The Japanese limited liability partnership (in Japanese the ‘有限責任事業組合’ or ‘yuugen sekinin jigyou kumiai’ and below the ‘LLP’) is a relatively new Japanese entity form that was introduced in 2005.
Formed by the ‘Law Concerning Contracts for Limited Liability Business Partnerships’ (in Japanese the ‘有限責任事業組合契約に関する法律’ or ‘yuugen sekinin jigyou kumiai keiyaku ni kansuru houritsu’, link here in Japanese and below the ‘LLP Law’) and similar to the LLP form adopted by some countries in America and Europe, the LLP form is intended to be used by entrepreneurs or specialists for who are providing services in the fields of accounting, legal, design, IT, financial or similar knowledge based areas.
Characteristics of the LLP entity form
The LLP entity form has some special characteristics that had not previously been combined in a single Japanese entity:
Limited liability for contributors of capital to the LLP (below the ‘LLP Members’) up to the amount of their contribution (this is discussed further below).
Internal governance: The LLP Members themselves carry on the management of the LLP business, with flexibility to decide how profits and losses should be allocated between different LLP Members.
Taxation at the member level: LLP Members are taxed directly on the results of the LLP, avoiding double taxation through the imposition of corporate taxes at the LLP entity level.
Certain non LLP businesses
While the LLP entity form was created in order to encourage the development of small-scale cooperative businesses involving creative, high-tech or similar activities and although the LLP form can be used for professional services under Japanese law, some part of the business of lawyers, certified accountants, or qualified tax accountants cannot be carried out in LLP form and hence remains subject to unlimited liability.
Article 1 of the LLP Law outlines the special characteristics of an LLP, noting that an LLP must be based on a partnership contract that recognises the common management of the business by the LLP members with the objective of realizing profit, the liability of the members of the LLP is limited to their initial capital contribution.
Limited liability of LLP Members
As noted, a key characteristic of an LLP is that the liability of each member is limited to their contributed capital. In contrast, a normal Japanese civil law partnership (in Japanese a nin’i kumiai – see these articles for further background) has unlimited liability with respect to the activities of the partnership (LLP Law article 15).
Accordingly, the merit of the LLP to its individual members is a reduction in commercial risk owing to limited liability. However there are a number of measures in the LLP system intended to prevent risks being transferred excessively to the creditors of the LLP. Three key rules in this area are as follows.
In order to allow third parties to recognise that they are transacting with an LLP there are regulations requiring the use of the term LLP on correspondence, and recording the business and the address in the LLP contract (LLP Law articles 57 and 9). Also the LLP is under an obligation to respond to requests for disclosure of the partnership contract and the financial statements of the LLP to creditors.
Preservation of assets of the LLP
Measures to preserve the assets of the LLP include limitations on the type of capital that can be contributed to an LLP at the time of its establishment (LLP law article 31), responsibilities for the contribution of LLP members (under LLP law article 16), limitations on the types of contributions (under LLP law article 119), an obligation to separate the management of the assets of the partnership (under LLP law article 20), a prohibition on the transfer of claims against the intrinsic assets of each member to be compulsory transferred as a claim against the assets of the partnership (under LLP law article 22), and limitations on the distribution of partnership assets (under LLP law article 34).
Regulations relating to the liquidation of the LLP
Article 49 of the LLP law requires preferential settlement of debts of the partnership prior to the distribution of assets to members of the LLP even at the time of liquidation along with other methods of preserving creditors interests.
Internal governance principles
The LLP law does not determine the detailed provisions of the internal rules of the LLP. Rather, these are determined by the LLP Members themselves in agreement under the LLP contract. Furthermore, the distribution of profits or losses to members in the partnership and the establishment of governance institutions, such as a managing organisation equivalent to a board of directors in a company or similar, can be determined flexibly by the LLP Members. For example, under article 33 of the LLP law, the provision of services or intellectual property or know-how by members of the partnership can be a factor reflected in the distribution of profits or losses to them.
Carrying out a common business and taxation at the LLP Member level
The LLP Law requires all the LLP Members to participate in the carrying out of the LLP business and in the important decision-making activities of the business (this is the ‘Common Enterprise Condition’ in LLP article 12 I9). If this Common Enterprise Condition is not fulfilled the partnership will be treated as a normal civil law partnership (that is, as a nin’i kumiai) with respect to limitation on liability and other matters including taxation.
The Common Enterprise Condition is not only intended to protect creditors, but is also intended to prevent the inappropriate use of the pass-through taxation treatment accorded to LLP members through, for example, allowing such treatment to some members of the partnership ,who may be motivated to realise tax benefits from accelerated depreciation or similar tax loss creating activities while not participating other than as a passive investor in the business concerned.
Pass through taxation treatment is important to individual LLP Members through firstly preventing taxation as a corporation at the entity level and secondly, for an individual, potentially in allowing flexibility in the offset of losses arising from the LLP against other sources of income.
Both individuals and corporations can become LLP Members, although a Japanese civil law partnership (nin’i kumiai) cannot itself become an LLP member. Furthermore, at least one member must be a resident of Japan or a Japanese domestic company. As previously discussed, all members must have rights to participate in the business of the LLC in principle. However such participation does not have to be through institutions resembling those of a corporation but can be freely determined by the company LLP.
Financing and the LLP form
It is not unusual for an LLP to raise borrowings at the time of its establishment to add to the contribution of the LLP Members. However in order to prevent inappropriate tax loss recognition and related tax avoidance, funds only investing for monetary return and not participating in the business are forbidden. Furthermore under LLP article 12 relating to such financing, either the agreement of all members of the LLP is required or, if a rule is established in the LLP contract, a majority of at least two thirds of the total number of LLP members.
Taxation of an LLP
It is clear from the individual income tax and corporate tax instructions that the Japanese taxation of an LLP is the same as that of a Japanese nin’i kumiai or civil law partnership. Regulations in this area cover matters such as the allocation of profits to members, the timing of profit recognition, the taxation of non-resident members including withholding taxes and similar matters.
A key matter in Japanese partnership taxation is the way in which income is reported on the Japanese tax return, whether net in both the balance sheet and profit and loss account, net in the balance sheet and gross in the profit and loss account, or gross growth in the balance sheet and profit and loss account. Such treatment will alter the range of tax benefits available to the taxpayer. This is discussed in greater detail in this article on nin’i kumiai taxation.