Openness to Foreign Investment
Japan is the world's second largest economy, the United States' fourth largest trading partner, and an important destination for U.S. foreign direct investment (FDI). The Government of Japan explicitly promotes inward FDI and has established formal programs to attract it. Since 2001, Japan's stock of FDI, as a percentage of GDP, grew from less than one percent to more than three percent at the end of 2008. Despite the worldwide financial market turmoil, as of December 2008 Japan continues to attract positive FDI inflows, albeit at a slower pace than in previous years. It is possible Japan could see a short-term net outflow of FDI in the first half of 2009, however, as a number of multinational firms, especially non-Japanese financial institutions and automobile manufacturers restructure overseas assets in response to changing global credit risks and domestic liquidity problems.
As of the third quarter of CY 2008, Japan's economy entered recession for the first time since 2002. Beginning November 2008, several major firms in Japan's key export sectors, such as automobiles and consumer electronics, facing rapidly decelerating international demand began to cut production and terminated employment contracts of more than 100,000 temporary contract workers. As of December 2008, domestic spending had begun to fall, but the situation could deteriorate further in the first half of 2009 if the global recession lasts longer than expected and domestic job losses continue to mount.
The Ministry of Economy Trade and Industry (METI) and the quasi-governmental Japan External Trade Organization (JETRO) are the lead agencies responsible for assisting foreign firms wishing to invest in Japan. Many prefectural and city governments also have active programs to attract foreign investors, but lack many of the financial tools U.S. states use to attract investment.
Risks associated with investment in many other countries, such as expropriation and nationalization, are not of concern in Japan. The Japanese Government does not impose export balancing requirements or other trade-related FDI measures on firms seeking to invest in Japan.
Foreign investors seeking a presence in the Japanese market or to acquire a Japanese firm through corporate takeover face a number of unique challenges, many of which relate more to business practices, rather than government regulations. The most notable are:
The U.S. and Japanese Governments discuss all these issues in working groups under the Regulatory Reform and Competition Policy and the Investment Initiatives, as part of the U.S.-Japan Economic Partnership for Growth. There has been progress in some areas. Japan's government recognizes that open and transparent corporate governance is critical to attract FDI and in 2008 convened two separate experts working groups to clarify rules governing the use of corporate takeover defenses and to examine the role of independent corporate directors in enhancing corporate governance.
Structural reforms, revisions to Japan's legal code, and proactive Japanese Government policies to promote FDI and corporate restructuring have led to a boom in merger and acquisition (M&A) activity in the country since 2001. The annual number of M&A transactions in Japan increased more than threefold over the past decade, from approximately 800 in 1998 to almost 2,700 in 2007, according to Recof, a Tokyo-based M&A consultancy. The majority of these mergers were domestic transactions, but transactions involving foreign counterparts also increased. The number of takeover bids (TOB) in Japan exceeded 100 for the first time in 2007. Although change is slow, many Japanese corporate leaders now appreciate the contribution M&A can make to increasing corporate value.
Despite the increase in FDI since the mid-1990s, Japan continues to have the lowest foreign direct investment as a proportion of GDP ratio of any major OECD member. On a yen basis, FDI stock in Japan as of September 2008 was 17.02 trillion yen, (3.3 percent of GDP), according to preliminary Ministry of Finance (MOF) statistics.
Meanwhile, Japan runs a significant imbalance between inward and outward FDI (see Table 1b). Japan’s outward foreign direct investment rose from USD 50.1 billion in 2006 to USD 73.4 billion in 2007 (see Table 5). More recently, Japanese companies' large cash holdings combined with low global equity values and the strengthening of the yen helped increase outbound FDI activity. In the first 10 months of 2008, according to Recof, the total value of M&A deals involving Japanese companies rose 5.2 percent to 10.3 trillion yen. At the same time, Japanese M&A directed at foreign companies rose more than 260 percent to 6.6 trillion yen.
Legal Reform Facilitates M&A Activity
In recent years, reforms in the financial, communications, and distribution sectors encouraged foreign investment in these industries. The 2005 Company Law, an amended bankruptcy law, and the 2007 Financial Instruments and Exchange Law helped increase the attractiveness of Japan as a destination for FDI.
The most significant legislative change was the substantial revision of Japan’s Company Law. These changes significantly expanded the types of corporate structures available in Japan as well as the variety of M&A transactions available for corporate consolidation and restructuring. A foreign firm, for the first time, may now use its stock as consideration in a cross-border M&A transaction by means of a procedure known as a triangular merger, as long as the foreign acquirer has an existing Japanese subsidiary with which to merge the target company.
Unfortunately, the tax regulations that govern triangular mergers contain strict conditions regarding business viability and business relevance between the acquiring subsidiary and the target Japanese firm for the transaction to be granted tax deferral of capital gains. As a result, the procedure has not attracted significant new investment flows. As of December 2008, only one major foreign investor has used the triangular merger provisions of the Company Law to complete the purchase of a Japanese firm and, in that case, the foreign acquirer already had a significant existing Japanese operation into which it could merge its new Japanese acquisition. The U.S. Government has repeatedly raised the issue of effective tax deferral for M&A transactions in the discussions of the Bilateral Investment Working Group. The Japanese Government itself acknowledges the issue and a government-appointed Expert Committee on FDI Promotion, in its May 2008 report to the Council on Economic and Fiscal Policy (CEFP), identified tax rules for triangular mergers as a continuing obstacle to inward M&A and something requiring further study and resolution.
The 2007 Financial Instruments and Exchange Law establishes a flexible regulatory system for financial markets and applies a uniform set of rules for similar financial instruments. At the same time, the law allows brokers and financial advisors to treat investors differently, depending on whether they are deemed "professional" investors (assumed to be capable of more sophisticated investment strategies and requiring less protection and disclosure) or "general", i.e., retail investors. Brokerage firms must provide the latter with detailed disclosure of risks related to different types of financial products at the time of offering.
