax procurators and the inspectors in the selection of cases to prosecute; (3) diligent action by the procurators to prosecute the cases so selected. The goal is a well-directed, strong drive against tax evasion.

It is essential that such a drive be vigorously pushed in accordance with the above procedure. Diligent prosecution and punishment of tax evaders, coupled with full publicity of the results will materially assist in securing greater taxpayer compliance. Such activity will involve considerable training on the part of both the inspectors and the procurators. The special tax procurators have been entrusted with a task of considerable significance. They must approach it with the realization that it is not a short-run affair, but a permanent and important phase of their work. Its proper execution requires complete familiarity with the provisions of the tax law, coupled with ingenuity and imagination in the handling of cases.

The judges must reexamine their procedures to ascertain if they are sufficiently efficient to accommodate the drive against tax evasion. Thus, consideration should be given to continuous trials in place of separated hearings occupying weeks and months. Judges should not hesitate to impose severe sentences, both of imprisonment and monetary penalties, when convictions are obtained and the offenses warrant such severity. These and other questions are naturally bound up with studies presently being made concerning improvements in the general judicial procedure and in its relation to the administrative process.

A recommendation for a civil penalty in fraud cases will be discussed below. Such a penalty will make it unnecessary to prosecute criminally every fraud case and thus permit such prosecution to be reserved for the flagrant offenders.

d. Specialized Judicial Consideration of Tax Cases - As tax litigation increase in amount and importance, it will become necessary to develop specialized judicial tribunals to consider tax cases. The complexity of tax disputes and the need for nationwide uniformity in the application of the tax laws combine to make the usual judicial processes unsuited to disposal of tax litigation. Tax problems are highly technical. The ordinary judge can ensure a correct decision in a tax case only after spending a great deal of time in the study of problems, laws, and regulations with which he is not familiar. There is need for a rapid and centralized appeal system so as to maintain certainty in tax collection and uniformity of tax burden. While complete specialized judicial consideration is probably not immediately warranted, plans should be made now so that the expected increase in tax litigation may properly be handled.

One alternative would be to create an exclusive jurisdiction for civil tax cases in a tax panel of the Tokyo High Court. Effective operation of this device would require members of that panel to travel on circuit to other designated parts of the country at scheduled times. Such a circuit system would require a change in the discontinuous trial procedure now obtaining. Appeal by certiorari would exist to the Supreme Court. Such limited appeal would be an undesirable feature of this plan. Another alternative is the creation of tax panels in each of the High Courts to conduct all civil tax cases within the particular jurisdiction, subject to appeal by certiorari to the Supreme Court. This latter alternative would result in less uniformity of decisions and hence in the application of tax law than would the alternative of centralizing tax cases in the Tokyo High Court. It would have the same defect as respects subsequent review.

Both of these alternative would eliminate the District Courts from the consideration of civil tax cases. If specialization within each court at the District level is fully obtained, it is too expensive; in practice, due to pressure of other duties, it often becomes specialization in name only. On the other hand, continuation of unspecialized jurisdiction in the District Courts with appeal to a High Court specialized tax panel would not meet the need for an initial trial by trained and qualified tax authorities.

The plan that would appear most promising would be to create a completely new inferior court for original jurisdiction in civil tax cases. This court, called the Civil Tax Court, would consist of a panel of three judges. One such court would be established in each High Court area with territorial jurisdiction similar to that of the High Court. It would travel on circuit within the area over which it had jurisdiction. Appeals from these Civil Tax Courts would be taken to a tax panel of the Tokyo High Court, thereby permitting rapid appeal and maintenance of geographical uniformity. This Tokyo High Court Panel would have responsibility for the coordination of the procedures and rules of the various Civil Tax Courts. If thought desirable, the scope of review of the Tokyo High Court on an appeal from a Civil Tax Court could be limited in a fashion similar to that applicable to appeals from the Fair Trade Commission, i.e. issues of fact would be considered only when evidence was introduced of gross error in findings of fact. Further appeal under recognized procedure would be to the Supreme Court.

