Investing In... 2021

Last Updated January 18, 2021

Japan

Law and Practice

Authors



Anderson Mori & Tomotsune is a full-service law firm with over 500 professionals that is best known for serving overseas companies doing business in Japan since the early 1950s. It is proud of its long tradition of serving the international business and legal communities, and its reputation as one of the largest full-service law firms in Japan. Its combined expertise enables it to deliver comprehensive advice on all legal issues that may arise in the course of a corporate transaction, including those related to M&A, finance, capital markets and restructuring/insolvency, and litigation/arbitration. Most of its lawyers are bilingual and experienced in communicating, drafting and negotiating across borders and around the globe. The firm’s main office in Tokyo is supported by offices in Osaka, Nagoya, Beijing, Shanghai, Singapore, Ho Chi Minh City, Bangkok, Jakarta and Hong Kong.

The Japanese legal system has its origins in the civil law tradition and is mainly based on written law. Under the Constitution of Japan (1946), state power has been separated into three branches (ie, legislative, executive and judicial branches) which are independent of each other.

The legislative body is the Diet. The Diet possesses the authority to appoint the Prime Minister, enact laws, approve budgets and ratify treaties.

The executive power is vested in the Cabinet. The Cabinet consists of the Prime Minister and other Ministers of State, and it has the power to control and supervise all administrative branches. There are more than ten Ministries under the Cabinet. The organisation and affairs of each Ministry are based on the establishment law applicable to that specific Ministry.

Judicial power is vested entirely in the courts. The courts consist of the Supreme Court, high courts, district courts and summary courts. The courts handle civil, criminal and administrative cases. The Japanese judicial system has a three-tier structure and appeals may, in principle, be made two times. The Supreme Court is the court of last resort for all cases.

Under the local autonomy principle, administration in local areas is dealt with by local public entities (eg, prefectures and cities). The local public entities have both legislative and executive powers but not judicial powers.

Therefore, business entities operating businesses in Japan may be in touch with both national level bodies and with local level legislative and executive bodies.

Certain foreign direct investment (FDI) in Japan requires the review of the Ministry of Finance and relevant ministries under the Foreign Exchange and Trade Act (the FEFTA). Under the FEFTA, foreign investments in Japan may, in general, be freely conducted. However, investments from countries that have no treaties on inward direct investment (including some countries in Africa and Central Asia), and investments in "designated businesses" and "core businesses" may require FDI notification to the Japanese government. These businesses are:

(i) weapons, aircraft, nuclear facilities, space, dual-use technologies;

(ii) cybersecurity, electricity, gas, telecommunications, water supply, railways, oil; and

(iii) heat Supply, broadcasting, public transportation, biological chemicals, security services, agriculture, forestry and fisheries, leather manufacturing, air transportation or maritime transportation.

Designated businesses consist of (i), (ii) and (iii) and core businesses consist of (i) and part of (ii).

Notification of foreign investment in these industries to the Japanese government is given, via Bank of Japan (the Japanese central bank), prior to the acquisition of the Japanese company’s shares (pre-closing FDI notification) at least 30 days prior to the making of such investment. Upon receipt of the pre-closing FDI notification, the government will review, and may recommend changes to, or the cancellation of, the investment. If the foreign investor does not accept the recommendation, then the government may order a change or cancellation of the investment, which is legally binding. Please also note that many FDIs that are not subject to pre-closing FDI notification are still subject to a post-closing report, depending on the type of transaction.

The Japanese market has been affected by the recent COVID-19 pandemic to a certain extent. The Japanese government declared a state of emergency in April 2020 and, until it was finally lifted on 25 May 2020, many business activities had been suspended, and entry into the Japanese territory from overseas had been strictly restricted. While the state of emergency was different to a strict lockdown, as it did not involve a mandatory restriction on each individual’s activity, most people voluntarily stayed at home during the period. This greatly affected businesses, including restaurants, tourism, transportation, entertainment and aviation. In addition, the Tokyo Olympic and Paralympic Games, which were originally planned to be held in 2020, were postponed to 2021, and such postponement also had a huge impact on the Japanese economy.

The FEFTA and Government Attitudes to FDI

The drastic modifications of the Japanese FDI regulations, as outlined in 1.2 Regulatory Framework for FDI, was largely driven by the Japanese government’s desire to tighten the monitoring of inward investment from overseas into high-risk and sensitive businesses, in line with the similar movements in other countries. The modification was originally irrelevant to the COVID-19 pandemic. Prior to the announcement of the modification of the FEFTA in 2019, there were in fact very limited cases where the government had conducted an intense investigation into a specific FDI case, one of which was the well-known case of the potential acquisition of Toshiba Memory by foreign investors. The recent modification of the FEFTA is not expected to radically change the attitude of the Japanese government; however, it has at least already affected a number of FDI transactions by requiring pre-closing FDI notifications, as well as other follow-up notifications to the government, even subsequent to the completion of the transactions.

In addition to the above, with the recent COVID-19 pandemic, the necessity to protect domestic companies engaging in healthcare/medical activities related to COVID-19 prompted the Japanese government to add relevant sensitive business areas which trigger the pre-closing FDI notification requirement in July 2020. This will affect foreign investors’ potential investments in both listed and unlisted companies in Japan.

COVID-19 Trends

While, overall, the Japanese economy and the business climate does not seem to have been critically damaged by the COVID-19 pandemic, and there is no high-profile enforcement/litigation to be noted so far, some notable movements driven by the COVID-19 pandemic include:

  • a trend towards Japanese listed companies holding their shareholder meetings online/virtually;
  • aggressive investments by foreign-based private equity funds into Japanese businesses/assets, including their acquisition of non-core businesses/assets sold by high-profile companies;
  • continuing shareholder activism, which in particular is focused on requests for appropriate commercial decision and corporate governance in the COVID-19 situation;
  • increasing cuts to labour forces; and
  • increasing numbers of bankruptcies or voluntary rehabilitations chosen by companies affected by COVID-19.

These trends may continue until the threat of COVID-19 is over.

Share deals, asset deals, and corporate reorganisation transactions such as mergers and share exchanges are often used in Japan.