Limited Sector-specific Investment Restrictions Remain
Japan has gradually eliminated most formal restrictions governing FDI. One important restriction remaining in law limits foreign ownership in Japan's former land-line monopoly telephone operator, Nippon Telegraph and Telephone (NTT), to 33 percent. Japan's Radio and Broadcasting Law also limits foreign investment in broadcasters to 20 percent, or 33 percent for broadcasters categorized as facility-supplying. Foreign ownership of Japanese companies invested in terrestrial broadcasters will be counted against these limits. These limits do not apply to communication satellite facility owners, program suppliers, or cable television operators. The government is also considering a December 2008 recommendation of an Experts Advisory Council on Airport Infrastructure to limit an investor -- whether foreign or domestic -- to a maximum 20 percent ownership stake when the Japanese Government sells off its shares in the privatized Narita International Airport Corporation. Whether that limit will also apply retroactively to Tokyo's already-privatized Haneda Airport Authority is under discussion.
The Foreign Exchange and Foreign Trade Control Law governs investment in sectors deemed to have national sovereignty or national security implications. In most cases, foreign investors need only report transactions to the Bank of Japan within 15 days of acquiring more than 10 percent of the shares in a publicly listed company or any shares of a closely held company. However, if a foreign investor wants to acquire over 10 percent of the shares of a listed company in certain designated sectors, it must provide prior notification (and thus obtain specific approval) of the intended transaction to the Ministry of Finance and the ministry that regulates the specific industry. Designated sectors include agriculture, aerospace, forestry, petroleum, electric/gas/water utilities, telecommunications, and leather manufacturing. In practice, the Japanese Government has rejected only one proposed investment when in May 2008 it blocked a foreign activist fund from increasing its stake in electricity wholesaler J-Power Corporation. The Japanese Government stated it took this action on the grounds that the proposed investment could constitute a "risk to public order" and the smooth operation of Japan's electric power sector. The Japanese Government said there were concerns the proposed investor might cancel or otherwise alter J-Power's planned construction of a nuclear power plant in northern Japan. The case sparked such extensive press controversy that the Experts Committee on Investment Promotion in its May 2008 report to the CEFP recommended the government clarify which sectors are covered by the Foreign Trade Control Law and the possible reasons it may use to block a proposed investment. The government commenced an inter-ministerial review of the law in December 2008.
Several sections of the Japanese Anti-Monopoly Law (AML) are relevant to FDI. Chapter Four of the AML includes extensive anti-trust provisions pertaining to international contract notification (section 6), shareholdings (sections 10 and 14), interlocking corporate directorates (section 13), mergers (section 15), and acquisitions (section 16). The stated purpose of these provisions is to restrict shareholding, management, joint venture, and M&A activities that may constitute unreasonable restraints on competition or involve unfair trade practices. The Japanese Government has emphasized these provisions are not intended to discriminate against foreign companies or discourage FDI.
Limitations on Facility Development and Availability of Investment Real Estate
Aiming to increase the liquidity of Japanese real estate markets, the government in recent years has progressively lowered capital gains, registration, and license taxes on real estate. It also reduced inheritance and gift taxes to promote intergenerational transfer of land and other real assets. More changes in tax policy and accounting standards could increase real estate liquidity, but the market remains hampered by a shortage of legal and accounting professionals and by a relative lack of information on prices and income flows.
Japan continues restricting development of retail and commercial facilities in some areas to prevent excessive concentration of development in the environs of Tokyo, Osaka, and Nagoya, and to preserve agricultural land. Conversely, many prefectural governments outside the largest urban areas make available property for development in public industrial parks. Japan's zoning laws give local officials and residents considerable discretion to screen almost all aspects of a proposed building. In some areas, these factors have hindered real estate development projects and led to construction delays and higher building costs, in particular, in cases where proposed new retail development would affect existing businesses.
Japanese law permits marketing of real estate investment trusts (REITs) and mutual funds that invest in property rights. As of December 2008, there are 40 REITs listed on the Tokyo Stock Exchange (TSE), two fewer than a year earlier.
The 2008 global economic turmoil and resulting credit contraction, however, hit Japan's real estate sector particularly hard. A number of developers have gone bankrupt and others have been forced into emergency restructuring as regular short-term financing has evaporated. As of December 2008, the sector continues to experience extended and painful contraction.
Corporate Tax Treatment
Local branches of foreign firms are generally taxed only on corporate income derived within Japan, whereas domestic Japanese corporations are taxed on their worldwide income. Calculations of taxable income and allowable deductions, and payments of the consumption tax (sales tax) for foreign investors are otherwise the same as those for domestic companies. Corporate tax rules classify corporations as either foreign or domestic depending on the location of their "registered office," which may be the same as -- or a proxy for -- the place of incorporation. As part of its annual tax amendments, the Japanese government in December 2008 began consideration of a partial tax holiday for Japanese firms' foreign operations to encourage firms to repatriate earnings to Japan.
The current U.S.-Japan bilateral tax treaty allows Japan to tax the business profits of a U.S. resident only to the extent those profits are attributable to a "permanent establishment" in Japan. It also provides measures to mitigate double taxation. This "permanent establishment" provision combined with Japan's high 40 percent corporate tax rate serves to encourage foreign and investment funds to keep their trading and investment operations off-shore.
Cross-border dividends on listed stock are not subject to source country withholding tax if the parent company owns 50 percent or more of the foreign subsidiary. Interest on financial transactions payable to a nonresident and royalties paid to a foreign licensor are no longer subject to source country withholding tax. A special tax measure allows designated inward investors to carry over certain losses for tax purposes for ten years rather than for the normal five years.
