Procedures began in April 2016 for the long awaited listing of the first infrastructure fund on the Tokyo Stock Exchange targeted at investments in renewable energy plants and other infrastructure facilities.
Among the various measures and issues to consider in advance of listing an infrastructure fund, in this Letter, we outline how infrastructure funds are formed (incorporation procedures) and explain a number of points related to relevant permits, leasing fees and tax requirements through a case study of Takara Leben Infrastructure Fund, Inc., the first fund to be listed1 , 2 .
- Outline of Formation, Permits, Leasing Fees and Tax Requirements for Infrastructure Funds
- Summary of Infrastructure Fund Formation (Incorporation Procedures)
- Asset Management Company
- Summary of Infrastructure Fund Formation (Incorporation Procedures)
Similar to the Japanese version of REITs (J-REITs), infrastructure funds are likely to generally take the form of investment corporations (toushi houjin), which tend to be preferred by investors in terms of governance structure and other considerations.
In such case, in addition to the formation of the infrastructure fund itself, an asset management company (shisan unyou kaisha) must also exist to provide services for management of the assets owned by the infrastructure fund in accordance with the Act on Investment Trusts and Investment Corporations (toushi shintaku oyobi toushi houjin ni kansuru houritsu; the “ITIC Act”).
The asset management company must be registered to engage in an investment management business (toushi unyou gyou) as prescribed in Article 28, Paragraph 4 of the Financial Instruments and Exchange Act, and accordingly meet certain requirements for assets (minimum capital and minimum net assets of JPY 50 million, respectively), governance structure (establishment of board of directors and statutory auditor, etc. and internal regulations), personnel composition (securement of fully knowledgeable and experienced personnel) and other matters. Depending on the nature of the assets owned by the infrastructure fund and the subject assets invested, the asset management company may also be required to obtain permits under the Building Lots and Buildings Transaction Business Act (the “BLBTB Act”).3
In the case of the first listing project by Takara Leben Infrastructure Fund, Inc., Takara Asset Management CO., LTD (being an asset management company thereof) has established and maintained the various organs and divisions, including a board of directors, statutory auditor, investment management division, investment management committee, compliance division, compliance officer and compliance committee, and has also established risk management rules and maintained compliance structures.
- Infrastructure Fund
Upon establishment of an infrastructure fund, the asset management company described the above acts as an organizer (setsuritsu kikaku nin) to incorporate the investment corporation. After incorporation and satisfaction of certain requirements for the infrastructure fund (such as minimum net assets of at least JPY 50 million, a paid-in amount of at least JPY 100 million for investment equity (toushi guchi) issued at the time of incorporation, appointment of executive officers, auditing officers and accounting auditors, etc.), the infrastructure fund needs to be registered pursuant to the ITIC Act (normal processing takes approximately one month) to allow the same to conduct asset management activities. Once the investment corporation has been incorporated, asset management affairs are entrusted to the asset management company.
In the case of the first listing project by Takara Leben Infrastructure Fund, Inc., the asset management company, Takara Asset Management CO., LTD., acted as the organizer therefor.
- Listing Requirements
In addition to the above, listing an infrastructure fund requires fulfillment of the following conditions.
a. Major Formal Requirements for Listing Examination
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b. Major Substantive Requirements for Listing Examination
- Circumstances that allow proper disclosure of information (such as timely disclosure on the operator related information, and sufficient disclosure on the asset management company related information)
- Circumstances that allow sound management of the assets (such as proper implementation of basic policies on operator selections and risk management)
- Expectations for continuous distributions of cash or profit after the listing
- Listing is not considered unsuitable in terms of public interest or investor protection
- Points to Note in Relation to Permits
In addition to the above permits necessary to obtain on the part of investment corporations and asset management companies upon the formation of infrastructure funds, transition to the Leaseback Scheme4 may require some consideration of potential impact on the various project related permits that must be obtained in relation to the renewable energy business utilizing the infrastructure fund’s investment assets.
In other words, the project SPC would be required to obtain and maintain the various permits (such as an agricultural land conversion permit and forest development permit) that are necessary for the development and implementation of the subject project, and depending on the timing of the project’s transition to the Leaseback Scheme (i.e., transfer of the infrastructure assets, etc. and leaseback thereof), it would be important to consider how to avoid any adverse effects on the various existing project related permits in relation to such transition process and choose the appropriate methods and timing for such transition with respect to each such permit.
If a permit for conversion of agricultural land (Article 5 permit) was initially obtained pursuant to the Agricultural Land Act (nouchi hou) due to inclusion of the agricultural land on the project site, for example, then it may be necessary to re-apply for an Article 5 permit or undertake certain other measures for succession thereof if the transfer of rights for the subject project site and transition to the Leaseback Scheme are to take place prior to the completion of the business premised upon such Article 5 permit (i.e., installation of renewable energy facilities)5 . On the other hand, if such transfer is to be conducted after the completion of such premised business for the Article 5 permit, then there are no other particular steps that must be taken in relation to the Agricultural Land Act once a completion report has been submitted and accepted.