In general, with respect to the acquisition of more than one third of the shares in a public company, mandatory tender offer or takeover bid (called a TOB in Japan) regulations will kick in.

One of the main legislative purposes of the TOB regulations is to provide general shareholders with an opportunity to consider whether to accept the purchaser’s offer on an informed basis. The Financial Instruments and Exchange Act (the FIEA) provides for strict disclosure rules for a TOB, including:

  • public notice;
  • TOB registration statement and TOB prospectus; and
  • announcement of opinion by the target company.

Other than corporate reorganisation transactions, the consideration for acquisitions is generally cash.

However, in order to facilitate domestic and cross-border M&A transactions, relevant laws and regulations have been reformed and it is now easier to use the purchaser’s shares as consideration in the transaction.

As legal structures for M&A transactions become more flexible, the creation of tax efficient transaction schemes may become the most critical issue for companies/businesses in Japan.

Other than the regulatory regime under the FEFTA which, basically, applied to FDI, major relevant regulations in connection with domestic M&A transactions are antitrust/competition regulations and TOB regulations.

For antitrust/competition regulations, please see 6 Antitrust/Competition.

The TOB regulations, as stated in 3.1 Transaction Structures, generally apply to acquisitions of more than one third (or 5%, if the number of counterparties within 60 days is more than ten) of the voting rights of the shares in a public company. Other than the information disclosure requirements mentioned in 3.1 Transaction Structures, certain rules for conduct are also stipulated under the FIEA, which include that:

  • the TOB period shall be, in principle, 20 to 60 business days;
  • the terms of the TOB should be applied equally to all the shareholders throughout the TOB period;
  • the purchaser must not, in principle, change the terms of the offer in a way that is unfavourable to the shareholders; and
  • in principle, the purchaser cannot cancel or withdraw the TOB.

Under the Japanese Companies Act, there are four types of business vehicle:

  • the stock company (Kabushiki Kaisha);
  • the limited liability company (Godo Kaisha);
  • the general partnership company (Gomei Kaisha); and
  • the limited partnership company (Goshi Kaisha).

Stock Companies

The main business vehicle used in Japan is a stock company. All public companies are stock companies. Furthermore, most private companies are also stock companies. For tax reasons, a limited liability company (Godo Kaisha) may be more advantageous to overseas investors on some occasions (for example, limited liability companies can be deemed as pass-through entities under US tax laws), but, as it is a relatively new form of legal entity, it is sometimes deemed as lacking legal stability compared to a stock company. For overseas investors who seek to have a flexible governance structure, however, a limited liability company still seems an attractive choice.

The most common corporate governance structure with respect to a private stock company is a board of directors and corporate auditor(s). While it is possible for a private stock company to not have a board of directors that makes decisions concerning the organisation, operations and management via director(s) or the shareholder meetings, many private stock companies do. The corporate auditor(s) is a unique governance body; the role of which is to supervise, monitor the management decisions and the business operations conducted by the directors.

As regards public stock companies, it is common to have a board of directors and a board of at least three corporate auditors. Currently, in order to strengthen the corporate governance structure, a certain number of public stock companies have shifted to companies with three committees (namely, audit and supervisory committee, nominating committee and remuneration committee); all of which consist of at least three directors, with the majority as outside directors.

In 2013, a corporate governance reform was positioned as a key policy to promote foreign investment in Japan. This led to the establishment of the Stewardship Code as a code of conduct for institutional investors in 2014, and the Corporate Governance Code as a code of conduct for public companies in 2015.

The general principle under the Companies Act is to treat all shareholders equally.

Cumulative voting for appointing directors is allowed in Japan unless the articles of incorporation state otherwise. Therefore, even minority shareholders have the opportunity of appointing director(s). The Companies Act also stipulates that certain types of companies can issue shares of different classes and can let shareholders of those different classes elect their own directors. Accordingly, if minority shareholders can obtain a majority of votes within their share class, they have the opportunity to appoint a director to the board.

Further, under the Companies Act, minority shareholders are granted certain rights against the company and directors including, without limitation, the rights to:

  • require an inspection of the books, records and shareholders' register of the company;
  • require the convocation of the general shareholders' meeting and to submit an agenda for that meeting;
  • initiate a shareholders' lawsuit;
  • request the suspension of illegal conduct by directors; and
  • request the dismissal of directors and corporate auditors in certain cases.

A stock company must provide its annual financial statements at its head office and branch offices at least two weeks before its annual shareholders' meeting. Furthermore, a stock company shall publicly disclose a summary of its balance sheet (in the case of a large company, the balance sheet and profit and loss statement) for each fiscal year. In addition, changes to certain matters such as an increase of paid-in capital and amendments to the articles of incorporation shall be registered with the relevant authorities.

A public stock company must undertake more stringent disclosure obligations, such as:

  • business operation and financial statements must be disclosed to the general public on a quarterly basis in accordance with the FIEA; and
  • any material information – such as a merger, corporate split or declaration of dividends – must also be disclosed in a timely manner in accordance with the listing rules.

The main equity market in Japan is the Tokyo Stock Exchange (TSE), established in 1878. The TSE mainly offers three markets:

  • the first section (for blue-chip companies with high liquidity) on the main board;
  • the second section (for well-established medium-sized companies) on the main board; and
  • Mothers (for emerging companies).

In addition to these markets, the TSE manages JASDAQ (for emerging companies). JASDAQ offers two markets:

  • JASDAQ Standard; and
  • JASDAQ Growth.

Currently, the TSE is considering recategorising these five markets into three new markets (Prime Market, Standard Market and Growth Market).

Bank financing is another way to access funds. Companies will choose how to raise funds through capital markers or debt financing based on various factors such as, interest rates, relationships between banks, funding costs, shareholders’ intentions or overall trends in capital markets.

The key statutes and regulations affecting the securities markets in Japan are set out below.

The FIEA

The FIEA regulates the issuance, placement and trading of securities, such as corporate shares, corporate bonds, and interests or shares in investment trusts and investment corporations. It also regulates the primary and secondary markets of such securities in Japan.

The FIEA regulates financial transactions in a cross-sectoral manner including various derivatives, commodity funds, partnerships, investment advisory/management services, investment trusts, etc.

