Would a private equity fund vehicle formed in your jurisdiction be subject to taxation there with respect to its income or gains? Would the fund be required to withhold taxes with respect to distributions to investors? Describe what conditions, if any, apply to a private equity fund to qualify for applicable tax exemptions.
Under Japanese tax law, a limited partnership is itself a non-taxable entity, and income or gain arising from investment through the partnership will be allocated to each partner without imposition of a tax at the limited partnership level. All distributions made by the limited partnership to foreign investors (if they maintain a permanent establishment in Japan) are generally subject to a withholding tax at the rate of 20 per cent. Other than this, neither the limited partnership nor the general partner is required to withhold taxes regarding distributions to partners.Local taxation of non-resident investors
Would non-resident investors in a private equity fund be subject to taxation or return-filing requirements in your jurisdiction?
According to a tax authority ruling, investment activities conducted by a general partner on behalf of a limited partnership are generally deemed to be activities jointly carried out by all partners of the partnership. Based on this idea, when a non-Japanese investor becomes a limited partner of a limited partnership, the investor is deemed to have a permanent establishment in Japan so that all investment income derived from the partnership is subject to Japanese taxation if at least one general partner of the limited partnership is a Japanese resident. Therefore, all distributions made by the limited partnership to foreign investors are generally subject to taxation in Japan. However, there is a statutory exemption, under which a foreign investor as a limited partner of a limited partnership is deemed to have no permanent establishment in Japan. In such cases, distributions made to the limited partner (that would otherwise be subject to taxation because of a permanent establishment) will not be subject to withholding tax in Japan and no obligation to file a Japanese tax return is imposed. To rely on the exemption, a foreign investor who satisfies all of the following requirements must file an application with the Japanese tax authorities via the general partner stating:
- it is a limited partner;
- it does not engage in business operations or management of the limited partnership;
- it does not hold 25 per cent or more of the whole of the partnership interests;
- it does not have any close capital relationship with the general partner; and
- it has no permanent establishment in Japan other than by virtue of having invested in the partnership.
Under Japanese tax law, even if a non-Japanese resident investor does not have a permanent establishment in Japan, when a non-Japanese resident investor possesses 25 per cent or more of the total issued shares of a Japanese corporation at any time within three years prior to the last day of the business year containing the date of transfer, and the investor transfers 5 per cent or more of the total issued shares, the transfer of shares is taxable in Japan (the 25 per cent/5 per cent rule). In calculating these ratios, the number of shares held or transferred by specific persons related to the investor is aggregated, and when the non-Japanese resident investor invests in a limited partnership which invests its partnership assets into shares of Japanese corporations, other limited partners of the limited partnership fall into the category of specially related persons. If, however, a non-Japanese resident investor that is a limited partner in a limited partnership satisfies certain conditions, it may exclude other partners’ shares to calculate the 25 per cent/5 per cent rule. This exemption applies when the non-Japanese resident investor satisfies the following requirements:
- either the limited partnership is one to which the previously discussed exemption applies, or during the relevant three-year period, the non-Japanese resident investor was not involved in the conduct of the operations or management of the limited partnership;
- at any time during the three-year period, no specially related person (other than other limited partners) of the non-Japanese resident investor held 25 per cent or more of the interest of the domestic company;
- the limited partnership held the relevant shares for at least one year;
- the investment target is not a proscribed type of insolvent financial institution; and
- the non-Japanese resident investor files certain documents with the Japanese tax authorities by 15 March of the following year (for an individual investor) or two months after the fiscal year-end (for a corporate investor).
Besides the above, capital gains resulting from any of the following share transfers are subject to Japanese tax unless otherwise exempted:
- the transfer of shares in a Japanese corporation by conducting certain market manipulations or greenmail activities against the Japanese corporation; and
- the transfer of more than 2 per cent (in the case of the listed shares, 5 per cent) of the shares in a corporation that derives 50 per cent or more of the value of its gross assets directly or indirectly from real estate (including related rights over real estate) in Japan by the non-Japanese resident investor and other specially related shareholders.
Is it necessary or desirable to obtain a ruling from local tax authorities with respect to the tax treatment of a private equity fund vehicle formed in your jurisdiction? Are there any special tax rules relating to investors that are residents of your jurisdiction?
There is no special necessity to obtain a ruling from the Japanese tax authorities.Organisational taxes
Must any significant organisational taxes be paid with respect to private equity funds organised in your jurisdiction?
To register the formation of a limited partnership, ¥30,000 must be paid as a registration tax.Special tax considerations
Describe briefly what special tax considerations, if any, apply with respect to a private equity fund’s sponsor.
On the assumption that the general partner is a corporate entity (as opposed to an individual), there are no special considerations regarding carried interest and management fees from the viewpoint of Japanese taxation.Tax treaties
List any relevant tax treaties to which your jurisdiction is a party and how such treaties apply to the fund vehicle.
Japan has entered into a number of tax treaties, and how those treaties apply to a specific fund vehicle or its partners depends on the specific facts, including the structure of that fund vehicle and the residence of the relevant parties.Other significant tax issues
Are there any other significant tax issues relating to private equity funds organised in your jurisdiction?
As with many other jurisdictions, the tax rules in Japan are complex and intricate. Nevertheless, tax matters occupy an important position in fund structuring, and we highly recommend that tax advisers are consulted with regarding the specific fund structure and investment.