In terms of the project related permits, therefore, certain statutory procedural burdens could be avoided and potential need for practical coordination or arrangement with supervisory and relevant agencies or local municipalities could be minimized by adjusting the timing of the transfer of the subject infrastructure assets6 .
In the case of the first listing project on Takara Leben Infrastructure Fund, Inc., it seems that there is minimal impact on the project related permits since the target assets to be acquired are limited to the project facilities that are already in operation (already fully constructed).
- Substance and Method of Setting Leasing Fees (Fixed Leasing Fees vs. Variable Leasing Fees)
Once the Leaseback Scheme is in place, the infrastructure fund is expected to receive from the initial owner the leasing fees for the infrastructure assets, etc. which are leased back under such scheme. There are no particular statutory restrictions as to the substance or method of setting such leasing fees, and the probable options would be 1) a fixed leasing fee, 2) a variable leasing fee (varying with electricity sales revenue), or 3) a combination of the fixed and variable leasing fee. For project SPCs, a variable leasing fee structure may be a better fit compared to a fixed fee structure, but in terms of the allowed scope of the investment corporation’s business and from an investor perspective expecting stable earnings, the third option, a combination of fixed and variable fees that is also used for JREITs, could be a workable option upon the actual setting of leasing fees.
In this regard, in the first listing project, Takara Leben Infrastructure Fund, Inc. has opted for the third option above and set a leasing fee that in principle combines a certain fixed minimum guaranteed amount with a variable amount that is to be linked to the actual electricity sales revenue from the leased property (i.e., solar power plants). The relationship and ratio between such fixed minimum guaranteed amount and such variable amount is structured such that the majority of the leasing fee is to be comprised of the fixed minimum guaranteed amount, which is not linked to fluctuation of the actual electricity sales revenue (which is expected to be 100% of the expected monthly power sales amount calculated based on the estimated power generation), and in instances where the expected monthly power sales amount exceeds 110% of such fixed minimum guaranteed amount, such variable amount must be paid up to 50% of such excess amount.
- Tax Requirements (Conduit Conditions)
A key point to consider in transitioning to the Leaseback Scheme is that basically, the following conditions on conduit nature (doukan sei) must be met continually after such transition for an infrastructure fund to enjoy tax advantages (i.e., inclusion of dividends in deductible expenses):
Principle requirement: More than 50% of total assets must be comprised of “Assets Specified by Cabinet Order” (seirei de sadameru shisan; meaning certain specified assets within the scope designated by cabinet order and not including “renewable energy facilities” or investment interests (shusshi mochibun) in a silent partnership (tokumei kumiai) the principle business assets of which are such facilities; hereinafter the same)7 .
Exceptions: If the following conditions are met, the “renewable energy facilities” may be included in the “Assets Specified by Cabinet Order” from the date of the initial acquisition thereof until the business year ending by the date 20 years from the date on which the initial leasing commenced8 :
- The investment corporation has acquired the “renewable energy facilities” by March 31, 2017 (including, by the same date, acquisition by a counterparty (i.e., silent partnership operator; eigyou sha) to a silent partnership agreement (tokumei kumiai keiyaku) executed by the investment corporation of the “renewable energy facilities”, and acquisition by the investment corporation of investment interests under a silent partnership agreement in which a “renewable energy facility” is a business asset);
- Investment equities were publically offered upon incorporation (with an issue price of at least JPY 100 million) or are listed; and
- In the certificate of incorporation of the investment corporation, leasing is the sole method of management for the “renewable energy facilities.”
In the first listing project, Takara Leben Infrastructure Fund, Inc. has no specific plans to alter the type or ratio of its target investment assets upon expiration of the 20 year exception period above in order to continuously fulfill such conduit conditions.
In this regard, an issue that may arise in relation to the conduit condition is whether the “renewable energy facilities” that may be included in “Assets Specified by Cabinet Order” are limited to those acquired by March 31, 2017 (that is, whether any additionally acquired “renewable energy facilities” thereafter could be included in “Assets Specified by Cabinet Order”). From the language of the applicable laws and regulations and in light of the actual form of the expected investments and management, however, any such additionally acquired renewable facilities after such threshold date would also be included in “Assets Specified by Cabinet Order”9 .
In this regard, in the first listing project, Takara Leben Infrastructure Fund, Inc. intends to expand in future its assets by utilizing first refusal rights granted from its sponsor for the purchase of sponsor’s certain assets.