The FIEA also regulates the dealing, brokering, underwriting and distribution (acting as a selling group member in a public offering), and arranging of private placement of FIEA Securities by foreign securities firms.

The Act on Investment Trusts and Investment Corporations

The Act on Investment Trusts and Investment Corporations (ITICA) regulates investment trusts and investment corporations, both domestic and foreign, including the establishment and operation of investment corporations registered as such under the ITICA, while the operation of domestic investment trust management companies registered as such under the FIEA are primarily regulated by the FIEA.

JSDA Rules

The rules of the Japan Securities Dealers Association apply to all securities dealing. In addition to these, each securities exchange also has its own rules to regulate public companies.

FDI through investment funds is also subject to regulations under the FEFTA. See 7 Foreign Investment/National Security for details of the regulations under the FEFTA. When filing a pre-closing FDI notification under the FEFTA, information regarding general partners (and parent companies) of the funds may also need to be disclosed.

The rules and regulations applicable to the marketing and sale of interests/shares in foreign investment funds are categorised into two major parts. The rules and regulations applicable to foreign investment trusts/foreign investment corporations are entirely different from those applicable to interests in foreign collective investment schemes. Therefore, the specific requirements to be met for private placement of the funds vary depending on the legal characteristics of each fund.

If the fund is regarded as either a foreign investment trust or foreign investment corporation, under the current regulatory environment and practice applicable to fund-type securities, there are two private placement exemptions for newly issued interests in the fund (namely, the “small number offerees exemption” and the “qualified institutional investors exemption”).

If the fund is regarded as a foreign collective investment scheme, a private placement for newly issued interests in the fund would be available if the number of investors is 499 or fewer (note that the threshold number is counted based on the number of subscribers, not the number of offerees). In practice, however, the number and category of Japanese investors would need to be limited in order to enjoy exemptions from the registration requirements imposed on the general partner of the fund.

Japan has a merger control regime. Certain types of FDI involving a “business combination” – such as the acquisition of shares, amalgamations, joint share transfers, and acquisition of businesses – would trigger a requirement to file a prior-notification to the Japanese Fair Trade Commission (JFTC). For example, in the case of an acquisition of shares, a prior notification would be required if:

  • the total domestic sales of the acquiring company’s side exceed JPY20 billion;
  • the total amount of domestic sales of the acquired company and all of its subsidiaries exceeds JPY5 billion; and
  • the ratio of voting rights of the acquiring company after the acquisition newly exceeds 20% or 50%.

The requirement to file a prior notification applies regardless of whether the company is a domestic company or a foreign company.

If a business combination is subject to the prior notification requirement, it is prohibited, in principle, for the companies to close the transaction for a period of 30 days after filing the prior notification unless the JFTC shortens this period at its discretion. The JFTC may request reports, information and materials from the parties during the period, and if it is considered necessary, this waiting period may extend up to 120 days from the filing of prior notification.

A business combination that would result in the substantial restraint of competition in any field of trade is forbidden under the Antimonopoly Act. This regulation is applied regardless of whether such a business combination triggers the prior notification requirements mentioned in 6.1 Applicable Regulator and Process Overview.

As to the criteria for review, the JFTC publishes “Guidelines to Application of the Antimonopoly Act Concerning Review of Business Combination” (the Business Combination Guidelines). The Business Combination Guidelines gives safe harbour in deciding whether a horizontal business combination substantially restrains competition. If the parties involved fall under any of the following situations after the implementation of the proposed business combination, the horizontal business combination is not considered to be a restraint on competition:

  • Herfindahl-Hirshman Index, which is the sum of the square value of the market share for each enterprise in the particular field of trade (HHI), after the business combination is 1,500 or less;
  • HHI after the business combination is between 1,500 and 2,500, and the increase of HHI is no more than 250; or
  • HHI after the business combination is more than 2,500 while the increase of HHI is not more than 150.

The Business Combination Guidelines also provide that the JFTC is highly unlikely to conclude that any business combination falling within the following threshold would substantially restrain competition:

  • HHI after the business combination is 2,500 or less; and
  • the market share of company groups after the business combination is 35% or less.

In the review of business combinations, the JFTC may require remedies from the parties to a contemplated business combination. The Business Combination Guidelines illustrates certain types of remedies that the JFTC may require.

Business Transfer from a Party Group to Its Competitor

According to the Business Combination Guidelines, creating a new independent competitor or strengthening its existing competitor should be the prime remedies. The Business Combination Guidelines provide the following as examples:

  • transferring of all or a part of relevant business to competitor;
  • dissolution of combination within the party groups (decrease of holding ratio of voting rights, etc); and
  • dissolution of business alliance with third parties.

Other Remedies or Commitments

The Business Combination Guidelines also provide the following remedies or commitments:

promotion of imports and new entries into the relevant market such as committing to allow importers to use stock or logistics facilities that are necessary for the relevant business; or

commitment on actions and conduct of the parties, such as committing to not exchanging sales information between sales department and production department within the party group, etc.

The JFTC has the authority to block FDI that would result in the substantial restraint of competition in any field of trade, either before or after the investment is made. Decisions of the JFTC may be appealed in a competent court.

In the case where a FDI is made without the prior approval of the JFTC:

  • a cease-and-desist order by the JFTC to the relevant parties, which may include disposition of such investments, can be placed; and
  • a criminal penalty may be imposed on the relevant parties and individuals.

Relevant Authorities and Types of FDI Subject to Review

Certain FDI in Japan requires review from the Ministry of Finance and relevant ministries pursuant to the FEFTA. Among other actions, certain acquisitions of a Japanese company’s shares would require foreign investors to file a pre-closing FDI notification.

The key factors to be examined in determining whether a pre-closing FDI notification applies to a foreign investor’s contemplated acquisition of shares in a Japanese company are as follows:

  • whether the target is engaged in a designated business;
  • the stake that the foreign investor intends to acquire in the target; and
  • whether the target is privately held or listed on a Japanese stock exchange (acquisition of only one share of a privately held company would trigger pre-closing FDI notification, whereas acquisition of 1% or more of the shares of a listed company would trigger such notification.)