The option of consolidated taxation is available to corporations. The purpose of these rules is to facilitate investment and corporate restructuring, because losses usually expected from a new venture or recently acquired subsidiary can be charged against the profits of the parent firm or holding company.
Since 2001, the Japanese Government has sought to revitalize the country's economy, in part, by increasing inward FDI. In 2003, the Japan Investment Council adopted a five-point Program for the Promotion of Foreign Direct Investment into Japan that called on the government to: (1) make administrative processes clearer, simpler, and faster; (2) improve the business environment by facilitating cross-border M&A; (3) create a favorable work and living environment for foreign residents in Japan; (4) improve local efforts to attract FDI through use of Special Zones for Structural Reform; and (5) disseminate information on investment opportunities both domestically and internationally. In June 2006, the government accepted the JIC report recommended to establish a national goal of increasing Japan's stock of FDI to the equivalent of five percent of the country’s GDP by FY2010 (March 2011.)
In the wake of a number of controversial foreign investment cases, the Cabinet Office in January 2008, appointed an ad-hoc Experts Committee on FDI Promotion to examine and make recommendations on ways to further improve Japan's climate for foreign investment. The committee's May 2008 report included five recommendations, among which were that the government (1) review and improve Japan's rules for M&A; (2) undertake a comprehensive examination of national security-related FDI regulations; (3) establish priority sectors for FDI that that will have a positive impact on the Japanese economy and quality of life; (4) reduce business costs, including by lowering corporate tax rates, and improve regulatory transparency; and (5) develop a strategic plan to spur regional economies' revitalization through the use and attraction of foreign capital. The government incorporated the broad outline of the committee's recommendations into its 2008 Basic Fiscal and Economic Policy document, which the Cabinet adopted in June 2008. The Cabinet office is now preparing a new national investment strategy that should be ready for submission to the Cabinet in early 2009.
JETRO operates six Invest Japan Business Support Centers in major urban areas to provide investment-related information and "one-stop" support services to foreign companies interested in investing in Japan. (More detailed information is available at http://www.jetro.go.jp/en/invest.) Most national level ministries also have information desks to help guide potential investors in navigating Japanese Government administrative procedures. (Links to the "Invest Japan" contact points at each ministry are at http://www.investment-japan.go.jp/links.htm.)
Many city or regional governments work to attract foreign capital through outreach to prospective foreign investors, business start-up support services, and limited financial incentives. JETRO supports local government investment promotion efforts. Detailed information on local and regional FDI promotion programs is available in English on the JETRO website.
Conversion and Transfer Policies
Generally, all foreign exchange transactions to and from Japan -- including transfers of profits and dividends, interest, royalties and fees, repatriation of capital, and repayment of principal -- are freely permitted. Japan maintains an ex-post facto notification system for foreign exchange transactions that specifically prohibits specified transactions, including certain foreign direct investments (e.g., from countries under international sanctions) or others which are listed in the appendix of the Foreign Exchange and Foreign Trade Control Law.
Japan is an active partner in the struggle against terrorist financing. In coordination with other OECD members, Japan has strengthened due-diligence requirements for financial institutions. Japan has had a "Know Your Customer" law since 2002. Customers wishing to make cash transfers exceeding 100,000 yen (USD 1100) must do so through bank clerks, not ATMs, and must present photo identification.
Expropriation and Compensation
In the post-war period, the Japanese Government has not expropriated or nationalized any enterprises, with the exception of the 1998 nationalization of two large Japanese capital-deficient banks and the 2002 nationalization of two failed Japanese regional banks as part of the government's efforts to clean up the banking system after its near collapse in 1998. Expropriation or nationalization of foreign investments is extremely unlikely.
There have been no major bilateral investment disputes since 1990. Nor are there any outstanding expropriation or nationalization cases in Japan. There have been no cases of international binding arbitration of investment disputes between foreign investors and Japan's Government since 1952. Japan is a member of the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitration Awards. Nevertheless, Japan is considered an inhospitable forum for international commercial arbitration.
There are no legal restrictions on foreign investors' access to Japanese lawyers and reforms in the legal services sector and the judicial system have increased the ability of foreign investors to obtain international legal advice related to their investments in Japan. Japan does, however, retain certain restrictions on the ability of foreign lawyers to provide international legal services in Japan in an efficient manner. Only individuals who have passed the Japanese Bar Examination and qualified as Japanese lawyers (bengoshi) may practice Japanese law. However, under Japan's Foreign Legal Practitioner system foreign qualified lawyers may establish Japanese/foreign joint legal enterprises (gaikokuho kyodo jigyo) and provide legal advice and integrated legal services on matters within the competence of its members. Foreign lawyers qualified under Japanese law (gaiben), may provide advice on international legal matters. Gaiben and bengoshi in joint enterprises can adopt a single law firm name of their choice and may determine the profit allocation among them freely and without restriction. However, foreign lawyers are unable to form professional corporations in the same manner as Japanese lawyers and are prohibited from opening branch offices in Japan. Gaiben may hire Japanese lawyers to work directly with them or in a joint legal enterprise or in a Foreign Japanese Joint Legal Office (gaikokuho-jimu-bengoshi jimusho) composed of multiple gaiben. The Japanese Government has adopted a long term goal of increasing the number of legal professionals who pass the Bar Examination to 3,000 per year by 2010.
Japan’s civil courts enforce property and contractual rights and do not discriminate against foreign investors. Japanese courts, like those in other countries, operate rather slowly and experience has shown them sometimes ill-suited for litigation of investment and business disputes. Japanese courts lack powers to compel witnesses to testify or a party to comply with an injunction. Timely temporary restraining orders and preliminary injunctions are difficult to obtain. Filing fees are based on the amount of the claim, rather than a flat fee. Lawyers usually require large up-front payments from their clients before filing a lawsuit, with a modest contingency fee, if any, at the conclusion of litigation. Contingency fees familiar in the U.S. are relatively uncommon. A losing party can delay execution of a judgment by appealing. In appeals to higher level courts, additional witnesses and other evidence may be allowed.
