Key issues

Preparation

What measures should be taken to best prepare for a corporate reorganisation?

When corporate reorganisations are undertaken between group companies (ie, between a parent company and its non-wholly owned subsidiary), avoiding or mitigating the conflict of interest is often a key issue, especially when the non-wholly owned subsidiary is a listed company. On the other hand, due diligence is not always an important issue when a corporate reorganisation is conducted between group companies.

Employment issues

What are the main issues relating to employees and employment contracts to consider in a corporate reorganisation?

In the case of a merger, the working conditions of the dissolving companies continue to apply to the employees transferred even after the merger. If the dissolving company wishes to unify the working conditions, it needs to make amendments to the work rules by following Japanese labour law. Under Japanese labour law, there are strict restrictions on amendment to the work rules in a manner disadvantageous to the employees. In the case of a company split, labour contracts with employees shall be treated in accordance with the Act on the Succession to Labour Contracts upon Company Split (the Labour Contract Succession Act). Under the Labour Contract Succession Act, the splitting company must discuss with all its employees and obtain their understanding and cooperation for the company split. In addition, the splitting company must individually hold a discussion with the employees who belong to the transferred business regarding the details of the succession, and thereafter, must send notices to:

  • the employees (i) who are mainly engaged in the transferring of business and (ii) who will be transferred to the succeeding company (except for employees in (i)); and
  • the labour union, if applicable, by the earlier of two weeks before the date of the shareholders meeting to approve the company split or within two weeks from the date of execution of the company split agreement or preparation of the company split plan (if a shareholders’ meeting is not required, the earlier date shall be replaced by the latter).

Employees who are mainly engaged in the transferring of business but are not planning on being transferred to the succeeding company or newly incorporated company, or who are not mainly engaged in the transferring of business but are planned to be transferred to the succeeding company or newly incorporated company, may raise objections, and such employees may request that they be transferred or not transferred (as applicable) to the succeeding company or newly incorporated company. In the case of share exchange and share transfer, labour contracts with the employees are not transferred, since this results only in the change of shareholders. However, consultation with or the consent of labour unions may be necessary, depending on the agreement with the union.

What are the main issues relating to pensions and other benefits to consider in a corporate reorganisation?

There are seldom many complicated issues relating to pensions so long as the corporate reorganisation is conducted within the group companies. However, when the company absorbs another company within the same group whose place of business does not belong to the pension plans, employees of the absorbed company do not automatically belong to the pension plans of the absorbing company. In this case, it is necessary for an absorbing company to take the procedures to add the absorbed business place to its pension plans.

Financial assistance

Is financial assistance prohibited or restricted in your jurisdiction?

In Japan, there is no concept equivalent to financial assistance that is applicable to corporate reorganisations. However, directors of the company and parties to the corporate reorganisation should be aware of the duty of care and duty of loyalty of directors when considering a corporate reorganisation, unless such corporate reorganisation is undertaken between a parent company and its wholly owned companies.

Common problems

What are the most commonly overlooked issues or frequently asked questions in a corporate reorganisation?

Among others, one of the questions that is frequently asked is whether it is possible for a company with negative assets to be a party to a merger as a dissolving company. Although there are no clear provisions or controlling views on this question, it is generally considered to be legally possible.

Similar questions are often raised in the case of company splits, such as whether an insolvent company may only carve out its solvent businesses. Although this is legally possible, a splitting company should be aware of possible resistance by its creditors. Before the amendment to the Companies Act in 2014, creditors of the splitting company did not have any right unless the creditors’ rights were transferred to the succeeding company, and the exercise of fraudulent act cancellation rights under the Civil Code was the only possible way to argue. However, after the aforementioned amendment, creditors of a splitting company have the direct right against the transferring assets under certain conditions, in addition to the exercise of fraudulent act cancellation rights under the Civil Code.