Exemptions

For acquisition of a privately held company

If the designated business of the Japanese company is not a core business, an exemption may apply. This exemption requires the foreign investor to refrain from participating in the business of the target company with respect to the following specific actions (“general restrictions”):

  • neither the foreign investor, nor its related persons shall become board members or corporate auditors (Kansa-yaku) of the target;
  • the foreign investor shall not make shareholder proposals for the divestiture of functions or assets in the designated business in whole or in part; and
  • the foreign investor shall not access non-public information concerning the target's technology in the designated business, propose any disclosure of such information or request any changes to the target’s internal rules concerning the control of such information.

For acquisition of a listed company

If the foreign investor is a financial institution and undertakes the general restrictions, the investor will be exempted from the pre-closing FDI notification requirement.

If the foreign investor is not a financial institution and undertakes the general restrictions, the foreign investor will be exempted from the pre-closing FDI Notification requirement subject to the following further requirements.

  • If the designated business of the target company qualifies as a core business, the foreign investor must accept the following additional restrictions:
    1. the foreign investor shall not attend any meetings of the target’s executive board/committees where decision-making concerning the Core Business activities is discussed; and
    2. the foreign investor shall not submit any written recommendations regarding the core business activities to any of the target’s executive board/committees requiring action or response within a specific timeframe.

Even if the foreign investor undertakes all the applicable restrictions, no exemption will be available if the foreign investor intends to acquire a stake or voting rights of 10% or more of the outstanding shares of a target company engaging in a core business.

Foreign governments or government-affiliated entities are, in principle, not eligible for the exemption described above.

Timeline of Pre-closing FDI Notification

If a pre-closing FDI notification will be submitted, its lead time will need to be factored into the transaction schedule in consideration of the mandatory waiting period as described below.

  • Generally, 30 days – as a general rule, where a pre-closing notification is required, a 30-day waiting period applies from the date of the filing.
  • Possibility of shortened waiting period – for simple cases not requiring scrutiny, the Bank of Japan has been given authority to provide filers with a notification of acceptance within a shortened period.
  • Possibility of extended waiting period – the government may extend the waiting period to up to five months from the date of the filing where the government deems that the contemplated transaction warrants particular scrutiny for its potential impact on national security or the Japanese economy.

In the review process, the government considers whether the contemplated transaction warrants particular scrutiny for its potential impact on national security or the Japanese economy.

The government may ask the foreign investor, among other things, for the following information:

  • basic information about the investor and related parties;
  • the investor's investment activities;
  • the investor's intention to be involved in management of the target;
  • the business scale and content of the investor; and
  • matters concerning the information management system of the investor.

The government does not clearly explain whether its criteria, considerations and analyses of review are different for:

  • partnerships and joint ventures;
  • acquisitions by foreign governments or government-affiliated entities; or
  • non-controlling minority investments.

However, since the FEFTA treats foreign governmental entities and other entities differently, and certain forms of minority investment are not subject to the pre-closing FDI notification, it is reasonable to expect that the government may see the three types differently in its review process.

The government may recommend a change to the details, or the cancellation, of the investment upon its review of the pre-closing FDI notification. A foreign investor who receives such a recommendation may either accept or reject it. However, if the foreign investor does not accept the recommendation(s), the government may order a change to the details, or the cancellation, of the investment, which is legally binding.

During the history of the FEFTA, there has only been one publicly available case where the government issued an order to cancel the investment to a foreign investor. This does not mean, however, that the government accepted all other investments. Rather than issuing an order, the government tends to, officially or unofficially, recommend that an investor voluntarily withdraw its notification in cases where the government is of the view that the investment should not be implemented.

As a condition for clearance, the government occasionally requests that the investor make certain commitments in connection with the target company and/or the designated business (eg, not proposing the company to dispose of the designated business).

As described in 7.1 Applicable Regulator and Process Overview, if an exemption is applied to a foreign investor, the foreign investor shall comply with the general restrictions and additional restrictions where applicable.

Violation of the FEFTA and/or an order made by the government may be subject to criminal sanctions such as imprisonment and/or fines. Such criminal sanctions may be disputed through criminal litigation before the relevant courts.

There are no legal restrictions for a foreign investor in real estate transactions in Japan.

Under the FEFTA, cross-border transfer of a certain amount of funds is subject to post-facto reporting; however, such filing is generally handled by financial institutions in Japan involved in these transactions.

Industry-Specific Regulation

With regard to industries such as telecommunications, broadcasting and aircraft, which are related to public infrastructure, there are cases where foreign investment regulations are included in the laws regulating the relevant industry.

For example, the Civil Aeronautics Act provides that if one third or more of the voting rights of a corporation are held by foreign entities, the aircraft owned by the corporation may not be registered (Article 4 of the Civil Aeronautics Act). This means that if one third or more of the shares of a Japanese airline company are acquired by foreign entities, the airline company will be unable to continue its business operations. In order to avoid this, the Civil Aeronautics Act permits airline companies to reject any request for a registration of foreign entities in its shareholder registry if the change will result in one third or more of the shares being held by foreign entities.

Similarly, the Radio Act and the Broadcast Act limit foreign investment in corporations with radio station licences to not more than one third or one fifth (depending on the type of licence) of their voting rights, and the Act on Nippon Telegraph and Telephone Corporation, etc limits foreign investments in Nippon Telegraph and Telephone Corporation (NTT) to not more than one third of its voting rights.

Corporate tax and consumption tax are the main taxes generally imposed on companies doing business in Japan.

Corporate Tax

Corporate tax is a tax on the income of companies. Corporate tax is imposed on all incomes of domestic corporations regardless of whether their sources are in Japan or abroad. For foreign corporations, only domestic source incomes are subject to taxation. Partnerships are not subject to taxation, but their partners are taxed.

Consumption Tax

Consumption tax is a kind of value added tax. It is imposed on nearly all domestic transactions (sale and lease of goods and provision of service for consideration) and import transactions, excluding certain transactions, such as transfers and lending of land and transfers of securities.

The consumption tax rate is 10% of the sales amount, while the reduced tax rate of 8% applies to certain sales transactions, such as the transfer of foodstuffs.

