Tokumei Kumiai (TKs) are Japanese silent partnership form similar to German Stille Gesellschaft or French Société en participation. The origin of allegedly comes from the middle ages when wealthy Italian members of the clergy or aristocracy wanted to participate anonymously given their position in society, in Mediterranean trade and would do so by investing in partnership with the operators of ships. The investors would stay ashore as silent investors while the ship captains would do the actual business – an analogy that it would be good for current cross border TK Investors into Japan to remember.
TK arrangements are very familiar to cross border investors into Japan given both their flexibility and certain tax advantages. What is sometimes not appreciated is that TKs are used extensively domestically in securitisation structures or other financial arrangements given their flexibility, often allowing an economic pass-through in the structure concerned. An
Given the above TK arrangements have been subject to a great deal of scrutiny by the Japanese tax authorities. The NTA website includes an excellent paper on the theoretical aspects of TK taxation addressing all the issues foreign investors will have heard from their local advisers. A case is currently progressing through the Japanese court system around whether the other income in the Netherlands/Japan treaty will exempt from taxation in Japan the distributions TKs. Both of these will be discussed in detail in later posts.
TK scheme outlineIn contrast to nin’i kumiai/任意組合 which are partnerships under the Japanese Civil Code, TKs are contractual arrangments under the Japanese Commercial Code. They have the following features:
- They are a contractual agreement between an Operator and a TK Investor (JCC Art 535).
- Based on the contract, the TK Investor makes a payment of capital (TK Investment) to the Operator
- Using the capital from the TK Investor and its own capital the Operator will acquire assets required for the venture – i.e the TK Business.
- The Operator manages the TK Business
- The Operator distributes the profits arising from the TK Business to the TK Investor
JCC defines a TK Contract as an agreement where one person invests for the purposes of another’s business and in returns receives a right to a distribution from that business. When the TK Contract is completed, it is necessary for the Operator to return the original investment (JCC Art 541).
It is important to obtain a legal opinion from a Japanese lawyer that a given contract would be respected as a TK Contract for Japanese legal purposes in order to ensure that the expected tax treatment applies – “boiler plate” TK style contracts drafted under foreign law may not qualify.
Rights based on certain specified TK Contracts may be treated as Marketable Securities under the Financial Products Transaction law.
Outline of TK Tax Treatment
TK Contracts are not taxed as corporations for Japanese tax purposes. The logic to this is as follows: For Japanese tax purposes, ‘groups without (legal) personality’ – jinkaku no nai shadan/人格のない社団 – are deemed to be taxed as corporations (CTL art 3), however under the JCC 535 TKs are not included in the the scope of jinkaku no nai shadan. Accordingly gain or loss from TKs is treated as taxable income of either the TK Investor or Operator and taxed accordingly.
Although as noted above a contract must be recognised for Japanese legal purposes as a TK in order to apply TK tax treatment the contract should also be recognised as having the economic substance of a TK agreement for tax purposes. For example, the activity carried out by the Operator should be recognised as having the characteristics of a business and the investor should bear risk and reward consistent to his investment in the TK Business concerned.
Also, the TK Contract is one of investment from the TK Investor’s standpoint. The TK Investor should not be involved in the carrying out of the TK Business except for certain defined controls (a certain level of controls is possible within the scope of the defined rights of the TK Investor – this will be discussed in later posts).
In judging whether or not a TK Contract has economic substance one point of comparison is the nin’i kumiai (‘NK’) mentioned above. A NK is a contract under which the persons concerned invest in a business which they operate co-operatively (JCivC art 667). Like a TK an NK is not treated as a jinkaku no nai shadan and hence is not taxed as a corporation but is rather a pass through entity and investors should include gains or losses from the underlying NK business in their annual taxable income. If a purported TK agreement was treated as an NK agreement then the investor would be treated as holding, in common with the operator, a direct interest in the assets of the operator concerned. In the case of a foreign investor this could lead to the investor being treated as holding a direct interest in such assets – including real estate or monetary assets – with implications for sourcing taxable income and taxable presence implications, especially if the operator is deemed an agent of the investor.
Despite the extensive use of TKs in various transactions there are very little tax legislation or tax interpretations issued by the tax authorities – for example CLT TT 14-1-3 (which is little more than a statement that distributions or losses should be taxed in the period that includes the end of the TK acconting period rather than when distributions etc are actually paid). These themselves do not propose clear guidance, so extensive interpreation is required having regard to the legal character of the TK.
One interesting site for TK information is run by a Japanese zeirishi and can be found here.