PLC Global Finance update for February 2011: Japan

The Japan update for January 2011 for the PLC Global Finance multi-jurisdictional monthly e-mail.


New tax measures aimed at facilitating Islamic Bond issuance

The Japanese government continues to remain keen to facilitate the conduct of Islamic finance business in Japan. In December 2008, the Ordinance for Enforcement of the Banking Law/lnsurance Business Law was amended to allow subsidiaries of Japanese banks/insurance companies to conduct business in certain Islamic finance products such as Murabahah (cost-plus sale) or Ijarah (leasing).

Recently, the government has announced its intention to facilitate Sukuk (bonds) issuance by Japanese domestic corporations by extending to them the benefits of certain tax reforms regarding non-taxability of interest on bonds paid to offshore investors that formed part of government's tax reform package in 2010.

Under the abovementioned tax reforms, interest paid on book-entry bonds paid to non-residents and foreign entities are fully tax-deductable. The Financial Services Agency of Japan (FSAJ) proposed to improve the tax treatment of Islamic finance by treating the dividends payable on Sukuk in the same manner as interest on bonds. The Japanese Tax Commission accepted the above proposal in its Tax Reform Outline 2011 in relation to structures where a Japanese originator:

  • Entrusts assets (such as real estate, the "Underlying Assets") to a trustee of a specified purpose trust (SPT) established pursuant to the Asset Liquidation Act.

  • Acquires a bond-type beneficial interest (for example, a beneficial interest in relation to which fixed distributions are payable which resemble interest payments on bonds, the "Bond-Type Beneficial Interest").

  • Issues the Bond-type Beneficial Interest as Sukuk to investors.

  • Enters into a Ijarah lease agreement with the trustee in respect of the Underlying Assets and makes periodic lease payments to the trustee.

  • Repurchases the Underlying Assets at maturity, and the trustee makes periodic distributions of dividends to the investors during the trust period, redeeming the Bond-Type Beneficial Interest by using the amount it receives on repurchase of the Underlying Assets from the originator at maturity.

The trustee makes periodic distributions of dividends to the investors during the trust period, redeeming the Bond-type Beneficial Interest by using the amount it receives on repurchase of the Underlying Assets from the originator at maturity.

Under the proposed amendments:

  • Distributions of dividends on book-entry Bond-Type Beneficial Interests (that do not carry voting rights other than in relation to significant matters) payable to non-resident investors shall not constitute taxable income.

  • In relation to the sale of Bond-Type Beneficial Interests, the requirement that more than 50 percent must be offered domestically shall be excluded from the conditions for tax-deductibility of dividends paid by the SPT.

  • In relation to the Bond-Type Beneficial Interests, the repurchase of the Underlying Assets from the SPT by the originator (settlor of the SPT) at maturity shall be excluded from registration license taxes and real estate acquisition taxes.

The JFSA stated in its Action Plan for Japan's New Growth Strategy in December 2010 that the taxation of cross-border transactions (including this reform) constitutes one of the core items in its agenda to improve the status of Japan in the Asian market. As such, it is expected that this reform will take effect within 2011.

Amendments to the Moneylending Control Act and Instalment Sales Act have positive impact

Recent amendments to the Moneylending Control Act (which became fully effective on 18 June 2010) and to the Instalment Sales Act (which became fully effective on 17 December 2010), according to a recent report published by the Japan Credit Information Reference Centre Corp. (JCIRCC), appear to be having a positive impact on the levels of personal debt in Japan. The amendments to both pieces of legislation were made to protect individuals from over-borrowing.

The main amendments to the Moneylending Control Act were:

  • To require moneylenders (except for banks and other institutions that are controlled by other acts, the "Moneylenders") to investigate each customer's ability to repay through a credit information bureau designated by the prime minister (each a Designated Credit Information Bureau) and Moneylenders are prohibited from lending an amount exceeding the amount the customer is able to repay (for example, an amount which causes the outstanding debt of the customer to be over one-third of annual income of the customer).

  • Prohibition of charging "grey zone interest rates" (interest rates between 15%-20%, depending on the loan amount), and 29.2% which though unenforceable was not penalised.

The main amendment to the Instalment Sales Act was to require intermediary traders for credit sales (for example, credit card companies, the Credit Sales Intermediaries) to investigate the limit that each customer can pay (the Credit Limit Amount) based on annual income, living costs and outstanding debt through a Designated Credit Information Bureau and such Credit Sales Intermediaries are prohibited from offering credit to customers over the Credit Limit Amount (for individual credit), or 90% of the Credit Limit Amount (for credit lines made available to customers).