Japan's Alternative Dispute Resolution (ADR) law provides a legal framework for arbitration, including international commercial arbitration. Foreign lawyers qualified under Japanese law can represent parties in ADR proceedings taking place in Japan in which one of the parties is foreign or foreign law is applicable, at least to the extent such representation is not inconsistent with Japanese law. The United States continues to urge Japan to promote alternative dispute resolution mechanisms by ensuring that gaiben and non-lawyer experts can act as neutrals in international arbitration or other international ADR proceedings in Japan, in whole or in part, regardless of the governing law or matter in dispute.
Courts have the power to encourage mediated settlements and there is a supervised mediation system. However, this process is often time-consuming and judges transfer frequently, so continuity is often lost. As a result, it is common for companies to settle cases out of court.
Performance Requirements and Incentives
Japan does not maintain performance requirements or requirements for local management participation or local control in joint ventures.
Right to Private Ownership and Establishment
Foreign and domestic private enterprises have the right to establish and own business enterprises and engage in all forms of remunerative activity.
However, the 2005 Company Law includes a provision -- Article 821 -- which creates uncertainty among foreign corporations that conduct their primary business in the Japanese market through a branch company. As written, Article 821 appears to prohibit branches of foreign corporations from engaging in transactions in Japan "on a continuous basis." The Japanese Diet subsequently issued a clarification of the legislative intent of Article 821 that makes clear the provision should not apply to the activities of legitimate entities. However, some legal uncertainty remains, particularly with respect to possible private litigation against directors and officers of affected firms. The U.S. Government has urged that Japan revoke Article 821 or more formally clarify its meaning. The Japanese Government has undertaken to ensure Article 821 will not adversely affect the operations of foreign companies duly registered in Japan and conducting business in a lawful manner.
Protection of Intellectual Property Rights
In general, Japan maintains a strong intellectual property rights (IPR) regime, but there are costs and procedures of which prospective investors should be aware. Companies doing business in Japan are encouraged to be clear about all rights and obligations with respect to IPR in any trading or licensing agreements. Explicit arrangements and clear understanding between parties will help to avert problems resulting from differences in culture, markets conditions, legal procedures, or business practices.
Registering Patents, Trademarks, Utility Models and Designs: TheIPR rights holder must register patents and trademarks in order to ensure protection in Japan. Filing the necessary applications requires hiring a Japanese lawyer or patent practitioner (benrishi) registered in Japan to pursue the patent or trademark application. A U.S. patent or trademark attorney may provide informal advice, but is not able to perform some required functions.
Patent and trademark procedures in Japan have historically been costly and time-consuming. There have also been complaints about the weaknesses of Japanese enforcement and legal redress, for example, that judges are not adequately trained or that court procedures do not adequately protect business-confidential information required to file a case. Japan's Government has revised the law and continues to take steps to address these concerns and it is becoming easier and cheaper to obtain patent and trademark protection. Procedures have been simplified, fees cut, and judges are receiving more training and are being assigned to specialized IPR courts. Courts have strengthened rules to protect sensitive information and the government has established criminal penalties for inappropriate use of sensitive information used in court or administrative proceedings.
Prompt filing of patent application is very important. Printed publication of a description of the invention anywhere in the world, or knowledge or use of the invention in Japan, prior to the filing date of the Japanese application, could preclude the granting of a patent. Japan grants patents on a first-to-file basis. Japan accepts initial filings in English (to be followed by a Japanese translation), but companies should be careful as translation errors can have significant negative consequences. Unlike the United States, where examination of an application is automatic, in Japan an applicant must request examination of a patent application within three years of filing.
The Japanese Patent Office (JPO) publishes patent applications 18 months after filing, and if it finds no impediment to granting a patent, publishes the revised application a second time before the patent is granted. The patent is valid for 20 years from the date of filing. Currently, the law allows parties to contest the terms of a patent after issuance (for up to six months), rather than prior to registration as was the previous practice.
Patent Prosecution Highway: The Patent Prosecution Highway (PPH) is a noteworthy development for U.S. firms seeking patent protection in Japan. This arrangement became fully operational January 4, 2008, after an 18-month pilot program. The PPH will allow filing of streamlined applications for inventions determined to be patentable in other participating countries and is expected to reduce the average processing time (from request for examination to First Action) from 26 months to two to three months for second filings. The program, which is based on information sharing between national patent offices and standardized application and examination procedures, should reduce costs and encourage greater utilization of the patent system.
Trademarks, Utility Models, and Designs: Japan's Trademark Law protects trademarks and service marks and, like patent protection, requires registration by means of an application filed by a resident agent (lawyer or patent agent). As the process takes time, firms planning on doing business in Japan should file for trademark registration as early as practicable. Japan is a signatory of the Madrid Protocol. Trademarks registered at the WIPO Secretariat are protected among all member countries.
Japan's Utility Model Law allows registration of utility models (a form of minor patent) and provides a 10-year term of protection. The JPO reduced registration fees in 2005 and streamlined the application procedures in such cases. A separate design law, effective April 2007, allows for protection of designs for a 20-year term from the date of registration. Semiconductor chip design layouts are protected for 10 years under a special law, if registered with the Japanese "Industrial Property Cooperation Center" -- a government-established public corporation.
