Depending on the metrics, Japan is currently the world’s fourth- or fifth-largest economy by GDP, with sophisticated and well-developed debt and equity capital markets, and is home to many world-leading corporations. So it may be surprising that, until recently, the Japanese alternatives industry lagged behind that of other developed countries. However, Japanese fundraising and M&A activity has increased significantly over the past decade, and Japan’s domestic alternatives investment industry is becoming increasingly attractive to both domestic and foreign investors.

Private equity has a clear and unique value proposition in Japan, as a majority of the economy is made up of small and medium-sized enterprises, in addition to there being a persistent under-penetration of M&A, a paucity of succession options in light of Japan’s declining birth rate and rapidly aging population, and high inheritance taxes. Against this backdrop, recent government policies have directly and indirectly helped to foster the development of the domestic alternatives industry. The tightening of listing requirements on the Tokyo Stock Exchange has made take-private transactions by private equity firms more attractive, and reforms in law and at self-regulatory organisations such as the Japan Investment Trust Association have helped to make it easier for Japanese investors (particularly high net worth and retail investors) to access historically higher performing alternative investments for the first time.

Please refer to the Japan Trends and Developments chapter in this guide for information on key trends.

A variety of alternative funds can be established in Japan, including buyout, venture capital, private credit, hedge funds, real estate funds including J-REITs (ie, listed real estate investment trusts), and infrastructure funds, and there are relatively few limits on the types of foreign funds that can be marketed to Japanese investors.

The following six types of domestic fund structures may be formed under Japanese law and are commonly used by sponsors for their private equity funds. Their key characteristics and common uses are summarised below.

Nin’i Kumiai (NKs)

A nin’i kumiai (commonly referred to as an NK) is a type of contractual partnership that has been permitted under the Japanese Civil Code since it came fully into force in 1898. As a contractual partnership, an NK is governed under a written partnership agreement. It is a basic pass-through entity (ie, treated as being tax transparent) for Japanese tax purposes. An NK does not have separate legal personality under Japanese law. In an NK, both the fund manager and its investors (ie, its “members”) are deemed to be partners in a general partnership. All partners therefore generally share in the profits and losses of the partnership and have unlimited liability.

To mitigate unexpected losses, NK partnership agreements commonly declare that the fund manager will be ultimately liable for losses of the partnership, although third parties that transact with the partnership may still be legally entitled to assert claims against the partnership’s investors for their losses, notwithstanding any contractual agreements in the partnership agreement to the contrary. NKs are commonly used for small joint ventures, legacy fund structures and syndications, although the potential lack of limited liability can be a concern for investors.

Investment Business Limited Partnerships (IBLPs)

An IBLP (sometimes referred to by Japanese practitioners as an LPS) is a form of limited partnership established under a law enacted specifically to create this vehicle: the Limited Partnership Act for Investment (IBLP Act), which was enacted in 1998 to promote investment funds in Japan. The IBLP is the most commonly used vehicle for private equity funds in Japan.

It is based on the Civil Code partnership (NK), but with several additional features introduced by the special law, the most significant of which is the introduction of limited liability for investors (ie, limited partners), to the amount of their capital contribution. The manager of the fund acts as the general partner and has unlimited liability for the debts and obligations of the IBLP. Similar to an NK, an IBLP does not have separate legal personality under Japanese law. IBLPs are generally prohibited from investing 50% or more of their assets in foreign corporations, and must be registered in the commercial registry within two weeks of formation.

Limited Liability Partnerships (LLPs)

A Japanese LLP (yūgen sekinin jigyō kumiai) is a variation of the Civil Code partnership (NK) and is permitted under the Japanese Limited Liability Partnership Act, which became effective in 2005. In a Japanese LLP, each partner’s liability may be limited to the aggregate amount of its contributions to the LLP. Similar to NKs and IBLPs, Japanese LLPs do not have separate legal personality under Japanese law. They are typically treated as pass-through (ie, tax transparent) for purposes of Japanese law.

A key requirement for a Japanese LLP is that all partners must actively participate in the partnership’s activities; passive investment is not permitted. As a result, Japanese LLPs are typically not suitable for private equity funds seeking to raise capital from a broad range of passive institutional investors. However, where there are only a few investors who contemplate being actively involved in the fund’s investment activities, as may be the case with corporate venture capital funds, a Japanese LLP may be a suitable option.

Like IBLPs, Japanese LLPs must be registered in the commercial registry within two weeks of establishment.

Tokumei Kumiais (Silent Partnerships or TKs)

Another type of fund-like arrangement commonly used by alternative investment funds is a tokumei kumiai, commonly known as a “silent partnership” or a TK. TKs have been permitted under the Japanese Commercial Code since it became effective in 1899. Originally based on the German form of silent partnership (stille gesellchaft), a TK is not technically a fund and does not have separate legal personality; rather, it is a bilateral contractual relationship between a TK operator and a TK investor that meets certain requirements required of TKs under the Japanese Commercial Code.

In a TK, the TK investor and TK operator enter into a TK agreement that sets forth the terms under which the TK investor must contribute capital to a particular business operated by the TK operator, and under which the TK operator must distribute the TK investor’s share of profits from that business. The TK investor must be “silent” with respect to the operation of the TK operator’s business, with all business activities conducted in the operator’s name (and not, eg, in the name of a “fund”).