Thinking about this question of judicial specialization in tax cases should be started now. Such consideration will necessarily be affected by developments and ideas in the overall fields of judicial review of administrative action and improvement of general judicial procedure. But the peculiar needs of tax litigation should clearly be kept in mind in such overall planning; proper judicial disposition of tax cases should not be hampered by lack of development in other areas. It would thus appear desirable to create panels immediately at the District Court level in the large cities where the majority of tax litigation now exists. Such specialized District Court consideration in areas where tax litigation is already sufficiently extensive to warrant that consideration will develop a group of judges technically trained in tax law to serve as the core for the Civil Tax Courts or other specialized tax panels when they are created in the future. It will also permit experimentation to develop the procedure and techniques best suited to tax litigation.

8. Penalties

The system of penalties applicable to income tax violations should be reexamined as the administrative pattern changes. Some specific revisions that may be recommended in view of present developments are:

a. Failure to File Return

At present the failure to file a tax return does not appear to be subject to any penalty. The law should be amended to make it clear that willful failure to file such return is a criminal offense. In addition, a civil penalty should also be prescribed. It is suggested that 10 percent of the tax added as a civil penalty if the failure is for not more than one month, with an additional 10 percent for each additional month or fraction thereof during which such failure continues, up to an aggregate of 30 percent of the tax. Such penalty shall not apply if the failure to file the return is due to reasonable cause and not to willful neglect. The penalty would be collected in the same manner as the tax is collected, since it would in effect become part of the tax. At present, if a person does not have funds in hand to pay his tax, he has nothing to gain by filing his return on time. These penalties would furnish such an inducement and thereby at least provide the Tax Office with a record of the taxpayer, even when no immediate payment can be made with the return.

b. Failure to Pay Tax

The present 25 percent penalty for failure to pay the tax on time is too drastic. If a taxpayer cannot pay his tax on time, he is in a sense impelled to continue to attempt to avoid payment since even a slight delay in payment carries the 25 percent penalty. The amount of the penalty should, therefore, depend on the length of time payment is delinquent.

In addition to this lump sum penalty there is a one-tenth of one percent per day interest charge that applies until the tax is paid, or about 36 percent a year. After demand, the interest is two-tenths of one percent per day, or about 73 percent a year, on the tax plus the previous interest and the 25 percent lump sum penalty. These interest charges are clearly excessive, and serve to aggravate the delinquency problem.

It is recommended that the present system be replaced by the following:

(1) In the case of failure to pay tax prior to a demand, interest should be charged on the unpaid tax (including any civil penalties) at the rate of 12 percent per annum from the date prescribed for payment until the tax is paid.

(2) In the case of failure to pay tax upon proper demand (either after assessment of reassessment), interest should be charged on the unpaid tax (including any civil penalties and prior interest) at the rate of 24 percent per annum from the date the tax should have been paid pursuant to the demand until the tax is paid.

c. Extension of Time for Payment

In keeping with the penalty recommended or failure to pay on time, any extension of the time for payment granted by the Tax Office should be subject to a similar interest charge at the rate of 12 percent or 24 percent per annum, whichever is applicable. In all cases, interest may for simplicity be figured at 1 percent or 2 percent, respectively, per month of fraction of a month.

d. Civil Fraud Penalty

At present the only penalty applicable to fraud is a criminal penalty requiring prosecution for its application. Fraudulent activity should not go unpunished. In order to avoid the necessity of criminal prosecution in every case, it is recommended that a civil fraud penalty be adopted. Under such penalty, if any part of deficiency in tax is due to fraud with intent to evade tax, 60 percent of the amount of the deficiency in tax should be paid in addition to such deficiency. This penalty may be collected in the same manner as the tax, so that in effect it becomes part of the tax.

e. Failure to Keep Books and Records

There appears to be no income tax penalty applicable to an individual who fails to keep proper books and records. As indicated above, such record keeping is essential to proper self-assessment. In view of the recency of self-assessment, it is probably undesirable to make a failure to keep proper books a criminal offense under the income tax. It would be difficult properly to enforce such a penalty under the present inadequate condition of record keeping. In the future, however, after an intense educational campaign and other action designed to produce more widespread acceptance of the need for keeping proper books, it would seem appropriate to make a willful failure to keep proper books and records subject to a criminal penalty.