Finally, one of the most commonly overlooked issues is the loss realised as a result of certain corporate reorganisations. As an example of a merger, when the surviving company is a parent company of the dissolving company, and the dissolving company has positive assets, the surviving company will suffer losses, if the amount of book value of the shares of dissolving company held by the surviving company is more than the amount of positive assets of the dissolving company multiplied by the percentage of shares held by the surviving company. In such case, corporate re-organisations require approval of the shareholders’ meeting, even if it falls under other conditions to qualify as a simplified merger (see question 15).

Accounting and tax

Accounting and valuation

How will the corporate reorganisation be treated from an accounting perspective? How are target assets and businesses valued?

Under the Japanese Generally Accepted Accounting Rules, accounting treatment of corporate reorganisations is basically governed by the Accounting Rule for Corporate Combination (the Corporate Combination Rule).

Under the Corporate Combination Rule, corporate reorganisations are classified into three types:

  • an acquisition;
  • a transaction among companies under common control; and
  • a formation of a jointly controlled company.

If a company acquires control over another company or its business by corporate reorganisation, such corporate reorganisation is, in principle, treated as an ‘acquisition’ and the purchase method is applied. Under the purchase method, the acquired assets and liabilities shall be valued at their fair value.

A corporate reorganisation falls under ‘a transaction among companies under common control’ if all of the combining companies or businesses are ultimately controlled by the same shareholder after the corporate reorganisation as before the corporate reorganisation, and such control is not temporary. In this case, the assets and liabilities transferred by the corporate reorganisation shall be recorded at their fair book value immediately before the corporate reorganisation.

A corporate reorganisation is considered to be ‘a formation of jointly controlled company’ if multiple independent companies form a company jointly controlled by them, pursuant to contract, etc. The assets and liabilities transferred from the jointly controlling companies to the jointly controlled company shall be recorded at their fair book value immediately before the corporate reorganisation.

Tax issues

What tax issues need to be considered? What are the tax implications of carrying out a corporate reorganisation?

In principle, a corporate reorganisation shall be tax-qualified if assets other than shares of the dissolving company, etc, are not allotted as consideration, and it is:

  • undertaken between companies that have a 100 per cent relationship or are 100 per cent controlled by the same person or entity and such 100 per cent control is expected to continue;
  • undertaken between companies that have a controlling relationship or are controlled by the same person and such control is expected to continue, and some other requirements are met; or
  • undertaken to jointly engage in businesses and certain requirements are satisfied.

Tax on a corporate reorganisation is different depending on whether such corporate reorganisation is tax-qualified or not. In the case of a merger, company split or share exchange, the capital gain and loss of assets and liabilities of the dissolving company, splitting company or wholly owned subsidiary resulting from the corporate reorganisation (in case of share exchange, only certain assets) are realised and subject to tax.

However, if a merger, company split or share exchange is a tax-qualified corporate reorganisation, such capital gain and loss is not recognised. In principle, shareholders of dissolving companies, shareholders of the splitting company that is allotted consideration for the company split, or shareholders of the wholly owned subsidiary after share transfer or share exchange are subject to tax on capital gain or loss as a result of the corporate reorganisation.

Also, in principle, shareholders of the dissolving company and shareholders of the splitting company that is allotted consideration for the company split are subject to tax on the deemed dividend.

If the shareholders of a dissolving company, of a splitting company that is allotted with consideration for company split, or of a wholly owned subsidiary after share transfer or share exchange, receive only shares of the surviving company after the merger, of the succeeding company or newly incorporated company after the company split, or of the sole owner after share transfer or share exchange (as applicable), as consideration for the corporate reorganisation, these shareholders are not subject to tax on capital gain or loss.

In addition, if a merger or company split is tax-qualified, the shareholders of the dissolving company or of the splitting company are not subject to tax on the deemed dividend. In the case of a merger, the succession of the net operating loss is often an important issue, and if the merger is tax-qualified, such succession is possible, subject to certain conditions.

If the draft bill is approved and becomes law, the shareholders of the acquired company who transferred their shares in exchange for the shares of the acquiring company in a ‘share delivery’ (see question 1) shall basically be subject to tax on capital gains or losses. No tax law amendment has been announced so far with regard to this point; however, deferral of the capital gains or losses is expected in order to facilitate the usage of the share delivery system.