Funds contributed by the TK investor become the property of the TK operator. A TK investor does not have a direct interest in the assets of the business, and their liability is limited to the amount of their contribution. There are no registration requirements for forming a TK, although it must meet certain requirements set forth under the Commercial Code, including that the TK investor remains silent with respect to management and governance of the bilateral arrangement. Being characterised as a TK will permit TK investors to achieve certain preferential tax treatment.

A TK is essentially pass-through, although the tax treatment of a TK differs from other pass-through partnerships, particularly for individual TK investors, in that the TK investors will generally be subject to tax on its share of profits at the same rate as would be the case for ordinary income (instead of being taxed at a lower rate as capital gain income).

TKs are often used in combination with a Japanese gōdō kaisha (GK), which is a limited liability company that acts as the TK operator, in an arrangement known as a GK-TK scheme. Multiple parallel GK-TK arrangements may also be used to mimic a fund arrangement, subject to each GK-TK meeting the legal requirements applicable to TK arrangements. GK-TK arrangements are commonly used for real estate transactions, often below investor-facing aggregation vehicles.

Investment Trusts (Tōshi Shintaku or Tōshin)

Investment trusts, known as tōshi shintaku or tōshin, are domestic trusts that are established pursuant to a trust agreement and are subject to regulation under the Act on Investment Trusts and Investment Corporations (AITIC). In a tōshin, a trustee holds the trust property and a manager manages the trust. The tōshinhas no separate legal personality.

The AITIC requires certain filings and disclosures to be made. Under the AITIC, there are two categories of investment trusts, but the type most commonly used is the “Investment Trust Managed under Instructions from the Settlor”, which is limited to investing in certain specified assets, such as securities and real estate. A tōshin is commonly used for Japanese retail mutual funds and ETFs.

Investment Corporations (Tōshi Hōjin)

An investment corporation (tōshi hōjin) is a legal entity established primarily to pool funds from multiple investors for investment in various types of assets. Investment corporations are also subject to regulation under the AITIC. An investment corporation is a standard structure used for Japanese Real Estate Investment Trusts (J-REITs). Investors hold units in the tōshi hōjin.

The tōshi hōjin is required to satisfy certain criteria, including a requirement to distribute most of the income it receives within the same fiscal year in which it receives it. Satisfaction of these criteria will enable the tōshi hōjin to maintain pass-through tax treatment for Japanese tax purposes. This structure is common for both listed and non-listed REITs.

The Japanese regulatory regime generally divides alternative investment funds into two broad categories – partnership-type funds and corporate-type funds, with different regulatory regimes applying to each. In practice, partnership-type funds tend to be more commonly used for Japan-focused funds. Partnerships are characterised as collective investment schemes, with their interests falling within the definition of “securities”, as enumerated in Articles 2(2)(v) and 2(2)(vi) of the Financial Instruments and Exchange Act (FIEA). Consequently, any partnership-type entity that accepts Japanese investors is generally subject to regulation under the FIEA, even if the partnership is formed and operated outside of Japan and the partnership’s general partner is a non-Japanese entity.

If the partnership is subject to regulation under the FIEA, the general partner may be subject to separate (but sometimes overlapping) compliance regimes that govern the marketing (the “Marketing Regulations”) and management (the “Investment Management Regulations”) of the fund. Being subject to either the Marketing Regulations or the Investment Management Regulations would require the general partner to either register with the Financial Services Agency (FSA) or perfect an exemption therefrom by making a notice filing with the applicable authorities. A general partner would generally become subject to the Marketing Regulations if it were to engage in the offering of its interests in Japan or to Japan-resident investors, and would generally become subject to the Investment Management Regulations if it were to engage in investment management in respect of Japanese investors.

The Marketing Regulations and the Investment Management Regulations presume that the relevant activities are conducted by the general partner of the partnership, rather than by any third-party manager of the fund. Therefore, any registration or notice filing requirement under the Marketing Regulations or the Investment Management Regulations would typically be an obligation of the general partner of the relevant fund and not, for example, of a third-party manager or adviser.

Marketing Regulations

Under the Marketing Regulations, the general partner of a fund would, in principle, need to either register with the FSA as a “Type II Financial Instruments Business Operator” (a FIBO) or perfect an available exemption from registration in order to market interests in partnership-type private equity funds to Japan-resident investors. Registration as a Type II FIBO is a document-intensive process and may take several months (or even years) to complete. In light of the administrative burden and time requirements, many funds – at least initially – seek to perfect applicable exemptions from registration under the Marketing Regulations – eg, under Article 63 of the FIEA. Alternatively, a foreign fund may engage an existing Type II FIBO (such as a securities firm) and delegate the marketing of the fund to Japanese investors to such third-party firm.

Investment Management Regulations

Similar to the Marketing Regulations, general partners of partnership-type funds that have one or more Japanese investors are generally required to register with the FSA as a Type II “Investment Management Business Operator” (IMBO) or perfect an exemption from registration, although a broader set of exemptions may be available than under the Marketing Regulations. It generally takes longer to register as a Type II IMBO than to register as a Type II FIBO; as a result, foreign private equity funds often seek to rely on exemptions from the IMBO registration obligation to the extent available.