Consumption tax is imposed on companies whose revenue for the fiscal year preceding the last fiscal year is more than JPY10 million.

Other Taxes

In addition to the above, the following notable taxes may be imposed on companies:

  • withholding income tax;
  • corporate inhabitant tax;
  • business tax;
  • fixed property tax;
  • real property tax;
  • registration and licence tax; and
  • stamp tax.

Withholding at Source

For foreign corporations, Japanese taxation is relevant only in respect of their domestic source income. Certain domestic source income such as:

  • dividends received from Japanese corporations or distributions of profit from certain investment trusts in Japan;
  • income from a partnership, which means the income received through a distribution that is made in accordance with a partnership agreement in Japan; and
  • interest on bonds and debentures, which include interest on bonds or debentures issued by Japanese corporations and interest on deposits with banks or other financial institutions in Japan,

is subject to withholding at source.

The tax rate of withholding at source is, in principle, 20% (20.42%, including special income tax for reconstruction; hereinafter the same) with certain exceptions such as 15% (15.315%) for dividends from listed companies, 15% (15.315%) for interest on bonds and debentures.

Taxation under Tax Treaties

For the purpose of avoiding international double taxation, tax treaties are in place between Japan and other countries. In the case where there is a conflict between a provision of tax treaty and that of local tax law, the former will prevail in principle. Tax treaties may provide rules regarding domestic source income or tax rates which are different from those provided by domestic tax laws. For example, under the Convention between the Government of Japan and the Government of the United States of America for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income (the Japan-US Tax Treaty), lower tax rates apply to dividends and interest (10% and 0%, respectively). In the case of dividends, if dividends paid between a parent-subsidiary relationship (where the parent has (i) no less than 10% and no more than 50%, or (ii) more than 50% of the subsidiary’s shares), the rate is (i) 5% or (ii) 0% under the Japan-US Tax Treaty.

There are no general limitations for “treaty shopping” under domestic tax law, but some treaties have the following to counter treaty shopping:

  • only “beneficial owner” (not “receivers”) of dividends, interests, royalties are eligible to receive benefits by the treaty;
  • certain “limitation of benefits” clauses applies; and
  • a "principal purpose test” applies.

Tax Benefits of Consolidation by Companies and Their Controlled Subsidiaries

Tax benefits of consolidation by companies and their controlled subsidiaries are available. A company may, with approval by the National Tax Agency, adopt the consolidated return framework for itself and its subsidiaries that are, directly or indirectly, wholly owned by it. Under this consolidated return framework;

  • corporate income tax is calculated based on the group’s consolidated income and payable by the domestic controlling corporation as the taxpayer;
  • contributions, donations and dividends within such group companies are disregarded; and
  • the recognition of the profits and losses arising from transfers of certain kinds of assets within such group companies will be deferred until transfer of such assets to the entity out of the group.

This consolidated return framework is going to be replaced with a new group relief framework, which will be effective from any business years starting on or after 1 April 2022. Under the new group relief framework, each company within the group will pay corporate tax calculated by offsetting profits and losses among the group companies, while the ultimate parent company pays corporate tax on the group’s consolidated income under the current framework.

Earning Stripping

A foreign investor may avoid tax on its Japanese subsidiaries through the excessive payment of interest from them to persons in foreign countries. To prevent this, the earning stripping rule applies in Japan. This rule provides that a corporation is not allowed to include “net interest” payments (excluding interest payment which is included in taxable income of the recipient in Japan) in excess of 20% of the “adjusted income” of such a corporation into deductible expenses.

In principle, there are no general exemptions for capital gains from sale or other disposition.

However, capital gains from the sale or other disposition of stocks in Japanese companies by a non-resident without permanent establishment are generally exempted from Japanese tax other than in the two situations discussed below.

Quasi-business Transfer

Capital gains from the sale or other disposition of certain large portions of stocks in Japanese companies by an FDI may be taxed. Specifically, when an FDI, who holds 25% or more of the outstanding shares of a Japanese company, sells 5% or more of the outstanding shares of such a company, the capital gains from such a transaction are subject to Japanese taxation.

Stocks in a Real Estate Related Corporation

Capital gains from certain sales or other disposition of stocks in a Japanese company whose real property accounts for 50% or more of the total assets of that company (a real estate related corporation) may be taxed. For example, in the case of stocks in a non-listed Japanese company, when an FDI (who holds more than 2% of the total outstanding stocks of a real estate related corporation on the last date of the preceding business year) sells stocks in that corporation, the capital gains from the transaction are subject to Japanese taxation.

Below are the special anti-avoidance rules that may be imposed on FDI in Japan.

Transfer Pricing Rules

If the price of a transaction between a Japanese company and its foreign affiliated company deviates from the price that would be used in the same transaction if carried out between unrelated parties, that transaction is deemed to have been conducted using the transaction price between unrelated parties. In such a case, the relevant tax liability will be recalculated accordingly.

Thin Capitalisation Rules

Thin capitalisation rules apply if a Japanese subsidiary receives a loan from its foreign parent entity in the amount of more than three times the amount of capital contributed by such foreign parent into the subsidiary. In that case, that Japanese subsidiary may not include the interest for the excessive amount into deductible expenses.

If both the thin capitalisation and the earnings stripping rules apply to a corporation, the larger amount between them will be used as the amount against which the revenues of the corporation in the relevant fiscal year cannot be offset.

Controlled Foreign Corporation (CFC) Rules

A corporation may try to avoid Japanese taxation by establishing a subsidiary in a foreign country with low tax rates and accumulating profits in that subsidiary. To counter this, the CFC rules were introduced. The CFC rules focus on each activity of a subsidiary in a foreign country. For example, if a subsidiary in a foreign country falls within the category of a paper company, a company deemed to be an actual cash box or a company located in a blacklist country, the profit of the subsidiary will be included in the shareholders’ gross revenue amounts for Japanese tax purposes unless the tax rate applying to the subsidiary is 30% or more. If a subsidiary in a foreign country (other than a paper company, etc) does not satisfy certain economic activity requirements, the profit of the subsidiary will be included in the shareholders’ gross revenue amounts for Japanese tax purposes unless the tax rate applying to the subsidiary is 20% or more.