Unfair Competition and Trade Secrets: The Unfair Competition Prevention Law provides for protecting trademarks prior to registration. The owner of the mark must demonstrate that the mark is well known in Japan and that consumers will be confused by the use of an identical or similar mark by an unauthorized user. The law also provides some protection for trade secrets, such as know-how, customer lists, sales manuals, and experimental data. Recent amendments to the law provide for injunctions against wrongful use, acquisition, or disclosure of a trade secret by any person who knew, or should have known, the information in question was misappropriated. Criminal penalties were also strengthened. However, Japanese judicial processes make it difficult to file claims without losing the trade secrets.
Copyrights: In conformity with international agreement, Japan maintains a non-formality principle for copyright registration -- i.e., registration is not a pre-condition to the establishment of copyright protection. However, the Cultural Affairs Agency maintains a registry for such matters as date of first publication, date of creation of program works, and assignment of copyright. United States copyrights are recognized in Japan by international treaty.
Transparency of the Regulatory System
The Japanese economy continues to suffer from over-regulation, which can restrain potential economic growth, raise the cost of doing business, restrict competition, and impede investment. It also increases the costs for Japanese businesses and consumers. Over-regulation underlies many market access and competitive problems faced by U.S. companies in Japan.
The United States has for several years called on Japan to make improvements in its regulatory system to support domestic reform efforts and ensure universal access to government information and the policymaking process.
The Japanese Government has taken steps to improve its public comment procedures, but these improvements are not uniform throughout the government. The United States continues to urge Japan to apply consistently high transparency standards, including by issuing new rules to ensure transparency and access for stakeholders in the rulemaking process; by allowing effective public input into the regulatory process; and by giving due consideration to comments received. The United States also has asked Japan to lengthen its public comment period and to require ministries and agencies to issue all new regulations or statements of policy in writing or provide applicable interpretations to interested stakeholders in plain language.
In the financial sector, the Financial Services Agency has made efforts to expand the body of published written interpretations of Japan’s financial laws, including improvements to the "no-action letter" system, and improved outreach to the private sector regarding these changes. The United States recommends Japan take further steps to enhance the effectiveness and usage of the "no-action letter" system and provide regulated firms an opportunity to seek clarification of an administrative agency’s interpretation of law or regulation, including through more active use of the interpretive letter system.
The United States continues to hold bilateral working-level discussions in an effort to encourage the Japanese Government to promote deregulation, improve competition policy, and administrative reforms that could contribute to sustainable economic growth, increase imports and foreign direct investment into Japan. The National Trade Estimate Report on Foreign Trade Barriers, issued by the Office of the U.S. Trade Representative (USTR), contains a detailed description of Japan’s regulatory regime as it affects foreign exporters and investors.
Capital Markets and Portfolio Investment
Japan maintains no formal restrictions on inward portfolio investment and foreign capital plays an important role in Japan's financial markets. However, many company managers and directors resist the actions of activist shareholders, especially foreign private equity funds, potentially limiting the attractiveness of Japan's equity market to large-scale foreign portfolio investment. Nevertheless, some firms have taken steps to facilitate the exercise of shareholder rights by foreign investors, including the use of electronic proxy voting. The Tokyo Stock Exchange maintains an Electronic Voting Platform for Foreign and Institutional Investors in which more than 300 listed companies participate as of mid-2008. Beginning January 5, 2009, all holdings of TSE-listed stocks will be required to transfer paper stock certificates into electronic form.
Environment for Mergers and Acquisitions: Japan’s aversion to M&A is receding gradually, accelerated by the unwinding of previously extensive corporate cross-shareholding networks between banks and corporations in the same business family, improved accounting standards, and government mandates that began in the late 1990's that require banks divest cross-holdings above a set threshold. The majority of M&A over the past decade has been driven by the need to consolidate and restructure mature industries or in response to severe financial difficulties.
Friendly transfer of wholly owned or majority-owned subsidiaries remains by far the more common form of M&A in Japan. Similarly, unlisted owner-operated firms -- which traditionally would only sell out as a last resort before bankruptcy -- are becoming more amenable to acquisition, including by foreign investors. Nevertheless, there remains a strong preference among Japanese managers and directors for M&A that preserves the independence of the target company. If companies are forced to seek an acquirer, they are often most comfortable merging with a firm with which they have a pre-existing business relationship.
Since the 2006 Company Law expanded the types of M&A structure available in the Japanese market, many companies have adopted defensive measures against hostile takeovers. The most common of these are "advance warning systems" or "poison pill"-type rights distribution plans.
In response to the rapid adoption of such plans and the concerns of many foreign investors, including investment funds, that companies were using takeover defenses to entrench existing management, METI in early 2008 convened the Corporate Value Study Group (CVSG) to clarify the purpose of takeover defense measures and principles governing their use. The CVSG's final report issued July 2008 explicitly recognizes the "positive effects" of hostile takeovers and emphasizes defensive measures should not be used to protect managements' own interests at the expense of shareholders, nor should they deprive shareholders of the right to make their own determination whether to accept a takeover bid. Nevertheless, a number of technical factors continue to limit greater entry into the Japanese market through M&A. These factors include tax policy, a lack of independent directors, weak disclosure practices, and a relative shortage of M&A infrastructure in the form of specialists skilled in making matches and structuring M&A deals.
Company Law Revisions: The extensive revision of Japan's Company Law (Commercial Code) in 2005-06 significantly expanded the flexibility of corporate capital structures and increased the types of governance structures available to Japanese firms. The new law, which came fully into force in May 2007, revised and combined Part II of the previous Commercial Code with existing laws governing limited liability companies (yugen gaisha) and audits. The law also introduced changes to facilitate start-ups and make corporate structures more flexible, including elimination of minimum capital requirements for joint-stock companies (kabushiki kaisha). It merged a number of different corporate structures and created a new structure (godo kaisha) modeled on the U.S.-style limited liability company.