Exemptions

There are three main exemptions used by general partners of partnership-type funds:

• the Article 63 Exemption under the FIEA;
• the so-called “de minimis” exemption; and
• a foreign investor exemption that was introduced in 2021.

Article 63 Exemption

One of the more frequently used exemptions available under both the Marketing Regulations and the Investment Management Regulations is the Exemption for Special Business Activities for Qualified Institutional Investors, stipulated in Article 63 of the FIEA (the Article 63 Exemption) (a general partner relying on this exemption is referred to herein as an “Article 63 Exempted Operator”). Perfecting this exemption permits an eligible general partner of a fund with Japanese investors to engage in both marketing activities (including offering the interests in a fund to Japanese investors) and investment management activities in Japan. The general partner can perfect this exemption by making a “Form 20” notice filing with the FSA. The documents required to perfect the Article 63 Exemption can be submitted to the FSA in English.

Generally, the Article 63 Exemption requires that:

• at least one of the fund’s investors is a “Qualified Institutional Investor” (QII);
• the fund has no more than 49 Japanese investors who are not QIIs;
• each Japanese non-QII investor is an Eligible Non-QII;
• none of the Japanese investors is deemed a “disqualified investor”, including investors who are collective investment schemes (eg, fund-of-funds) that do not qualify for certain exemptions;
• the general partner submits a copy of its organisational document (articles of incorporation, LLC agreement, etc);
• officers and certain employees of the general partner submit their resume (CV) to the FSA and certify their compliance with certain eligibility requirements prescribed by the FIEA;
• the partnership interests are subject to certain transfer restrictions; and
• if the general partner is not a Japan resident, a local representative in Japan (who will be responsible for communication with the FSA) is appointed by the general partner.

In addition, the general partner will be required to comply with certain ongoing obligations under the FIEA, including:

• submitting a business report together with its balance sheet and profit and loss statements to the FSA within three months of the end of each fiscal year;
• making certain parts of its Form 20 and the business report available to the public (eg, on its website); and
• promptly filing an amended Form 20 after any relevant changes and/or submitting a copy of the general partner’s updated organisational documents if it is updated.

Article 63 Exempted Operators are also subject to supervision and enforcement by the FSA, including with respect to reporting requirements, on-site inspections and business improvement orders or business suspension orders.

For purposes of counting the number of investors in determining eligibility for the Article 63 Exemption, the exemption looks through fund-of-funds to the ultimate upper-tier investors, which must be included in counting the number of investors for purposes of the 49 non-QII investor threshold. Moreover, certain types of fund vehicles are prohibited from investing in a fund using the Article 63 Exemption.

The entire list of Article 63 Exempted Operators is publicly available on the FSA’s website.

Qualified Institutional Investors (QIIs)

QIIs are effectively the lynchpin of the Article 63 Exemption. The exemption is not available to general partners without a Japanese QII, making it difficult to perfect an exemption from registration without one. The definition of a QII is set by cabinet order under the FIEA. Investors that automatically qualify as QIIs include:

• banks;
• insurance companies; and
• IBLPs.

In addition, companies and individuals that hold investment assets (ie, securities) of at least JPY1 billion in value can become QIIs by duly making a filing with the FSA; this filing must be renewed biennially.

QIIs qualify as “professional investors” under the FIEA, so general partners that market to QIIs can take advantage of certain reduced regulatory burdens with respect to financial transactions, as discussed in relation to certain regulatory obligations described in more detail below.

Eligible Non-QIIs

Japanese investors who are not QIIs but who meet certain other requirements may qualify as “Eligible Non-QIIs” and can participate in a fund managed by Article 63 Exempted Operators. While the requirements for qualification as an Eligible Non-QII are substantially lower than those for a QII, the threshold may still be challenging for typical individual investors.

Transfer restrictions

As noted above, Japanese investors who invest in funds that rely on the Article 63 Exemption will be subject to certain restrictions on the transfer of their interests in such funds. Under these transfer restrictions, QIIs may only transfer their partnership interests to other QIIs, while Japanese non-QIIs may only transfer their entire interests to a single investor that is either a QII or an Eligible Non-QII. Appropriate transfer restrictions should be included in the relevant fund documentation (eg, the fund’s partnership agreement, subscription agreement, or other documents) in order to assure eligibility for the Article 63 Exemption.

De minimis exemption

Another exemption that may be available to the general partner of a partnership-type non-Japanese private fund that is marketed to Japanese investors is the so-called “de minimis exemption”. If the requirements for this exemption are met, the general partner would be exempted from registration as an IMBO and would also not need to make a Form 20 notice filing under the Investment Management Regulations.

The de minimis Japanese QII exemption requires that:

• the non-Japanese fund has fewer than ten direct or indirect Japanese investors – the rules look through collective investment schemes (eg, fund-of-funds) and count indirect Japanese investors of such a scheme for purposes of determining the number of Japanese investors;
• all direct and indirect Japanese investors in the fund must be QIIs; and
• aggregate capital contributions from Japanese investors must represent no more than one third of the aggregate capital contributions of all investors in the fund.