Anti-hybrid Rules

Under general tax rules, 95% of the amount of dividends from a foreign subsidiary are exempted from counting as profits of Japanese parent company. However, if a Japanese company receives dividends from its foreign subsidiaries and all or a part of the amount of dividends is included in deductible expenses in the country where such a subsidiary’s headquarters are located, the amount included into the deductible expenses at the subsidiary’s end will be excluded from such exemption.

Employment and labour matters in Japan are governed by a combination of various laws, including the Labour Standards Act (the LSA), the Labour Contracts Act (the LCA) and the Labour Union Act (the LUA). While the LSA and LCA stipulate the fundamental principles of labour relationships between employers and employees, the LUA mainly governs the matters related to collective labour management relationships. It is particularly important when engaging in a Japanese business to understand that:

  • the labour-related laws are protective for employees, especially compared to those of common law jurisdictions; and
  • labour-related matters may be heavily affected by judicial precedents (which are all written in Japanese).

Labour unions are commonly organised in Japan. Traditionally, labour unions were predominantly organised by workers from a certain enterprise or business establishment, but recently, labour unions comprised of workers across different enterprises and industries have also become common. The right of collective bargaining is guaranteed by the Constitution and is not uncommon in Japan. Once a labour union initiates collective bargaining, the employer must negotiate with the labour union in good faith and failure to fulfil this obligation could lead to an accusation of unfair labour practices.

Among various protections for employees, it is particularly important to note that unilateral dismissal of an employee by an employer is very difficult in Japan. Specifically, a dismissal is invalid if the dismissal is not based on any objectively and socially justifiable cause, as clarified by the judicial precedents.

Under the LSA, employers are required to pay wages directly to employees in cash (ie, Japanese yen). The wages must also be paid in full, at least once a month on a certain date.

While the basic wage must be paid in cash, it is becoming common in Japan that employees receive additional benefits from employers in other forms, such as stock options or restricted stocks, in most cases as an incentive payment. Also, under certain conditions, employees working at an enterprise must be covered by an employees’ pension system, on top of the basic pension provided by the National Pension System.

Since employee compensation is a critical part of the labour conditions between an employer and employee, any reduction or material change in the payment of employee compensation requires the clear informed consent of the relevant employee. In the event that a Japanese enterprise becomes involved in an acquisition, or any transaction involving a change of control (eg, business transfer, share transfer or corporate split), the basic principle is that the compensation of the employees belonging to the relevant enterprise should be maintained even after such a transaction, in the absence of a clear agreement between the employer and the relevant employees.

Share Sale Transaction

In a share sale transaction, the work conditions for the employees are expected to be maintained after the transaction unless the company and the employees specifically agree to change them. There is no requirement for the company to consult with the employees prior to the transaction unless any collective agreement between the company and a labour union obliges it to do so.

Acquisition/Asset Sale Transaction

Apart from merger, where employment is automatically succeeded to by the merging entity, there are two types of acquisition/asset transfer transaction in Japan: business transfer and corporate split.

Business transfer

In a business transfer transaction, where the rights and obligations of the transferred business must be individually transferred, the employment contracts with the employees belonging to the transferred business must also be individually transferred. In other words, while the employees do not have a mandatory right to transfer their employment in the transaction, they can also reject the transfer of their employment. It should be also noted that employers are advised to consult with the transferred employees prior to the transaction, based on the guidelines implemented by the Ministry of Health, Labour and Welfare.

Corporate split

In a corporate split transaction, where the rights and obligations of the transferred business are automatically transferred, the transferring entity is obliged to give certain notices to the employees involved and the labour union, and also to consult with the employees and the labour union, prior to the transaction, pursuant to the Labour Contracts Succession Act. If an employee is primarily engaged in the transferred business but is excluded from the employees to be transferred, that employee has the right to require the company to mandatorily transfer his or her employment. On the other hand, if an employee is not primarily engaged in the transferred business but is included in the employees to be transferred, that employee has the right to require the company not to transfer his or her employment.

As described in the Exemptions section of 7.1 Applicable Regulator and Process Overview, as one of the general restrictions for a foreign investor to be qualified for an exemption of pre-closing FDI notification and review by the government, the foreign investor shall refrain from accessing non-public information concerning the target's technology in the designated business. Intellectual property can be a key part of such non-public information. If the investor is eager to access such information, the investor is not qualified for an exemption and may be subject to filing a pre-closing FDI notification and review by the government as described in 7 Foreign Investment/National Security. Designated businesses subject to such review are as described in section 7.1 Applicable Regulator and Process Overview.

A variety of intellectual property rights are recognised and well protected under Japanese law, including rights relating to patents (including a business utility patent), utility models, designs, trademarks, trade secrets and other interests protected under the Unfair Competition Prevention Act. It should be noted that registration is required under Japanese law to protect the relevant intellectual property right. Japan adheres to the first-to-file principle which holds that, in principle, first use does not establish one’s intellectual property right.

The Act on the Protection of Personal Information (APPI) is the basic legislation in Japan for the protection of personal information. Furthermore, the Personal Information Protection Committee (the PPC) is the main authority that supervised the enforcement and application of the APPI.

Most of the provisions under the APPI apply to data handling operators, even though they are entities outside Japan, if they receive personal information when providing goods or services to individuals residing in Japan.

The civil/criminal/administrative sanctions for data handling operators in violation of the APPI are relatively moderate.

An amendment of the APPI has been adopted in June 2020 and will be enforced in 2022. In general, the 2020 amendment strengthens the regulatory framework under the APPI in various areas such as reporting obligations, penalties and extraterritorial enforcement.

Apart from the items mentioned in this article, there are no other significant issues.