The revised Company Law also permits formation of corporate holding companies in Japan for the first time since World War II. This step has facilitated use of domestic stock swaps in corporate restructuring, through which one party becomes a wholly-owned subsidiary of the other. Japan's tax law now provides special tax treatment and deferral of taxes on such stock-swap transactions at the time of exchange and transfer. As of May 2007, foreign equities can be used as consideration in triangular merger transactions targeting Japanese firms. However, to take advantage of the new rules, the foreign acquirer must legally establish a Japanese subsidiary firm to act as the counterpart to the stock exchange/transfer.
Changes in Corporate Governance: Under the new Company Law and the Industrial Revitalization Law, publicly traded companies have the option of adopting a U.S.-style corporate governance system instead of the traditional Japanese statutory auditor (kansayaku) system of corporate governance. This new system requires the appointment of executive officers and the establishment of a board committee system in which at least the audit, nomination, and compensation committees are composed of a majority of outside directors. Initially available only under the Industrial Revitalization Law and effectively limited to distressed companies, the new Company Law makes these options available to all listed companies. Companies also can use the Internet or other electronic means to provide notices of annual general meetings or similar communication with shareholders. Where available, shareholders may exercise voting rights electronically and companies are permitted to make required disclosures of balance sheet and other financial information in an electronic format.
METI inaugurated a Corporate Governance Working Group in December 2008 tasked with studying the corporate governance situation in Japan and, specifically, whether it is appropriate to require listed companies to have a minimum number of outside board members. The study group will issue its report in mid-2009.
Cross-shareholdings and M&A: Potential foreign investors in Japan frequently point out that cross-shareholding between Japanese listed companies greatly complicates market-based M&A activity and reduces the potential impact of shareholder-based corporate governance. Such cross-shareholding practices allow senior management to put a priority on internal loyalties over shareholder returns and can lead to premature rejection of M&A bids. Traditionally, a company maintained a close relationship with a large-scale commercial bank, known as a "main bank", usually part of the same loose corporate grouping. In return for holding a bloc of the company's shares, the bank provided both regular financing and emergency support if the company ran into financial difficulties. This "main bank" system largely dissolved in the late 1990's as Japan's banking system came close to collapse. With the recovery of the Japanese economy, however, some company boards have begun rebuilding cross-shareholding networks, this time with suppliers or nominal competitors rather than a commercial bank. Many boards see such linkages as an effective means of defense against hostile takeovers.
Accounting and Disclosure: Accounting and disclosure standards are an extremely important element in assessing and improving a country’s environment for M&A. Before any merger or acquisition can take place, it is critical that the merging or acquiring firms have the best possible information on which to make business decisions. Implementation of so-called "Big Bang" reforms since 1998 significantly improved Japan’s accounting standards.
Consolidated accounting is mandatory since 1999 and "effective control and influence" standards have been introduced in place of conventional holding standards, expanding the range of subsidiary and affiliated companies included for the settlement of accounts. Consolidated disclosure of contingent liabilities, such as guarantees, is also mandatory. All marketable financial assets held for trading purposes, including cross-shareholdings and other long-term securities holdings, are recorded at market value.
Companies are required to disclose unfunded pension liabilities by valuing pension assets and liabilities at fair value. Fixed asset impairment accounting, in effect since 2005, requires firms to record losses if the recoverable value of property, plant, or equipment is significantly less than book value.
The greater focus on consolidated results and mark-to-market accounting had a significant effect in encouraging the unwinding of cross-shareholdings and the "main bank" system. Corporate restructuring has taken place, in many cases with companies reducing pension under-funding and banks disposal of many low-yield assets. While recent changes to accounting standards and growth in M&A activity have been welcome, they have also exacerbated the shortage of accounting professionals.
The Accounting Standards Board of Japan (ASBJ) and the International Accounting Standards Board (IASB) began discussions on the convergence of Japanese both accounting standards and International Financial Reporting Standards (IFRS) practices in March 2005 and, in March 2006, further agreed to accelerate the process of convergence. The ASBJ embarked on similar discussions with the U.S. Financial Accounting Standards Board in May 2006.
Taxation and M&A: Japan's standard tax rate for capital gains is 20 percent. However, under special policy measures intended to stimulate capital markets, Japan applies a special 10 percent capital gains tax rate on the proceeds of sales of listed stocks through 2010 for capital gains of less than 5 million yen and for dividends on listed shares of less than 1 million yen. The government in December 2008 as part of its FY2009 tax reform plan proposed extending the 10 percent rate for all capital gains and dividends through 2011 and special maximum annual 1 million yen tax exemption on dividends and capital gains of small shareholders. Under a series of special measures Japan adopted to promote venture businesses, if the founding shareholder of a qualified company sells shares in the company a ten percent capital gains tax rate will apply if the sale is made prior to public listing in an M&A transaction and, from 2008, a ten percent rate will apply to shares sold by the founding shareholder within three years of listing.
Bankruptcy Laws: An insolvent company in Japan can face liquidation under the Bankruptcy Act or take one of four roads to reorganization: the Civil Rehabilitation Law; the Corporate Reorganization Law; corporate reorganization under the Commercial Code; or an out-of-court creditor agreement.
Japan overhauled its bankruptcy law governing small and medium size firm bankruptcies by enacting the Civil Rehabilitation Law in 2000. The law focuses on corporate restructuring in contrast to liquidation, provides stronger protection of debtor assets prior to the start of restructuring procedures, eases requirements for initiating restructuring procedures, simplifies and rationalizes procedures for the examination and determination of liabilities, and improves procedures for approval of rehabilitation plans. Japan’s Corporate Reorganization Law, generally used by large companies, was similarly revised in 2003. Amendments made corporate reorganization for large companies more cost-efficient, speedy, flexible and available at an earlier stage. By removing many institutional barriers to the restructuring process, the new bankruptcy regime accelerated the corporate restructuring process in Japan.