According to the data published by JCIRCC, between April 2010 and December 2010:

  • The number of persons having outstanding debt decreased from 15,190,000 to 14,800,000.

  • The number of cases of outstanding debt decreased from 31,550,000 to 28,480,000.

  • The total outstanding amount of debt decreased from JPY 13,434 billion to JPY 11,624 billion.

While the levels of personal debt appear to be declining, there is a concern that the reduced levels could mean that Moneylenders are declining to provide credit at the lower legally-imposed rates and that this could, in turn, lead to borrowers seeking other sources of funds (for example; illegal moneylenders). This would, for obvious reasons, not be a desirable consequence. In this regard, it is interesting to note that in June 2010, about 50% of people who borrowed from Moneylenders borrowed in excess of one-third of their annual income. It is unlikely that such persons will be able to make additional borrowings under the new regulations which could put them into a tougher situation.

According to a survey conducted by Japan Financial Services Association, 76% of individuals who could not borrow due to the new regulations said that they need to borrow in order to maintain their daily life and 56% of sole proprietors who could not borrow due to the new regulations said that they need to borrow working capital. Now the issue is how to protect such people from resorting to illegal Moneylenders and/or falling into more serious problems.

Japan moves to facilitate rights offerings

On 19 January 2011, the Financial Services Agency of Japan (the FSA) published a report by its study group regarding how to improve rules for rights offerings.

In Japan, it has been quite usual for companies in need of new equity to offer new shares in the market or to allocate the new shares to persons other than existing shareholders, but without providing existing shareholders with pre-emptive rights. Such share issuance can be made pursuant to a board resolution and without a shareholders' resolution, unless the company is a closed company or the issue price of new shares is particularly favourable to subscribers. Such share issue practice has recently been questioned (though not prohibited) from the viewpoint of dilution of existing shareholders' rights; this dilution issue may be one of the factors that has lead to a decline in investment in Japanese stock markets. Rights offerings are expected to overcome this problem (pursuant to which, share options are allocated to existing shareholders without consideration for the options themselves and such share options are listed so that the existing shareholders may either exercise the options by subscribing for new shares, or sell the options in the market).

The FSA report addresses issues under current rules for rights offering and proposes certain improvements (though a timetable for the rule amendments is yet to be determined) as follows:

  • Change of method in providing prospectus to existing shareholders. As a general rule, under the Financial Instruments and Exchange Act of Japan (the FIEA), listed companies may allocate share options without consideration only by means of public offering which would require a prospectus to be directly provided to each investor. This process might be quite onerous for rights offerings where there are numerous existing shareholders (while the existing shareholders, who will automatically be allocated with share options, need information in the prospectus only in relation to making a decision as to whether to exercise or sell the options); the FSA report proposes to change the rule so that publishing the prospectus on EDINET will constitute sufficient disclosure.

  • Appropriate regulations for "undertaking" type rights offerings. When an issuing company needs a securities firm to provide an assurance that a certain amount of equity funding will be obtained by the rights offering (effectively an "underwriting"), the most likely structure would be:

    • to provide in the terms of the share option that the issuing company will buy back the options from existing shareholders who do not exercise the options prior to the exercise date;

    • for the securities firm to provide an undertaking to purchase from the issuing company the bought-back options (then the securities firm will exercise the options and sell the new shares it obtains).

    Under the current FIEA, the provision of the abovementioned undertaking by a securities firm would not constitute an "underwriting of securities" for the purposes of that Act and would therefore not be subject to the various regulations thereunder applicable to underwriting by Financial Instruments Business Operators. However, the FSA report proposes to expand the scope of "underwriting of securities" to cover the same. Also, securities firms which provide such undertakings may be inclined to encourage existing shareholders to exercise the options in order to mitigate the risk they have undertaken as underwriters. Such activities would not constitute an "offering" of securities under the FIEA, but the FSA report suggests to add appropriate regulations to cover such activities (such as prohibition of false statements, etc.).

  • Dealing with foreign countries’ securities regulations. In the case of a shareholder who resides in a foreign country, such shareholder's exercise of share options may trigger an obligation on the issuing company to make onerous registration or disclosure under such foreign country's securities regulations. The FSA report states that further discussion is required on whether it would be permissible to exclude existing shareholders in foreign countries from the rights offering process.

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