This exemption is only available with respect to the Investment Management Regulations; it is not available with respect to the Marketing Regulations. Therefore, subject to certain exceptions (eg, marketing through a placement agent or intermediary that is a Type II FIBO), the general partner of a foreign fund would still need to perfect an exemption from the registration requirements under the Marketing Regulations by making a Form 20 notice filing to offer interests to investors in Japan.

Typically, a general partner relying on the de minimis exemption would:

• rely on the Article 63 Exemption for marketing the fund to Japanese investors in compliance with the Marketing Regulations, by making the Form 20 notice filing;
• abolish the notice filing after final close; and
• rely on the de minimis exemption for purposes of the Investment Management Regulations, which is beneficial to general partners as it effectively exempts them from some of the more burdensome ongoing filing and compliance obligations under the Investment Management Regulations.

Foreign investor exemption

A new exemption for “Specially Permitted Business for Foreign Investors” (the foreign investor exemption) was introduced in 2021, and is generally available to foreign fund managers who establish a physical office in Japan. Satisfying the requirements for this exemption may be challenging for foreign fund managers; according to the FSA website, as of August 2025, only one applicant has utilised this exemption to date.

In order to qualify for this exemption, a number of criteria must be satisfied, including that:

• a majority of the aggregate capital contributions to the fund must be made by investors that are not Japanese residents;
• the investors in the fund must meet certain criteria stipulated in the FIEA, including that any individual investors (other than sophisticated investors) in the fund must have no less than JPY300 million in net investment assets; and
• the foreign fund manager must maintain a physical office in Japan.

Since this exemption is intended for foreign funds with a global investor base, Japanese investors eligible to invest under this exemption are generally limited to professional investors (a “professional investor” is defined under the FIEA to include QIIs, publicly listed companies, Japanese corporations whose capital is reasonably expected to be no less than JPY500 million, and foreign legal entities).

A foreign fund manager that relies on the foreign investor exemption is permitted to engage in both marketing activities and investment management activities in Japan by making a “Form 21-4” notice filing with the FSA. A foreign fund manager relying on this exemption will be subject to regulations and ongoing obligations similar to those applicable to general partners that rely on the Article 63 Exemption.

Significant reforms took effect in 2016 that imposed heightened public disclosure requirements on general partners relying on the Article 63 Exemption. The main disclosure requirements are summarised below.

Form 20-2 Disclosure

After filing the Form 20, an Article 63 Exempted Operator must, without delay, make certain information included in the Form 20 available either on its website or by other method that can be accessed easily by the public. The pro forma Form 20-2 is available on the FSA website. The FSA will publicly disclose the Form 20-2 on its website after submission.

Annual Disclosure of Business reports and Disclosure Booklets

Article 63 Exempted Operators are obliged to submit a “Business Report” on Form 21-2 annually within three months of the end of each fiscal year. If the only Japanese investors in the fund are professional investors, certain information may be omitted from the Business Report, including the composition of fund assets.

The Article 63 Exempted Operator must also publicly disclose a “Disclosure Booklet” on Form 21-3 (ie, an excerpt from the Business Report) at its office in Japan, on its website or by other means, for a period of one year, commencing four months after the end of each fiscal year of the general partner.

The general tax treatments applicable to partnerships under Japanese tax laws (including the Income Tax Act, Corporation Tax Act, Act on Special Measures Concerning Taxation, and related cabinet orders and administrative guidelines) are summarised below.

Pass-Through and Income Recognition

IBLPs, NKs and LLPs receive pass-through tax treatment under Japanese tax law. Any tax liability is attributed to the individual partners of the IBLP, NK or LLP, and not to the partnership itself. Each partner of an IBLP, NK or LLP is required to recognise its share of the partnership’s profits or losses for Japanese tax purposes, regardless of whether any monetary distributions have been made to such partner or not. Corporate partners must calculate their share of the partnership’s profits or losses for their own fiscal year and include such amounts in their taxable income or deductible expenses for such period. However, if the allocation of profits or losses to a partner occurs within one year after such profits or losses arose, the amount can be calculated based on the partnership’s accounting period and is treated as income or loss for the partner’s fiscal year in which such accounting period ends.

There are three methods for recognising profits and losses distributed from the IBLP, NK or LLP:

• the gross method (ie, recognising income, expenses, assets and liabilities in proportion to the partner’s share);
• the intermediate method (ie, recognising income and expenses in proportion to the partner’s share); and
• the net method (ie, recognising only profits or losses in proportion to the partner’s share).

If a corporate partner wishes to exclude dividends it has received from taxable income or claim a tax credit, the gross or intermediate method must be used. If a partner wishes to use reserves or provisions in the tax return, the gross method is the only method that allows such treatment.

For individual partners, income derived through the IBLP, NK or LLP must be classified according to its nature in the appropriate category of income under the Income Tax Act (eg, dividend income, miscellaneous income, business income, or capital gains from the transfer of shares). Individual partners may, subject to certain requirements, treat the partnership’s operating expenses as deductible expenses in calculating their taxable income.

Non-Deductibility of Excess Partnership Losses

For corporate partners, any portion of partnership loss allocated to such corporate partner that exceeds their aggregate capital contributions (ie, an excess partnership loss) cannot be deducted in the fiscal year in which it arises. However, if such corporate partner subsequently receives a profit distribution from the partnership in a later fiscal year, the excess partnership loss from prior years may be deducted up to the amount of such profit distribution.