Undoubtedly other changes in the penalty provisions will suggest themselves as the administrative procedure improves. Consequently, continuous examination of these provisions will be necessary to insure their adequacy and fairness under developing administrative and taxpayer maturity.

9. Refund Procedure

As income tax assessment becomes more objective and as administrative operations become more effective, there will be an increase in the number of refunds due to taxpayers. Such refunds will arise from various causes: The tax shown on the declaration is higher than the final tax; the taxpayer has been successful in whole or in part as respects a protest of re-assessed tax; the tax withheld in the case of taxpayers also required to file returns is in excess of the proper tax, etc. Consequently, the refund procedure should be examined to see if changes are needed to permit it to bear such increased load. Interest paid on refunds should be coordinated with the 12 percent per annum interest charged for failure to pay tax on time. Refund claim forms should be devised which are simple to execute. Internal office procedures should insure prompt handling of such claims.

10. Delinquencies

The present income tax picture is marked by a very high delinquency rate as respects tax payments. As of 31 May 1949, the tax collections with respect to individual self-assessed income taxpayers for the taxable year 1948 were about ¥ 107,700,000,000 with a delinquency of approximately ¥ 35,183,000,000. In addition ¥ 6,570,000,000 was delinquent as respect 1947 taxes. The number of delinquent accounts was about 3 1/2 [# 3.5] million.

Such a delinquency situation is very serious. Proper tax administration cannot tolerate such a heavy load of unpaid taxes. Stern efforts are necessary to reduce these delinquencies immediately. It is estimated that a considerable percentage of the delinquent taxpayers could pay if proper and effective measures to enforce payment were taken. In other cases the delinquent taxes will be found to have been improperly reassessed. Tax Office personnel should be made immediately available to work on this matter and a persistent drive made to collect the unpaid taxes and to reduce the delinquencies to a reasonable level.

In the future, better record keeping would materially assist in curbing delinquency. The records of the Tax Office must be so kept as to permit it to become promptly aware of any delinquency and to send the delinquent taxpayer an immediate demand for payment. Such prompt action, followed by persistent efforts where necessary, would prevent the taxpayers from continuing in their non-payment through reliance on tax office inactivity. More objective reassessment and a proper scale of penalties and interest charges will also assist in reducing tax delinquency.

11. Simplification of the Tax Structure

The proper functioning of the administrative process is in large part dependent upon simplification of both the substantive tax structure and the procedural steps. Many of the substantive changes recommended will materially simplify the tax structure. Eliminating the co-living family rule, changing the dependent tax credit to a deduction from net income, increasing the personal exemptions, using last year's income as the basis for the declaration -- all these changes will greatly simplify the portions of the tax structure applicable to the mass of taxpayers. In addition, the rules as to which persons file returns, should be reexamined in the light of the various substantive changes to see if they can be simplified. The tax tables should also be checked to ascertain if they can be further simplified and their scope widened.

All forms which are required in one way or another from the large numbers of taxpayers, such as returns, declarations, instructions, employee withholding statements, and protests, should be examined from the standpoint of simplification. The Finance Ministry should obtain the assistance of advertising and publicity experts in the preparation of these forms. The tentative forms should then be tested by polling experts to obtain the reaction of taxpayers and to ascertain what parts prove troublesome and complicated. Advice should be obtained from representatives of the groups affected, unions, associations, chambers of commerce, farm organizations, etc. Similarly, such sample polls should be taken of employers and employees to ascertain what improvements are needed in the mechanisms of the withholding system.

[# end of Appendix D,section C ]