Anderson Mori & Tomotsune

Otemachi Park Building
1-1-1 Otemachi
Chiyoda-ku
Tokyo 100-8136
Japan

+81-3-6775-1163

+81-3-6775-2163

raku.raku@amt-law.com www.amt-law.com/en/
Author Business Card

Trends and Developments


Authors



Anderson Mori & Tomotsune is a full-service law firm with over 500 professionals that is best known for serving overseas companies doing business in Japan since the early 1950s. It is proud of its long tradition of serving the international business and legal communities, and its reputation as one of the largest full-service law firms in Japan. Its combined expertise enables it to deliver comprehensive advice on all legal issues that may arise in the course of a corporate transaction, including those related to M&A, finance, capital markets and restructuring/insolvency, and litigation/arbitration. Most of its lawyers are bilingual and experienced in communicating, drafting and negotiating across borders and around the globe. The firm’s main office in Tokyo is supported by offices in Osaka, Nagoya, Beijing, Shanghai, Singapore, Ho Chi Minh City, Bangkok, Jakarta and Hong Kong.

The year 2020 was a turbulent one for the global market, and similarly, the Japanese market experienced drastic movement both through a number of changes in the laws and regulatory frameworks and through the unexpected influence of COVID-19. Set forth below is a summary of the most recent legislative amendments and investment trends in the Japanese market.

Recent Law Developments

Amendments to the basic corporate framework

The most fundamental changes expected to impact the Japanese corporate world are the amendments to the Companies Act. Most of these amendments are expected to take effect in March 2021, with some exceptional provisions taking place later.

Some of the amendments, which were adopted to reflect the wishes of the business community, will allow Japanese stock companies (kabushiki kaisha) to have more flexibility in their management structures. For instance, under the amended Companies Act, Japanese stock companies will be allowed to circulate material reference documents and convocation notices for shareholders’ meetings via online tools. Furthermore, in M&A deals, they will have more flexibility to use their own shares as consideration for the shares of another Japanese stock company to be acquired in an M&A deal. On the other hand, some other amendments to the Companies Act will require Japanese stock companies to have stronger internal corporate governance. For instance, stock companies will be required to adopt board resolutions in certain circumstances, including where stock options are issued to the directors as remuneration, or where there is a deal causing a conflict between the company and a counterparty and the company’s board considers it appropriate to defer to the external directors on the determination of such a conflicting matter. Japanese companies should be well prepared for these upcoming amendments, and in 2020, many companies appear to have started their internal preparation.

Amendments to the frameworks for M&A deals and foreign investments

While the revision does not involve any direct change to the underlying laws, the introduction of the new Fair M&A Guidelines by the Ministry of Economy, Trade and Industry in 2019 has affected relevant M&A deals in Japan that have taken place recently. The focus of the guidelines is ensuring overall fairness in MBO deals (management buyouts) and acquisitions of a controlled company by a controlling shareholder. With a strong trend in the Japanese market for the management and controlling shareholders of a listed company to optimise the operation of the target listed company, which has also been more prevalent during the COVID-19 pandemic, the new guidelines have affected various deals in essentially requiring the target company to have stronger governance by organising an independent “special committee” with appropriate members, by putting more stress on the external directors of the company, and by obtaining legal advice from an independent law firm. We have also seen many MBOs and other relevant deals disclose the measures taken to ensure the fairness of the deals in a more comprehensive manner in 2020 than was typical before.

From the perspective of foreign investment in Japan, there was a significant amendment to the inward foreign direct investment regulations in 2020. The amendments to the Foreign Exchange and Foreign Trade Act (the FEFTA), which took effect on 7 June 2020, strengthened the screening of proposed foreign inward investment, mainly from a national security viewpoint, by, among other things, requiring foreign investors to follow stringent, pre-transaction scrutiny procedures enforced by Japanese authorities if 1% or more of the shares or voting rights of a Japanese listed company are to be acquired, which is far below the original threshold of 10%, with certain exemptions. Also, the necessity to protect domestic companies engaging in healthcare/medical activities related to COVID-19 prompted the government to add relevant sensitive business areas that require pre-transaction scrutiny in July 2020. This may affect foreign investment in companies involved in such healthcare/medical activities.

Other temporary measures taken in the COVID-19 situation

In addition to the above amendments to the laws, regulations and guidelines, in the first half of 2020, the Ministry of Justice and the Ministry of Economy, Trade and Industry issued various notifications and guidelines on the holding of general shareholders’ meetings and the making of financial disclosures for Japanese stock companies, which were significantly affected by COVID-19. While such notifications and guidelines did not amend the relevant laws or regulations themselves, they included some clear guidance on the material interpretation of the relevant legal provisions and heavily affected the practice. The most notable practical changes included the frequent postponement and adjournment of shareholders’ meetings when the financial results were not sufficiently ready and the holding of shareholders’ meetings with the assistance of online or hybrid systems. It is possible that some of these changes, in particular the extended use of online/virtual tools in shareholders’ meetings, will be further clarified by relevant laws and regulations in the future.

Recent Investment Trends

There have been many interesting recent developments in the Japanese corporate and M&A market, some of which, though not all, were directly related to the COVID-19 situation. Below is a broad picture of such trends.

Increase in hostile takeovers

One of the most interesting developments recently seen in the Japanese market is the drastic increase in hostile takeovers. The Japanese market used to be a very conservative one, where there were only a limited number of hostile takeovers of listed companies and very few (almost no) successful ones. Several underlying factors – including an increase in the number of Japanese listed companies that abolished their anti-takeover plans, less criticism from Japanese investors who pursue realistic profits from their investments and an increase in hostile takeovers in the US market – led to the number of hostile or unfriendly takeovers exploding in 2019–2020. Among various cases of hostile takeovers, Colowide, a restaurant operating company, succeeded in a hostile takeover of its competitor Ootoya through a tender offer in 2020. While, in this case, Ootoya could not take any countermeasures against Colowide, there have been a number of cases where anti-takeover measures were adopted. In Maeda Corporation’s attempt to acquire Maeda Road Construction in 2020, Maeda Road Construction adopted a special dividend as a defensive measure, but it ended up being unsuccessful. Also, in other cases, competitive buyers joined the takeover race and finally succeeded over the original buyer (such as in the most recent attempt by Nitori Holdings and DCM Holdings to acquire Shimachu).

Other M&A trends

Overall, the Japanese M&A market does not appear to have been materially affected by the COVID-19 situation so far, rather the trends that began prior to COVID-19 continued in 2020. Compared to other markets that were materially damaged, the Japanese market appears to have remained stable in terms of the length of M&A deals (including the time period required for the authorities to review the deal) and the complexity of the negotiation between the relevant parties associated with the deal.