Other Matters

If partnership assets are distributed in-kind to partners in proportion to their capital contributions, such distributions are not subject to taxation at the time of distribution.

If a partner withdraws from the partnership or transfers or redeems its interest, the transaction is treated as a transfer of the portion of the partnership’s assets attributable to that partner.

In addition, please see 4.8 Tax Regime for Investors for major tax exemptions applicable to foreign investors investing in Japan.

Any lender that engages in the business of originating loans in Japan is subject to the Japanese Money Lending Act. Only lenders that are registered under the Money Lending Act may engage in money lending business, which is defined as the origination of loans; origination is broadly defined and may include, for example, the intermediation of loans.

In 2024, the Japan Financial Services Association clarified an ambiguity as to whether the general partner of a partnership-type fund or the fund may make such registration by stipulating that either the general partner or the fund may register as money lenders.

The number of Japan-focused private credit funds has increased in recent years. One issue that has arisen with this increase is whether the investors in such funds might be considered “money lenders” for purposes of the Act. If investors are considered money lenders, they would also need to be appropriately licensed. The FSA has since clarified that investors in a Japan-focused credit fund will not be deemed to be money lenders for purposes of the Act, so long as the private credit fund meets certain specified requirements.

Crypto-Assets

An IBLP (the predominant fund vehicle for Japanese private equity and venture capital funds) has strict limitations on the types of assets into which it may invest. This is because the IBLP Act was originally enacted to support the growth of small businesses in Japan, and limited investments that could be made by an IBLP to those specifically enumerated in the statute. While these restrictions have been gradually relaxed over time, crypto-assets were not included among the permissible investments until very recently.

An amendment to the IBLP Act that came into effect in 2025 now permits IBLPs to hold certain crypto-assets. In principle, however, eligible crypto-assets are limited to those issued (minted) for the purpose of financing Japanese entities. In addition, under the amended IBLP Act, IBLPs may also hold crypto-assets or electronic payment instruments if those digital assets are received as a means of payment in transactions.

Real Estate

Real estate is not included in the list of assets in which an IBLP may invest under the IBLP Act and may only be held in limited circumstances – specifically, when it has been pledged as collateral for an IBLP’s investment and is subsequently acquired through foreclosure. However, an IBLP may hold real estate indirectly if the property is securitised and the IBLP invests by holding trust beneficiary rights in the securitised real estate.

By contrast, NKs and TKs are permitted to hold real estate directly, although doing so typically requires obtaining a licence under the Act on Specified Joint Real Estate Ventures. The TMK (tokutei mokuteki kaisha), which is a special purpose company established under the Act on the Securitisation of Assets, is another vehicle frequently used to form a real estate fund in Japan.

Japanese private equity funds frequently use special purpose vehicles (SPVs) as the direct holding entities for their investment activities. This structure helps to isolate risks and streamline financing arrangements in a private equity deal. In particular, when a private equity fund undertakes an investment using a leveraged buyout (LBO) loan, it is the SPV that will typically serve as the borrowing entity. By having the SPV act as the borrower for the LBO loan, the fund can both ring-fence liabilities within the SPV and facilitate more efficient execution of the acquisition.

That said, it is important to note that partnerships are not permitted to act as promoters of new companies in Japan. Accordingly, when a private equity fund organised as a partnership wishes to establish a new SPV in Japan, the SPV must first be incorporated by another party, after which its shares can be transferred to the fund.

One of the requirements of the Article 63 Exemption applicable only to non-Japanese funds is the appointment of a representative in Japan. If an Article 63 Exempted Operator is not a Japan resident, it must designate a local representative. This local representative may be either an individual or a corporation, and serves as the contact point for communications with the FSA or, in practice, the Kanto Local Finance Bureau.

Several service providers in Japan offer representative services for a fee to non-Japanese fund sponsors who otherwise have no local presence in Japan.

An amendment to the FIEA that came into effect in 2025 introduced a new regulation related to “investment management-related operations”. The new regulation covers accounting, compliance and other middle- and back-office functions connected with investment management activities performed for FIBOs and Article 63 Exempted Operators.

If a FIBO delegates its investment management-related operations to a registered investment management-related operator, its own eligibility requirements may be relaxed.

Investment management-related operators bear fiduciary duties under the FIEA and are subject to oversight by the FSA.

Some of the precise rules related to the amendments of the FIEA mentioned in 2.9 Rules Concerning Service Providers are yet to be finalised and are likely to be updated in the future.

Sponsors of a Japanese private equity fund have typically been Japan-based entities. However, in recent years, there has been a notable increase in the number of non-Japanese private equity sponsors establishing Japan-related funds.

Japanese LLPs have become increasingly common as the management entity used for such funds, and are particularly favoured where individual fund managers intend to receive carried interest from the fund.

It has been fairly common for domestic sponsors of Japanese private equity funds to act directly as the general partner of the managed fund, notwithstanding potential risks around liability. More recently, however, there has been a trend toward adopting a management company structure, under which a dedicated management company is established to manage and operate the fund business, with separate general partner vehicles formed for each separate fund or vintage. This structure allows for clearer segregation of responsibilities and better risk management and ring-fencing of liabilities across multiple funds.

