Japanese Tax Proposals Will Hit Foreign Investors

by Mary Swire, Tax-News.com, Hong Kong

06 January 2005

The Japanese government is currently contemplating a series of new taxes that could have serious implications for foreign investors, particularly in the real estate, private equity and venture capital sectors.

With the ruling coalition, controlled by the Liberal Democrats, looking for ways of increasing tax revenues to fix an ailing fiscal system, the government is proposing to close a capital gains tax loophole on real estate transactions, whilst placing a 20% withholding tax on gains made by private equity and venture capital funds.

Under a commonly used loophole, both domestic and foreign investors have been able to mitigate the impact of capital gains tax by utilising offshore companies to convert ownership of real estate into shares. The company then distributes these shares to the investors, who liquidate their equity as the company sells its property holdings. As they are dealing in shares, investors can circumvent capital gains tax. However, the new tax proposal would seek to tax the capital gains arising from the sale of such shares.

Meanwhile, the tax changes affecting private equity and real estate, recommended by the ruling Liberal Democrats, have already been approved by the Ministry of Finance, although analysts warn that the move could have serious negative consequences for future buyout deals.

According to the Wall Street Journal, total private equity and venture capital investment in Japan tripled in 2003 to $7.2 billion, and 2004 is also expected to have been a strong year for investment in the sector. Without this source of funding, fund managers warn that many ailing Japanese firms will struggle to survive.

Other observers point out that the new tax proposals sit uncomfortably with Prime Minister Junichiro Koizumi’s pledge to increase foreign investment in the Japanese markets, and they are seen by many as a politically motivated attempt to pacify an electorate angry at increasing foreign intervention in the nation’s economy.

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