A few other trends seen in the market are set out below.

MBO deals

In line with the introduction of the new Fair M&A Guidelines (as outlined above), the number of MBO deals and acquisitions of a controlled company by a controlling shareholder continues to be high. Even during the COVID-19 pandemic, partly due to the relatively low share price of the target companies, there were more than 25 deals in this category announced from January to November 2020. While, on one hand, the standards required for deals were clarified in the guidelines, on the other hand the deals have become more complicated, partly due to the increase in the number of auction deals and the more frequent involvement of private equity funds which pursue the optimisation of the deal through a combination of various schemes for the acquisition.

Sale of non-performing businesses

With the spread of COVID-19, the Japanese market has also witnessed more deals involving sales of unprofitable and non-core business and assets. Some of the larger deals were driven by financial institutions requesting quicker recovery of the financial position of relevant companies, and other smaller deals were initiated by private owners who lost the motivation to continue their business during these difficult times. Again, the involvement of private equity funds and the increase in auction deals have been apparent in Japan.

Foreign investment

In terms of foreign investment into Japan, despite the drastic change in the FEFTA outlined above, there continues to be very active inbound investment into the Japanese market. So far, the review process for an investment in a sensitive business category by the relevant authority appears to be sufficiently efficient, and no significant delays in the process have been reported. As mentioned above, a number of private equity funds, based in the USA and other foreign countries, are becoming more and more interested in the Japanese market, because of the excess liquidity and relatively low share price of Japanese listed companies.

Shareholder activism

Even prior to the COVID-19 pandemic, there was a trend for activist shareholders to make more active and aggressive proposals to Japanese listed companies. The trend did not weaken during the COVID-19 situation, but rather became much stronger. It was actually reported that the number of listed companies that received proposals from activist shareholders reached the highest level ever in June 2020.

This trend has been driven mainly by the belief that Japanese listed companies still have redundant reserves that are not effectively used, and activist shareholders continue to request appropriate and sufficient return to the shareholders. Even during the COVID-19 situation, the activists’ position remained the same. On the other hand, the proposals seen in 2020 were reported to be relatively modest compared to those of recent years, probably due to the shareholders’ consideration of the difficulties of the COVID-19 situation.

Another reason for this increased activism is that, following the introduction of the Corporate Governance Code in 2015, Japanese listed companies are required to have stronger standards on corporate governance structure. However, many listed companies have failed to establish appropriate internal corporate governance systems to date. In 2020, many of the proposals made by the activist shareholders were reported to be about the corporate governance structures of companies.

Trends in other legal areas

Apart from the trends in the M&A/corporate areas of the Japanese market, there have been some developments in other legal areas during these difficult times.

Of course, one of the trends, similar to the rest of the world, is the increase in the number of labour-related issues. Facing financial difficulties because of COVID-19, a number of Japanese companies have considered reducing their labour force or the salaries of their workers in order to survive. As Japanese labour laws are generally very strict on the employer’s side, especially when an employer intends to dismiss an employee, such companies are struggling to find a way to optimise their labour force without causing any conflicts with their employees. The radical increase in the number of employees working from home is also making it difficult for employers to properly manage their workers. Employers are required to establish new rules for their workers working remotely or doing so from home.

The number of corporate bankruptcies triggered by the spread of COVID-19 exploded even after the state of emergency declared by the government was finally lifted in May 2020. However, partly because the state of emergency did not involve mandatory lock-down of most of the businesses, the damage to the economy seems to have been limited so far, and the number of corporate bankruptcies has not risen to an extreme level. Nevertheless, it appears that foreign investors whose businesses are mainly based in overseas jurisdictions considered closing down their Japanese businesses in order to minimise their entire global business.

2021 Forecast

Although the 2021 forecast largely depends on the spread of COVID-19, many domestic and foreign investors are optimistic about the investment landscape in Japan in 2021. Despite COVID-19, the number of M&A deals and investments in Japan in the second half of 2020 recovered at full speed. In 2021, if the Tokyo Olympic and Paralympic Games take place as scheduled, they could be another driver encouraging investment in Japan. However, the further spread of COVID-19 through a second or third wave could possibly affect these expectations.

Anderson Mori & Tomotsune

Otemachi Park Building
1-1-1 Otemachi
Chiyoda-ku
Tokyo 100-8136
Japan

+81-3-6775-1163

+81-3-6775-2163

raku.raku@amt-law.com www.amt-law.com/en/
Author Business Card

Law and Practice

Authors



Anderson Mori & Tomotsune is a full-service law firm with over 500 professionals that is best known for serving overseas companies doing business in Japan since the early 1950s. It is proud of its long tradition of serving the international business and legal communities, and its reputation as one of the largest full-service law firms in Japan. Its combined expertise enables it to deliver comprehensive advice on all legal issues that may arise in the course of a corporate transaction, including those related to M&A, finance, capital markets and restructuring/insolvency, and litigation/arbitration. Most of its lawyers are bilingual and experienced in communicating, drafting and negotiating across borders and around the globe. The firm’s main office in Tokyo is supported by offices in Osaka, Nagoya, Beijing, Shanghai, Singapore, Ho Chi Minh City, Bangkok, Jakarta and Hong Kong.

Trends and Development

Authors



Anderson Mori & Tomotsune is a full-service law firm with over 500 professionals that is best known for serving overseas companies doing business in Japan since the early 1950s. It is proud of its long tradition of serving the international business and legal communities, and its reputation as one of the largest full-service law firms in Japan. Its combined expertise enables it to deliver comprehensive advice on all legal issues that may arise in the course of a corporate transaction, including those related to M&A, finance, capital markets and restructuring/insolvency, and litigation/arbitration. Most of its lawyers are bilingual and experienced in communicating, drafting and negotiating across borders and around the globe. The firm’s main office in Tokyo is supported by offices in Osaka, Nagoya, Beijing, Shanghai, Singapore, Ho Chi Minh City, Bangkok, Jakarta and Hong Kong.

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