Please see 2.1 Types of Alternative Funds and Structures and 2.2 Regulatory Regime for Funds.

There is no special tax regime applicable to fund managers in Japan. For the tax treatment of carried interest allocated to individual fund managers, please see 3.6 Taxation of Carried Interest.

Please see 2.4 Tax Regime for Funds.

FSA Notice on Tax Treatment of Carried Interest

Under Japan’s tax regime for partnership funds, where the carried interest allocated under the waterfall provisions of a limited partnership agreement (LPA) differs from a strict pro rata distribution based on each partner’s contributions, the distribution must be justified by demonstrating “economic rationality” in relation to the partnership’s business.

Until recently, however, the meaning of “economic rationality” had not been clearly defined. This issue has been particularly important for individuals serving as fund managers, since taxation for individuals depends on the classification of income (unlike the uniform corporate tax rate). A key question has therefore been whether carried interest received by individuals should be taxed as capital gains from the transfer of shares, or instead as business income or miscellaneous income arising from compensation for services rendered to the partnership.

On 1 April 2021, the FSA sought clarification from the National Tax Agency (NTA) on the concept of “economic rationality” in relation to carried interest. The FSA subsequently published a notice outlining the NTA’s response, the key points of which are summarised below.

Basic Principles

Under the guidance provided by the NTA, economic rationality must be assessed in light of the specific terms of each partnership agreement. That said, where the following conditions are satisfied, economic rationality will generally be recognised, and taxation on fund managers will follow the distribution ratios set forth in the partnership agreement.

With respect to the partnership agreement and the fund manager:

• the execution of the partnership agreement and the management of partnership assets must comply with applicable laws and regulations; and
• the fund manager must contribute capital (cash or other assets) to the partnership.

With respect to profit distributions, carried interest must be expressly provided for in the partnership agreement’s profit distribution provisions.

With respect to economic rationality:

• the terms and conditions relating to the distribution of profits under the partnership agreement must not be arbitrary;
• the terms of the partnership agreement must be generally consistent with prevailing market practice; and
• the fund manager must make substantive contributions to the partnership’s business.

With respect to non-arbitrary distribution conditions, the notice clarifies that such conditions require that the partnership agreement must have been entered into with the consent of all partners, and that the partnership must have multiple partners with potentially conflicting interests.

The notice clarifies that the requirement that terms of the partnership agreement must be generally consistent with prevailing market practice references a widely used distribution structure, including a hurdle with a catch-up followed by an 80/20 split. Since this waterfall is fairly standard in the industry, funds that follow this model would likely be deemed to be in conformity with market practice.

In light of the NTA’s response, carried interest received by individual fund managers will, in principle, likely be taxed as capital gains or losses arising from the transfer of shares, rather than as income arising from compensation of services, if the following conditions are met:

• the partnership has multiple partners with divergent interests;
• the general partner properly fulfils its obligations as the general partner of the partnership;
• the partnership agreement clearly specifies how carried interest will be allocated; and
• the profit splits and core economics of the fund do not materially depart from prevailing market practice.

Ancillary Documents

The FSA has also published some additional clarification relating to the notice:

• “Check Sheets” to confirm that the conditions for carried interest treatment are satisfied; and
• “Calculation Sheets” to break down carried interest income.

The FSA requests that these documents be attached to the final tax return for the fiscal year in which carried interest is reported.

Under the FIEA, in principle, investment management can only be delegated to an entity that is registered as an IMBO, and investment advice can only be provided by an entity that is registered as an investment adviser. By contrast, the outsourcing of other business operations is generally permitted. A number of service providers in Japan offer outsourcing solutions, particularly for fund administration and related operational support.

For recent regulatory developments concerning the outsourcing of middle- and back-office operations, please refer to 2.9 Rules Concerning Service Providers.

Japan does not adopt economic substance doctrine or economic substance tests. Please see 2.8 Local/Presence Requirements for Funds for the requirements regarding the appointment of a Japanese representative by an Article 63 Exempted Operator.

As a general matter, private equity funds operating under the Article 63 Exemption are not required to report changes in their shareholders.

By contrast, a party that becomes a major shareholder (shuyō kabunushi) of an IMBO registered under the FIEA must file a notice of such circumstances with the FSA. In addition, FIBOs are required to notify the FSA of changes in their parent company (eg, a new parent company, or a change in the name or address of the existing parent company).

There are no specific regulations applicable to fund managers in relation to AI and the use of data. However, fund managers are subject to the Guidelines for the Protection of Personal Information in the Financial Sector at the same level as other financial institutions, such as banks.

No substantial changes to the regulations relating to private equity fund managers are expected in the short term.

Traditionally, Japanese banks and large trading companies have been the principal investors in private equity funds. However, recent regulatory reforms have enabled pension assets – most notably the Government Pension Investment Fund (GPIF) – to take a more active role in private equity investing.

In addition, the Japanese private equity market has increasingly attracted non-Japanese investors, some of whom invest directly into funds established under Japanese law.

Side letters are widely used by Japanese investors, particularly institutional investors that are subject to regulatory restrictions on their private equity fund investments. At present, there are no specific rules in Japan that govern the use of side letters.