Previously, most corporate bankruptcies in Japan were handled through out-of-court creditor agreements because court procedures were lengthy and costly. The fact bankruptcy trustees had limited powers to oversee restructuring meant most judicial bankruptcies ended in liquidation, often at distress prices. Beginning in 2001, a group of Japanese bankruptcy experts published a set of private rehabilitation guidelines, modeled after the U.K.-based INSOL guidelines, for out-of-court corporate rehabilitation in Japan. Out-of-court settlements in Japan tend to save time and expense, but can sometimes lack transparency and fairness. In practice, because 100 percent creditor consensus is required for out-of-court settlements and the court can sanction a reorganization plan with only a majority of creditors’ approval, the last stage of an out-of-court workout is often a request for a judicial seal of approval.
Credit Markets: Domestic and foreign investors have free access to a variety of credit instruments at market rates. In general, foreign companies in Japan do not experience significant difficulties in obtaining funding. Most foreign firms obtain short-term credit from Japanese commercial banks or one of the many foreign banks operating in Japan. Medium-term loans are available from commercial banks or from trust banks and life insurance companies. Large foreign firms tend to use foreign sources for long-term financial needs, although sophisticated derivatives products are now available to assist in hedging foreign investors’ perceived risk.
Political violence is rare in Japan. Acts of political violence involving U.S. business interests are virtually unknown.
Japan's penal code covers crimes of official corruption. An individual convicted under these statutes is, depending on the nature of the crime, subject to prison sentences ranging from one month to fifteen years and possible fines up to three million yen or mandatory confiscation of the monetary equivalent of the bribe. With respect to corporate officers who accept bribes, Japanese law also provides for company directors to be personally liable for the amount of the bribe and some judgments have been rendered against company directors.
Although the direct exchange of cash for favors from government officials in Japan is extremely rare, some have described the situation in Japan as "institutionalized corruption." The web of close relationships between Japanese companies, politicians, government organizations, and universities has been said to foster an inwardly cooperative business climate that is conducive to the awarding of contracts, positions, etc. within a tight circle of local players. This phenomenon manifests itself most frequently and most seriously in Japan through the rigging of bids on government public works projects.
Japanese authorities have acknowledged the problem of bid-rigging and have taken steps to address it. Building on the longstanding laws on bribery of public officials and misuse of public funds, the 2003 Bid-Rigging Prevention Act is aimed specifically at eliminating official collusion in bid rigging. The law authorizes the Japan Fair Trade Commission (JFTC) to demand central and local government commissioning agencies take corrective measures to prevent continued complicity of officials in bid-rigging activities, and to report such measures to the JFTC. The Act also contains provisions concerning disciplinary action against officials participating in bid rigging and compensation for overcharges when the officials caused damage to the government due to willful or grave negligence. Nevertheless, questions remain as to whether the Act's disciplinary provisions are strong enough to ensure officials involved in illegal bid-rigging are held accountable.
Complicating efforts to combat bid rigging is the phenomenon known as amakudari whereby government officials retire into top positions in Japanese companies, usually in industries that they once regulated. Amakudari employees are particularly common in the financial, construction, transportation, and pharmaceutical industries, among Japan's most heavily regulated industries. A 2007 law aimed at limiting involvement of individual ministries in finding post-retirement employment for its officials and more transparent administrative procedures may somewhat ameliorate the situation.
Japan ratified the OECD Anti-Bribery Convention, which bans bribing foreign government officials. The OECD has identified deficiencies in Japan's implementing legislation, some of which the Japanese Government has taken steps to rectify. In 2004, Japan amended its Unfair Competition Prevention Law to extend national jurisdiction to cover the crime of bribery and in 2006 made changes to the Corporation Tax Law and the Income Tax Law expressly to deny the tax deductibility of bribes to foreign public officials. In March 2007, prosecutors indicted officials of a Fukuoka-based engineering firm in the first case brought under the 1998 Anti-foreign Bribery law. In July 2008, prosecutors charged former executives of a MOFA-linked consulting company with bribery of a foreign government official in connection with the approval of Japanese ODA contracts.
Bilateral Investment Agreements
The 1952 U.S.-Japan Treaty of Friendship, Commerce, and Navigation gives national treatment and most favored nation treatment to U.S. investments in Japan. As of December 2008 Japan has concluded or signed bilateral investment treaties with fifteen trading partners including Egypt, Sri Lanka, China, Hong Kong SAR, Turkey, Pakistan, Bangladesh, Russia, Mongolia, Vietnam, the Republic of Korea, and Cambodia, Laos, Uzbekistan, and Peru. The Japanese Government has announced plans to accelerate efforts to reach BITs with countries that are abundant in natural and agricultural resources, beginning with Qatar, Colombia and Kazakhstan in 2009, and gradually expanding the scope to other key trading partners, including China.
Japan has economic partnership agreements (EPA -- analogous to a free trade agreement) containing investment chapters in force with Singapore, Mexico, Malaysia, Thailand, and Chile. Japan has also signed such agreements with the Philippines, Brunei, and Indonesia, but these are not yet in force. A multilateral EPA with all 10 members of the Association of Southeast Asian Nations (ASEAN) came into effect in December 2008.
U.S.-Japan Investment Initiative: The U.S. Government's concerns about barriers to foreign investment in Japan are addressed through the U.S.-Japan Investment Initiative under the Economic Partnership for Growth, established by President Bush and Prime Minister Koizumi in June 2001. The Initiative's Investment Working Group holds semi-annual sessions to discuss policy measures that could improve the investment climate in both countries. The group pursues a vigorous program of public outreach. In order to increase business `receptiveness to FDI, the Initiative holds annual investment promotion seminars. The 2008 seminar took place in Shizuoka and included representatives of approximately 150 U.S. and Japanese companies.
