This article discusses the basic Japanese accounting treatment of membership of Japanese civil law partnership, in Japanese a nin’i kumiai and below an NK.
An overview of the legal aspects of an NK arrangement can be found in this article, which also includes defined terms or abbreviations used here.
A description of the tax treatment can be found in this article.
Nin’i kumiai and accounting regulations
Assuming that an NK is outside the scope of the Financial Products and Financial Transactions Law (the ‘FPFTL’ – the main Japanese investor protection law for securities transactions) and not hence not treated as a deemed marketable security subject to related securities law then there are no specific regulations applicable to NKs concerning their financial reporting, audit, governance or disclosure obligations. These matters may in principle be determined freely by the NK members and form part of the NK Contract. This would include defining the form of reports provided to members, the length of any reporting or financial accounting period and similar matters.
Some NKs deemed to be marketable securities
Notwithstanding the above principle, certain NKs may be deemed to be marketable securities and hence fall within the registration and disclosure requirements applicable to such deemed marketable securities, requiring them to complete a prospectus or ongoing securities registration report (in Japanese ‘有価証券届出書’ or ‘yuuka shouken todokede sho’).
Reference should be made to the FPFTL for the criteria under which these filings may be required (article 3-3, 4(i), 13 (i) ). NKs mainly carrying out a business of investing in marketable securities or where solicitation for investment is made for a relatively large number of investors may be subject to these rules.
Practical reporting requirements
As a practical matter the NK members will still have to include income arising from their NK interests in their corporate or individual tax returns compliant with the tax law. Therefore it would often be preferable for the NK to draw up its accounts for a period that coincides with the accounting period of the majority of its members under a basis from which it is straightforward to calculate taxable income. Accordingly it is common for an NK Contract to include a requirement to prepare financial records under Japanese GAAP.
Nin’i kumiai investor accounting
As a financial investment, an investor’s interest in an NK Contract is in principle subject to the ‘Financial Products Accounting Standard’ and its related ‘Guidelines’ applicable to financial products (in Japanese these are the ‘ 金融商品会計基準’ or ‘kinyuu shouhin kaikei kijun’ and the ‘金融商品会計事務指針’ or ‘kinyuu shouhin kaikei jimu houshin’ – links in Japanese).
When accounting for such NK interests as a financial asset or as a deemed marketable security under the FPOFTL, net gains or losses from the underlying operations of the NK would be treated as income or expense in the investor’s profit and loss account. The interest in the NK is also subject to period end impairment or valuation considerations similar to other investments. This method is called the ‘Net Method’ (in Japanese the ‘純額法’ or ‘jungakuhou’).
However, while the above Net Method accounting treatment can often be applied, the accounting for the NK investment should reflect the underlying economic reality of the transaction and two further accounting treatments that may better reflect such economic reality can also be adopted. These treatments, which match the treatments allowed for the recognition of NK income tax purposes discussed here, are as follows:
The ‘Gross Method’ (in Japanese the ‘総額法’ or ‘sougakuhou’): The investors share of the underlying assets and liabilities and income and expenses of the NK are fully grossed up in the investor’s balance sheet and profit and loss account, following applicable Japanese GAAP principles for each accounting line item concerned. Effectively this treatment is very similar to consolidation, albeit without the recognition of minority interest.
The ‘Compromise Method’: As the name suggests, this method is a compromise between the Net Method and the Gross Method. Only items in the investor’s profit and loss account are grossed up. The NK interest is shown on one line of the balance sheet as an investment.
Consolidation of interests in a nin’i kumiai
An investor in an NK should also consider whether or not he has an obligation to fully consolidate the underlying activities of the NK.
The scope of entities covered by the Japanese accounting standards and related guidelines relating to consolidation include not only subsidiary and affiliated companies but also partnerships. An NK investor should examine their rights under the NK Contract and consider whether they meet the ‘Control Standard’ or ‘Influence Standard’ thresholds defined for accounting consolidation purposes under Japanese GAAP.
The Japanese accounting standards board has also issued specific consolidation standards to apply to defined ‘Investment Business Partnerships’ (in Japanese ‘投資事業組合’ or ‘toushi jigyou kumiai’). These rules (the ‘Handling of the Practical Application of the Control and Influence Standards to the Investment Business Partnerships’ – link in Japanese) recognize that in assessing whether consolidation is required then not only the decision making authority attributable to the investor from his rights under the NK Contract should be considered, but also the extent to which an investor may bear economic gain or loss from the NK should be taken into account. The existence of this standard implies that these matters should also be considered when looking at other NK contracts.
Finally, if the assets of the NK include shares in a company, consideration should also be given to whether the Control or Influence Standards for consolidation are met when applied at the company level.