However, there are a few caveats. A side letter may not provide a limited partner with economic advantages deemed to be a “special benefit” (tokubetsu no rieki-teikyō), as such arrangements are prohibited under the FIEA. Unfortunately, there is no clear guidance on what constitutes a “special benefit.” The FSA states that whether an arrangement would be deemed a “special benefit” would be determined on a case-by-case basis, considering the reasonableness of the benefit under generally accepted social norms. As a practical matter, side letters are an integral part of private funds practice in Japan, and rights that are typically agreed to by sponsors in the market seem unlikely to constitute such a “special benefit”, but it is unclear whether this “special benefit” prohibition has ever been tested and to precisely what kind of unique rights or benefits it might apply.

Please see 2.2 Regulatory Regime for Funds for information on the marketing of alternative funds to investors.

Please see 2.2 Regulatory Regime for Funds and 2.3 Disclosure/Reporting Requirements regarding the rules concerning the marketing of alternative funds.

Until recently, Japanese retail and high net worth investors have not been significant investors in private equity funds. This has been due in part to regulatory restrictions, such as the rule under the Article 63 Exemption that only allows fewer than 50 Japanese non-QII investors to invest in a partnership-type fund, and regulatory limitations that made it difficult to distribute foreign alternative funds to Japanese retail and high net worth investors in a form that would be familiar to such investors.

Recently, however, securities firms and a few major private equity fund sponsors have increasingly focused on marketing to high net worth and retail investors. In particular, some securities firms now offer investment trust products that repackage private equity funds, making them accessible to a broader base of high net worth investors. Rule changes at the Japan Investment Trust Association that took effect at the end of 2024 also now permit domestic securities firms to distribute domestic investment trusts that invest in certain target foreign alternative investment funds, and the first such products have now begun to be distributed to Japanese retail and high net worth investors.

The rules on private placements and general solicitation under the FIEA are generally less restrictive than those in the United States. For example, there are no strict gun-jumping rules with respect to private placements of partnership interests in Japan; in practice, some Japanese private equity funds issue press releases announcing the initial closing of a fund even while continuing to fundraise and hold subsequent closings.

Although rules on solicitation are generally more liberal than in the United States, practitioners should still note that there are some significant compliance regulations under the FIEA’s marketing regime. For example, fund managers relying on the Article 63 Exemption are required to make a significant notice filing and disclose certain information in their offering materials, and in some cases must make certain information publicly available.

While many Japanese private equity funds conduct self-marketing of interests in their funds, some funds engage placement agents to expand their universe of potential investors. A placement agent involved in the offering of partnership interests must be registered as a Type II FIBO under Japanese law.

There is no specific prohibition under Japanese law against a fund’s own personnel receiving compensation in connection with the marketing of their fund interests. However, such personnel must exercise caution to ensure that their activities are not construed as providing placement services in the capacity of an independent third party, which would otherwise require separate registration.

Please see 2.4 Tax Regime for Funds regarding the general tax treatment applicable to investors.

Non-Japanese investors without a permanent establishment (PE) in Japan that invest through a tax-transparent collective investment scheme are generally not deemed to be subject to taxation in Japan, with certain exceptions. Notwithstanding such rule, two statutory safe harbours are available to non-Japanese investors that would, subject to qualification, shield such investors from becoming subject to Japanese taxation and tax filing obligations on account of such investor’s participation as a limited partner in a partnership. The two statutory safe harbours – one for PEs and the other for the so-called 25/5 Rule – are summarised below.

Permanent Establishments and the Statutory PE Exemption for Foreign Investors in Japanese Partnerships

A non-Japanese resident investor without a PE in Japan that invests as a limited partner in a partnership (eg, IBLP or NK) that is managed in Japan may be deemed to engage in the conduct of business in Japan, which would cause such non-Japanese investor to be deemed to have a PE in Japan and, therefore, absent an applicable exemption, become subject to Japanese tax and filing obligations. To avoid being deemed to have a PE in Japan on account of its investment in a Japan-managed fund, an otherwise eligible non-Japanese resident investor without a PE in Japan may avail itself of a statutory safe harbour from permanent establishment so long as the non-Japanese investor, among other things:

• holds less than 25% of the equity interest in the Japanese fund; and
• is not deemed to engage in the conduct of the “business operation” of the fund.

The Ministry of Economy, Trade and Industry (METI) has issued guidance on what constitutes “business operation” with respect to a fund, although the rules and the guidance are nuanced. A deep analysis of what constitutes engagement in the “business operation” of a fund is beyond the scope of this article, and foreign investors considering an investment in a Japan-focused fund formed as a partnership should consult with the fund manager, the fund sponsor or qualified Japanese legal and tax advisers to assess whether their participation in such fund might be deemed to constitute participation in the “business operation” of such fund and what the consequences of such a determination would be.

In order to perfect the statutory safe harbour from PE requirements, an eligible foreign investor must submit a filing (via partnership) in a predetermined form to the local tax authority to declare its intent to apply for this special exemption.