OPIC and Other Investment Insurance Programs Not Available
U.S. OPIC insurance and finance programs are not available in Japan. Japan is a member of the Multilateral Investment Guarantee Agency (MIGA). Japan's capital subscription to the organization is the second largest, after the United States.
Changing demographic patterns, macroeconomic trends, and regulatory reforms are gradually affecting traditional Japanese employment practices. Foreign investors seeking to hire highly qualified workers in Japan should benefit from many of these changes.
Throughout most of the post-war period, Japanese employment practices -- most notably in the nation's large, internationally competitive firms -- rested on three pillars: lifetime employment, seniority-based wages, and enterprise unions. Today all three are undergoing rapid transformation. Demographic pressures -- fewer young workers and a rapidly aging labor force and the subsequent structural changes in the Japanese economy are forcing many firms to reduce sharply lifetime employment guarantees and seniority-based wages in favor of merit-based pay scales and limited-term contracts. Although labor unions play a role in the annual determination of wage scales throughout the economy, that role is shrinking. As in the United States, trade union membership as a portion of the labor force has been declining for decades. However, the number of part-time workers who are union members has increased in recent years as a result of strengthened organizing efforts by some labor unions.
Investors should be aware of Japan's high wage structure. Growth in average wages has been slow, even in the midst of a return to economic growth, a situation that largely reflects the shift to increased use of non-regular employees and the hiring of younger workers to replace older, higher-wage workers who have begun to retire.
Traditionally, Japanese workers were classified as either "regular" or "other" employees. This system, to a considerable degree, remains in place. Companies recruit "regular" employees directly from schools or universities and provide an employment contract with no fixed duration. In contrast, firms hire "other" employees on fixed duration contracts, which generally cannot exceed one year but may be renewed several times. Since the mid-1990's, companies increasingly use part-time workers, interns, and temporary workers to fill temporary labor requirements. According to a 2007 MHLW survey, non-regular workers accounted for 71.8 percent of all employees aged 15-19 years and 43.2 percent of all employees age 20-24. There remains deep concern among Japanese Government policy makers that the number of non-regular employees age 25-34 remains stubbornly high and the ability of such workers to find permanent employment will declines as they get older. In the current economic contraction, these non-regular employees and temporary workers have born the brunt of corporate adjustment to the worldwide recession. In the last two months of 2008, the Japanese Government estimates that 115,079 temporary workers have had their employment contracts terminated. In many cases, terminations also o mean the loss of company-provided housing and other non-cash remuneration.
Defined contribution pension plans have been available in Japan since 2001. Such plans should promote greater labor mobility in the future, as workers are able to carry pension savings with them to new jobs. However, only about three percent of workers are currently covered by such plans and the ceiling on contributions is too low to realize the full potential of the program. In December 2008, the government submitted legislation that would, for the first time, allow employees to make individual contributions to their pension plans and would raise the tax deductible contribution limits.
Foreign Trade Zones/Free Ports
Japan no longer has free-trade zones or free ports. Customs authorities allow the bonding of warehousing and processing facilities adjacent to ports on a case-by-case basis.
Between 1998 and December 2007, Japan's stock of FDI increased from 3.0 trillion yen to 15.4 trillion yen. In the same period investment inflows were generally strong. All data in the tables below are current as of December 2007. Negative figures indicate net outflow.
Table 1a: Net FDI Inflows (Unit: billion dollars; balance-of-payment basis)
|JFY 1998||JFY 1999||JFY 2000||JFY 2001||JFY 2002|
|JFY 2003||JFY 2004||JFY 2005||JFY 2006||JFY 2007|
Table 1b: Ratio of Inward to Outward FDI (balance-of-payment basis)
1. Figures were first calculated in nominal Japanese yen and converted into U.S. dollars using Bank of Japan average annual exchange rates.
Table 2: Foreign Direct Investment in Japan, by country (Unit: million dollars; net and flow; balance-of-payment basis)
|E. Europe, Russia||-1||-1||0||-4||1|
Table 3: Japan’s FDI inward stock by country/region (Unit: million dollars)
|end of 2003||end of 2004||end of 2005||end of 2006||end of 2007|
|E. Europe, Russia||51||52||47||47||46|
Table 4: FDI in Japan, by industry (Unit: million dollars)
(net flow reporting basis for 2002 – 04, balance of payment basis for CY 2005 - 07)
|Chemicals and pharmaceuticals||--||--||-1,168||1,538||-1,010|
|Iron, non-ferrous metals||--||--||-34||60||230|
|Rubber & leather||--||--||1||35||35|
|Glass & ceramics||--||--||103||193||663|
|Farming & forestry||--||--||-1||11||41|
|Fish/ marine products.||--||--||0||-39||-33|
|Wholesale & retail||--||--||1,157||-387||1,660|
Table 5: Japanese Direct Investment Overseas, by country
(Unit: million dollars; net and flow; balance-of-payment basis)
Table 6: Japanese Direct Investment Overseas, by industry
(Unit: million dollars, net and flow; reporting basis for JFY2002 – 04, balance of payment basis for CY 2005 - 06)
|Chemicals and Pharmaceuticals||4.749||3,530||3,363||4,413||3,744|
|Iron, non-ferrous & metals||--||--||1,331||1,795||2,202|
|Rubber and leather||--||--||831||1,107||835|
|Lumber & pulp||28||119||826||420||745|
|Glass & ceramics||--||--||258||2,759||837|
|Wholesale & retail||--||--||4,623||5,483||4,792|
Table 7: FDI Inflow Relative to GDP (balance-of-payment basis)
|(a) GDP/Nom (trillion yen)||490.3||498.3||501.7||508.9||515.7|
|(b) FDI Inflow (trillion yen)||0.73||0.85||0.31||-0.76||26.55|