PLC Global Finance update for August 2009: Japan

Practical Law UK Articles 0-500-1594 (Approx. 4 pages)

PLC Global Finance update for August 2009: Japan

by Atsumi & Partners

Companies and corporate governance

Seeking the right model - corporate governance in Japan

Since the introduction of the Companies Act in 2005, studies and discussions regarding corporate governance have raged in Japan.

For non-Japanese investors, Japanese corporate governance was difficult to understand and perceived as being somewhat loose; they frequently required improvements in management and reporting rules so that they could reduce perceived risks of investing in Japanese companies.

The Companies Act approved the establishment of companies with committees (Iinkai-Setchi Kaisha) similar to structures provided for under US corporate laws in addition to companies with statutory auditors. However, many companies remain as companies with statutory auditors; such companies are required to appoint a statutory auditor who has general power of oversight of the directors.

In practice, statutory auditors are commonly connected to the company and very rarely take actions. In such a situation, foreign investors wanted to have independent directors, and reinforcement of the independence of "inside" directors.

The Financial Services Agency, the Ministry of Economy, Trade and Industry, the Tokyo Stock Exchange, and the Japan Federation of Economic Organisations (JFEO) (a body organised mainly by companies on the first section of the Tokyo Stock Exchange) have been separately discussing how to provide for better corporate governance in Japan.

The JFEO published their interim report in April 2009 in which they suggest that:

Appropriate governance should be decided by each company, and having an independent director does not, of itself, result in better governance.
The independence of directors and statutory auditors (Kansayaku) or otherwise should be a matter for each company to decide on an individual basis and should not be the subject of strict and impartial rules or laws.
Statutory auditors have sufficient authority to govern the company and companies should provide opportunities to statutory auditors to govern.
Statutory auditors should not have authority to appoint accounting auditors (Kaikei-kansa-nin) or decide the terms of reimbursement for such accounting auditors as this creates a duality of decision-making within the company; such authority should remain with the directors.
Companies are becoming better at disclosing the results of voting at general shareholders' meetings and mandatory disclosure of this can be overly time and cost consuming.
Large-scale allocations of shares to third parties approved by resolutions of the board can lead to an unfair dilution of the rights.

The issue regarding independent directors is particularly controversial. Market makers seek to introduce a mandatory requirement to appoint independent directors. The JFEO, on the other hand, opposes this and asserts that:

The US model of corporate governance (which includes a mandatory requirement to appoint independent directors) has failed.
The US corporate governance model is not necessarily appropriate for other countries.
Corporate governance in Japan is no less effective than corporate governance in the US, UK and the rest of Europe.

Hitachi launches tender offer in bid to delist five subsidiaries

Hitachi Ltd has launched tender offers to buy shares in five of its listed subsidiaries, the company announced in a press release on 28 July 2009. Hitachi, which seeks to raise profitability by consolidating marketing and technological development within the group, would ultimately delist the subsidiaries if the plan is successful, according to the press release.

If Hitachi gains control of more than two-thirds of the voting shares of a subsidiary through the tender offer, any minority shareholders would be forced to swap their shares for Hitachi stock. The targeted subsidiaries include:

Hitachi Maxell.
Hitachi Plant Technologies.
Hitachi Information Systems.
Hitachi Software Engineering.
Hitachi Systems & Services.

Until now, Hitachi has been at the forefront of Japanese companies promoting the practice of listing subsidiaries, a characteristic of many Japanese conglomerates. Through the practice, parent companies can raise capital with subsidiary shares and benefit by knowledgeable analysts and investors evaluating the subsidiaries.

Additionally, subsidiaries can more easily access outside financing when their shares are listed. The policy reversal by Hitachi suggests that the practice of listing subsidiaries may warrant review for several reasons.

For one, part of a listed subsidiary's profit flows out to minor shareholders of the subsidiary. Further, diluting parent ownership of subsidiaries through listing them weakens the parent's control over the subsidiary. As a result, the parent may not be able to flexibly set unified policy beneficial to the whole conglomerate's profit. Co-ordinating among the interests of the conglomerate and minor shareholders can potentially consume limited and valuable management resources.

The stock swap system, introduced in 1999, contributed to the trend of delisting conglomerate subsidiaries. Using stock swaps, Panasonic, Sony and Citizen delisted a total of eight subsidiaries between 2002 and 2005.

Current low stock prices may accelerate the trend. Investors may want to consider "consolidation risk" of shares in subsidiaries of Japanese conglomerates.

The Tokyo Stock Exchange is now reviewing new listing regulations to protect minor shareholders.

Tax

New taxation rules aimed at stimulating foreign investment in funds that invest in equities

In a bid to stimulate foreign investment in funds by foreign investors (both corporate and individual) the Japanese Diet has introduced new tax rules applicable to capital gains on the sale of shares sold on or after 1 April 2009 where such shares are held through limited partnership-type funds. The amendments comprise two pillars, as follows:

The first pillar applies to non-Japanese persons that are limited partners (LPs) of limited partnerships which have a permanent establishment, such as a general partner (GP), a fund manager or an office in Japan.
Japanese tax law imposes capital gains tax on the sale of shares in Japanese companies through limited partnerships where the LP has a permanent establishment in Japan. The applicability of this rule has been modified such that LPs are deemed to have no permanent establishment in Japan if they meet certain criteria, including (but not limited to) that:
- the partnership is a Japanese limited partnership or non-Japanese equivalent;
- the LPs do not manage the business of the partnership;
- the LPs' share in the partnership's property is less than 25%; and
- the LPs have no relationship with the GP of the sort which is specified in the tax rules.
The result is that the capital gain generally is not taxable.
The second applies to non-Japanese entities that are LPs of foreign limited partnerships which have no permanent establishment in Japan.
Prior to the amendments, any capital gain on the sale of shares in Japanese companies was taxable when the limited partnership held 25% or more of the relevant company's shares (the 25% test) and the partnership sold 5% or more of the company's outstanding shares.
This rule has been amended such that the 25% test applies not at the level of the limited partnership but at the level of each LP investor, provided that certain criteria are met, including (but not limited to):
- prior continuous holding of the shares for one year or more;
- similarity of the limited partnership to a Japanese limited partnership; and
- the LPs are not involved in the management of the business of the partnership.

PLC Global Finance update for August 2009: Japan | Practical Law