Details on The New Tax Bill

Further to our previous reports, here are some more details on the bill to provide tax exemptions to foreign investors who hold stakes in Japanese domestic investment limited partnerships. The bill passed the Diet late last month.

Investors (limited partners, “LP”) of a domestic investment limited partnership are seen as being engaged in "joint-business activities” with Japanese general partners and therefore deemed to have a permanent establishment (“PE”) within Japan, which in turn, leads to tax obligations.

The latest tax bill provides exemptions to certain foreign investors and non-resident investors from assuming PE status in Japan, even though they have directly invested in domestic limited partnerships as the LP.

To be eligible for the exemption, however, foreign/non-resident investors need to satisfy all of the following conditions (such qualified investors are called “Qualified Foreign Limited Partners”).

1) The investor must be a LP in the limited partnership.
2) The investor is not involved in the execution of the business of the limited partnership.
3) The investor should own less then 25% of the asset held by the limited partnership.
4) The investor is not affiliated with the general partner.
5) The investor does not have other PE except for the one for the investment limited partnership (to which this bill provides exemption).

It should be noted that a foreign investor without PE in Japan has NOT been subject to capital gain tax - while the investor could still be subject to the Quasi-Business Transfer Tax.

The bill also provides for changes in the application of Quasi-Business Transfer Tax. Under the Quasi-Business Transfer Tax (often called as 25%/5% rule or “Shinsei Tax”), if a non-resident investor acquires 25% or more of a Japanese company and the investor sells 5% or more of the company during any of the following three years, the realized gain will become subject to Japanese corporate tax rate of 30%. The rationale for this rule is that if an investor acquires more then 25% of a company, the investor should be regarded as being engaged in business activity rather than investment activity.

The latest bill will change the application of the 25% test from the current “per collective investment vehicle” basis to the “per each LP in the fund” basis. This change will reduce the chance of the Quasi-Business Transfer Tax being applied, as it is less likely that a LP owns more the 25% of a co-mingled fund.

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