Tax

January 2007

Omi Pledges Consumption Tax Debate In Fall, To Improve Finances
Finance Minister Koji Omi pledged Friday that the government will promote debate from this fall on whether to raise the consumption tax rate in an effort to achieve a comprehensive tax reform and to bring forward Japan's fiscal consolidation.　In his fiscal policy speech delivered to the 150-day ordinary Diet session which began Thursday, Omi said, ''We will hold a full-fledged and concrete debate on the tax system from the fall so that we will be able to realize a comprehensive reform of taxes, including the consumption tax, in fiscal 2007.'' Tax obligation is ''the foundation of democracy,'' Omi said. ''The public should be aware that they should be willing to pay taxes to support necessary state expenditures, rather than perceive something to be deprived of.'' The government had earlier postponed debate on tax system reform until sometime after the House of Councillors election in the summer, apparently for fear of a possible negative impact for the ruling parties on the election. There is a growing view among ruling party politicians that Japan may be able to bring forward fiscal consolidation without any tax hikes as tax revenues have recently increased along with the economic recovery, but Omi said tax system reform is necessary to secure stable revenue sources. He pointed to ballooning social security costs and expected increases in expenditures to address the nation's falling fertility rate to stress the importance of securing tax revenues. On the economy, Omi said the government will make efforts to boost economic growth through technological innovation and structural reform such as deregulation so that Japan can maintain sustainable growth led by private demand. Touching on the government budget plan for fiscal 2007, Omi said the government slashed the budget deficit for the fourth straight year to around 4.4 trillion yen, compared with about 19.6 trillion yen in the fiscal 2003 budget. He described the decline as ''a steady first step'' toward fiscal consolidation but warned that ''the situation is not optimistic at all.'' The ratio of the outstanding balance of state debt to gross domestic product is projected at 148 percent as of March 31, 2008, the worst among developed countries. By contrast, the national burden ratio -- the proportion of tax payments and social security costs to national income -- is forecast to come to 39.7 percent in fiscal 2007, effectively the lowest level among developed countries, Omi said. The government will aim to reduce the debt-to-GDP ratio in a stable manner by the middle of the fiscal 2010s, he said. The finance minister also reiterated that the government will implement reform of spending and revenues to achieve a budget balance at the national and local levels by the mid-2010s on a primary balance basis in which outlays other than debt servicing costs would be covered by revenues without relying on debts. (Kyodo News, January 26, 2007)

Tax rules could cripple triangular mergers
New regulations under review may exclude special purpose companies
Triangular mergers are set to be allowed in May, by which a foreign firm can acquire a Japanese company by merging its Japanese subsidiary with the target, using stocks as payment to that entity's shareholders. But it remains unclear whether they can be an effective tool for taking over Japanese firms because related regulations, including tax rules, are still being discussed. "It would be extremely harmful to allow triangular mergers when we still have very lenient laws on corporate buyouts," said Akio Mimura, president of Nippon Steel Corp., at a New Year gathering on Jan. 5 hosted by Japan's three major business organizations. Top corporate executives of domestic companies worry that the scheduled lifting of the ban on triangular mergers will encourage foreign takeover moves, allowing their firms to be swallowed up in a wave of global realignment. They are also concerned about the possible outflow of proprietary technological expertise, among other assets, held by Japanese firms. Taxation is now the focus of attention. Fiscal 2007 tax reform plans are expected to allow firms acquired through triangular mergers, as well as their shareholders, to defer tax liability until gains are realized upon the sale of their stock. Due to opposition from the Japan Business Federation (Nippon Keidanren) and others, however, eligibility for such tax deferral may be narrowed to exclude transactions made via Japanese subsidiaries established for the sole purpose of executing mergers. The fiscal 2007 tax reform package of the ruling parties, announced on Dec. 14, would grant the tax benefit only if the two merging companies operate in related business areas. As a result, transactions involving special-purpose companies are highly likely to be excluded. The framework is expected to be finalized around March. If tax liability cannot be deferred, paper gains on the foreign company's stock - received by shareholders of the target firm through a stock swap -would be immediately taxable. Investors without enough cash to pay the tax would be forced to sell their holdings. Commenting on the situation, Atsushi Oishi, an attorney at the firm Mori Hamada & Matsumoto with extensive knowledge of M&As and taxation, said, "That would mean foreign buyers will not be able to use a special-purpose company, a method expected to be adopted in many cases. Only those firms that already have local units actually operating in Japan would be able to execute a triangular merger." Nicholas Benes, chairman of the Foreign Direct Investment Committee of the American Chamber of Commerce in Japan, is furious that a measure meant to deregulate the corporate takeover process will be rendered effectively meaningless at the very last stage before implementation. He is certain that stringent restrictions on tax deferral would render triangular mergers dead in the water, since very few foreign companies entering the Japanese market would be able to conduct them. Opinion is also divided over requirements on the types of shareholder resolutions that must be enacted by target firms. Corporate acquisitions through a stock swap usually require a "special resolution," approved on a voting rights basis by more than two-thirds of shareholders in attendance at a special meeting. But the Japan Business Federation and others want to require an "extraordinary resolution" that would need the approval of more than half of all shareholders, regardless of the size of their holdings - a virtually impossibility for listed firms. In actuality, what worries the Japanese business community most is the possibility of hostile takeovers by firms from emerging countries like China. It is already possible for foreign companies to acquire Japanese businesses if they have enough money to carry out a takeover bid. Therefore, triangular mergers are likely to be chiefly used by companies from rising nations that do not have the financial wherewithal to make a cash purchase. Tsutomu Fujita, a stock strategist at Nikko Citigroup Ltd., said, "It would not be surprising if companies from emerging economies tried to acquire Japanese businesses in order to obtain their technology, brand power or software." Without the hurdles posed by tax regulations, the lifting of the ban on triangular mergers would make it easier for foreign businesses to conduct friendly takeovers in Japan. But it is uncertain whether it would work to facilitate hostile takeovers since only friendly buyouts will be able to gain the approval of the target firm's board of directors, a requirement for a triangular merger. Still, Yasuhisa Abe, a director of the economic policy bureau at the Japan Business Federation, said, "The new scheme could stimulate hostile takeovers because a foreign firm could easily carry out a triangular merger by first obtaining a sizable portion of shares through a tender offer, then simply replacing some of the board members." The effect of the deregulation will largely depend on rules implemented in regard to taxation and shareholder resolutions. Although the basic policy of Prime Minister Shinzo Abe's cabinet is to promote foreign direct investment in Japan, the Nippon Keidanren is maintaining a hard-line stance, and will likely force the Ministry of Economy, Trade and Industry to continue adjusting the triangular merger rules right up until the ban on the practice is lifted in May. (The Nikkei Weekly, January 22, 2007)