The 25/5 Rule and the Statutory 25/5 Rule Exemption for Foreign Investors in Japanese Partnerships

If a foreign investor who does not have a PE in Japan invests in a private equity fund organised as a tax-transparent partnership that invests in a Japanese company and such foreign investor owns (or together with its “specially related” shareholders is deemed to own) 25% or more of the equity interest in a Japanese company during a particular holding period, such foreign investor may, absent an applicable exemption, become subject to Japanese tax and filing obligations on capital gains from the disposition of such Japanese company if 5% or more of the shares in such Japanese company are disposed of during an applicable period (the 25/5 Rule). This is because such share disposition may be deemed to constitute a “business transfer”, which would be considered a taxable even for such foreign investor.

Under the aggregation principle referenced above, an investor’s equity interest in the underlying portfolio company is aggregated with its “specially related” shareholders, which are generally deemed to comprise the other partners in the partnership into which the investor invests. In other words, the 25% threshold is calculated on an entire partnership level basis rather than solely with respect to the individual partner. To illustrate, if the partnership through which the non-Japanese investor invests owns 100% of equity of a Japanese portfolio company, the non-Japanese investor will be deemed to own 100% of such company even if it has contributed only 1% towards the partnership’s investment in such company.

A statutory safe harbour was introduced in a 2009 amendment to the 25/5 Rule that permits a foreign investor in a partnership that otherwise meets certain requirements to perfect an exemption from taxation on disposition of the shares of the Japanese portfolio company. Among other requirements to perfect such exemption, the foreign investor must not hold 25% or more of the interest in the relevant Japanese company, calculated based solely on the non-Japanese investor’s individual interest in the partnership (in other words, the aggregation principal is waived for purposes of determining the foreign investor’s eligibility for the safe harbour).

To avail itself of the 25/5 Rule exemption, the foreign investor must timely make certain filings with the Japanese regulatory authorities. The partnership would also need to meet certain criteria, similar to that of the PE exemption above.

Japan has a number of tax treaties with foreign countries that offer benefits to eligible investors who invest from those countries. It should be noted that not every country has such a double taxation treaty, and the benefits vary from country to country for those that do. Consequently, when foreign investors invest in a Japanese corporation through a fund, to the extent that such fund is treated as a pass-through entity for tax purposes both in Japan and in the country where the foreign investor is domiciled, such investor must carefully examine whether a double taxation treaty is available for such country and further examine the extent to which it would be able to avail itself of any benefits under such tax treaty with respect to the treatment of income derived from the Japanese corporation, such as dividends and interest.

This assessment requires consideration of whether the tax treaty between Japan and the investor’s country of domicile provides for reduced withholding tax rates or other favourable treatment. In addition, investors should review the administrative procedures necessary to claim treaty benefits, such as filing applications with the Japanese tax authorities or obtaining certificates of residence. Ensuring compliance with these procedures is essential to secure the intended tax relief and avoid unnecessary withholding or double taxation.

FATCA

Japanese alternative investment funds are “financial institutions” under FATCA. Japan and the United States have entered into a Model 2 intergovernmental agreement with respect to FATCA, under which Japanese alternative investment funds are required to comply with certain due diligence, reporting and withholding obligations. Information with respect to US investors and non-compliant investors must be reported to the US Internal Revenue Service on an annual basis. If a Japanese alternative fund does not comply with its reporting obligations, payments of interest and dividends from certain US sources may be subject to withholding tax at a rate of 30%.

CRS

Japan is a member of the OECD. In order to implement the CRS for the automatic exchange of information, which was approved and published by the OECD in 2014, Japan amended the Act on Special Provisions of the Income Tax Act, the Corporation Tax Act and the Local Tax Act Incidental to Enforcement of Tax Treaties, etc (Special Taxation Measures Act) during the 2015 tax reform, which came into effect on 1 January 2017. Under the amended Special Taxation Measures Act, when engaging in new transactions, reporting financial institutions are required to have the counterparty submit a declaration form for identity verification to determine their country of residence. If the counterparty includes residents of countries that are parties to tax treaties, this information must be provided to the relevant tax officer in Japan.

“Reporting financial institutions” generally include general partners of investment funds; therefore, general partners are required to fulfil the obligations under the amended Special Taxation Measures Act.

Under the Act on Prevention of Transfer of Criminal Proceeds, both Article 63 Exempted Operators and FIBOs are required to obtain specified documentation for AML/KYC purposes prior to, or at the time of, executing a fund subscription agreement with each Japanese investor.

In particular, operators must collect sufficient information to verify the identity of the investor, including:

• identification of the individual signing the subscription agreement on behalf of the investor; and
• identification of the investor’s “effectively controlling person”.

If a transaction is deemed high risk under the Act (eg, it involves certain foreign politically exposed persons), operators must apply enhanced due diligence. Any transaction that gives rise to a suspicion of money laundering must be reported to the competent government authority.

In addition, the Act requires operators to maintain records of both investor identification procedures and transactions conducted with investors.

The Personal Information Protection Act, which governs personal data protection in Japan, has undergone multiple amendments in recent years. These revisions have tightened regulatory standards to align more closely with the recommendations of the Financial Action Task Force (FATF).

Fund managers, like banks and other financial institutions, are subject to the Guidelines for the Protection of Personal Information in the Financial Sector, and must therefore comply with equally stringent requirements for safeguarding investor data.

No substantial changes to the regulations discussed throughout 4. Investors are expected in the short term.