Legislation The sad reality in Japan
Hello. I'm Mike, a lawyer living in Hong Kong.
IN BOTH HONG KONG AND JAPAN, THERE ARE CERTAIN LAWS AND REGULATIONS GOVERNING THE PRACTICE OF FINANCE. I SPENT THE FIRST 10 YEARS OF MY 30 YEARS AS A LAWYER IN INTERNATIONAL TRANSACTIONS AND FINANCIAL MATTERS AT A LAW FIRM, THE NEXT 10 YEARS IN THE FUND BUSINESS AT A FOREIGN SECURITIES FIRM, AND THE LAST 10 YEARS IN THE FUND BUSINESS AT A PRIVATE EQUITY FUND. WHEN I WAS WORKING FOR A SECURITIES FIRM, I USED TO TRAVEL TO ITS KEY OFFICES IN NEW YORK, LONDON AND HONG KONG TO ASK MEMBERS OF THE LEGAL DEPARTMENT ABOUT LOCAL LAWS AND REGULATIONS. I ALSO SPENT THE LAST FIVE YEARS OF MY CAREER AT A PE FUND ACTUALLY OPERATING IN HONG KONG, SO I GOT A FEEL FOR THE LEGAL SYSTEM THERE. AND WHAT I REALISED WAS
Japanese ministries and agencies do not have the idea of constructively applying the legal system beyond the interests of their own ministries in order to foster industry.
It's a fact. Here are two examples, a little old-fashioned, that illustrate this point.
"A limited liability company is a legal entity. The Case
In the second half of the 1990s, the LLC (Limited Liability Company) was established in the US state of Delaware and the Cayman Islands, and has been actively used. This is a very convenient structure, as it allows a company to be recognized as a legal entity when it acts legally, but is not taxed at the LLC level for tax purposes. As a result, it was very useful as an investment entity for funds, and the fund business developed very much as a result. In a commercial law class at the US law school where I was studying at the time, my professor said, "The C in LLC is not a corporation, but a company. Don't make a mistake. Don't make that mistake." I remember the professor stressing, "Don't make a mistake. Naturally, the Ministry of International Trade and Industry (MITI) took the lead in amending the Commercial Code to create a similar system in Japan. In order to create a similar system in Japan, the Ministry of International Trade and Industry (MITI) took the initiative to amend the Commercial Code to create a new legal entity called a limited liability company (LLC). There were high hopes among all those involved in the fund business at the time that this would allow companies to act under the name of LLC in contracts, registrations and court proceedings, and that they would be treated as partnerships for tax purposes. However, the National Taxation Service (NTA) came to the conclusion that "a limited liability company is a legal entity and is subject to corporate taxation. Naturally, the business side chanted "What? and a sigh of disappointment. At this moment, the Japanese version of LLC, which took a long time and a lot of effort to establish, has become a system which has no more value than a stock company which can be established more easily. There was no point in abolishing the existing structure of the limited company.
THE "I'LL ONLY ACCEPT IT IF YOU DON'T GET INVOLVED IN THE RUNNING OF THE GP AT ALL" CASE
When foreign investors invest in a Japanese company, there is a common regulation called the "25%5% rule". To put it simply, if a foreign (legal) person who owns more than 25% of a Japanese company's shares sells more than 5% of those shares after holding them for a certain period of time, the gain on that sale is taxed in Japan. This system was introduced after the politicians of the time were angered by the fact that Ripplewood, who took the risk of investing in Naga Bank, which had failed and no one was able to save it, failed to tax it in Japan when it was later reborn as Shinsei Bank and made a huge return. So, when multiple foreign investors form a fund to invest in a Japanese company, this rule becomes a real problem because the fund is seen as a single investment entity. Around 2010, the Ministry of Economy, Trade and Industry (METI) again took the initiative to amend the law so that, if certain conditions are met, the decision is made at the level of the individual investor rather than the fund, in order to solve this problem. In essence, investors who are passive to the fund, i.e. not involved in the fund management, will be judged at the investor level. It was hoped that this would make it easier for foreign investors to invest in Japan, and we waited for the guidelines from the National Tax Agency. And the guidelines that came out were: " GP's fund management in any wayIf you are not involved in the management of the GP fund, you are allowed. If you have even one vote in the general meeting of members, you are not allowed." That was it. The LP contract, which is standard at a global level, does not give an LP the right to interfere in investment decisions or the day-to-day running of the fund, but does provide that basic rights, such as removal of a GP for breach of contract, or changes to the distribution of profits to an LP, will be decided by a resolution of the LP at a general meeting of the partnership. The IRS guidelines deny even this voting right, and are hardly acceptable to the global standard. In the end, the rule amendment was ineffective.
The two cases mentioned here would not have happened if the National Tax Service, METI and other relevant ministries had a common sense of purpose in amending the law in order to develop the business of investing in Japan. There have been many similar cases, including many minor ones, and we have been disappointed each time.
But Hong Kong was different. But Hong Kong was different, and we'll talk about that next time.
