The TMK scheme[1] and
the GK/TK scheme[2] are typically used by overseas investors as
tax-efficient schemes for real estate investment in Japan. Of such
schemes, the GK/TK scheme is subject to the regulations under the
Joint Enterprise Act[3] if the subject asset of the scheme is a fee
simple estate ("GK/TK (real asset)"). Due to the
regulatory constraint, a scheme with ownership in the form of a
trust beneficial interest is generally used[4] in the case of GK/TK
scheme ("GK/TK (trust beneficial interest)"). If the
Joint Enterprise Law is applied, the person operating the
enterprise is required to be licensed by the competent minister or
prefectural governor, and various conditions of the license apply,
such as the JPY 100 million minimum capital requirement, which is
not realistic for most overseas investors.[5]
On June 17, an
amendment to the Joint Enterprise Act was enacted. Under the
amendment, if a special purpose company ("SPC") meets
certain conditions as a business operator, it may readily conduct
business by giving notification to the Ministry of Land,
Infrastructure, Transport and Tourism ("MLITT"). The
amendment will become effective as from the date designated by the
cabinet order and shall be within six months from its promulgation
(i.e., six months from June 21). This development appears to be of
great interest to overseas investors who may wish to know whether
they can utilize this new scheme under the Joint Enterprise Act. We
have prepared this Commentary to address this
question.
At this time, it is
still unclear whether overseas real estate funds will qualify as
"special investors." Unless overseas real estate funds
can qualify as such, the amendment appears to confer nearly no
benefit to overseas investors. We will not know for sure until the
relevant ministerial ordinance is issued, which should become
available at the same time as the amendment goes into effect near
the end of this year. Thus, it is necessary to continue monitoring
the developments until that time, including the process of public
commentary with respect to the relevant cabinet order and
ministerial ordinance this fall.
The amendment will
significantly liberalize the regulations under the Joint Enterprise
Act in the sense that an SPC can be a business operator and may
conduct business without a license as long as it has notified the
MLITT, although certain regulatory restrictions remain, such as the
license requirement for contracts.[6] Compared to the frequently
utilized TMK scheme or GK/TK (trust beneficial interest) scheme, it
does not seem particularly advantageous. Most real estate investors
will not find the new scheme worth considering if they can turn to
the GK/TK (trust beneficial interest) scheme. As a result, the new
scheme will become significant where the relevant property may not
be entrusted for some reason, such as the existence of a defect.[7]
New
Investment Schemes Not Falling Under the Previous License
Scheme
In order to conduct
business with only a notification to the MLITT as a special
business operator (tokurei jigyousha) ("Special
Business Operator"), one must meet the following
requirements:
-
A Special Business Operator shall be a corporation (houjin) with the purpose of exclusively conducting the real estate specified joint enterprise business;
-
A Special Business Operator shall delegate the business related to real estate transactions to a real estate specified joint enterprise operator ("Item 3 RE Business Operator"—see below) and the business for the solicitation for the execution of real estate specified joint business contracts to a real estate specified joint enterprise operator ("Item 4 RE Business Operator"—see below);
-
Each business participant shall be a special investor (tokutei toshika) ("Special Investor") with specialized knowledge and experience related to real estate investment, such as a bank or trust company (see below); and
-
A Special Business Operator shall conform to certain other requirements to protect the interests of other business participants.
Item 3 RE
Business Operators. Two business categories have been
added to the real estate specified joint enterprises under Items 3
and 4 in Paragraph 4 of Article 2 of the Law. An Item 3 RE Business
Operator "[conducts] business, in response to the entrustment
by a Special Business Operator, related to real estate transactions
being carried on under a real estate specified joint enterprise
contract to which the Special Business Operator is a party"
(Item 3). So-called "asset manager businesses" are
thought to fall under such category.[8]
The person managing
such enterprise as a business shall obtain a license of the
competent government agency. The requirements for such license are
the same as those stipulated for business operators under Items 1
and 2.
As a newly
established regulation, it now establishes a prohibition on
self-dealing, etc. and the prohibition on subcontracting delegated
business, and if such provisions are violated, there may be an
instructional disposition, business-suspension order, or revocation
of license.
Item 4 RE
Business Operators. An Item 4 RE Business Operator engages
in "acts of agency or brokering of the execution of real
estate specified joint enterprise contract to which the Special
Business Operator is a party." While this category is
essentially identical to Item 2, it is limited to contracts to
which a "Special Business Operator" is a party.
Like an Item 3 RE
Business Operator, an Item 4 RE Business Operator must obtain a
license of the competent government agency; however, it is also
required to obtain a Type II business registration under the
Financial Instruments and Exchange Act.
Special
Investor. A "Special Investor" is defined as
"a person stipulated by the relevant ministerial ordinance as
a bank, trust company or any other person recognized as having
specialized knowledge or experience related to investment in real
estate or a stock company whose amount of capital is no less than
the amount determined by the competent government agency."
Both the tax laws and the Financial Instruments and Exchange Act
provide definitions for professional investors, including
institutional investors and qualified institutional investors.
Overseas investors can quality as institutional investors or
qualified institutional investors under Japanese law by submitting
a notification to the authorities if certain requirements are met.
On the other hand, as the relevant ministerial ordinance is not yet
available, the definition of "Special Investor" remains
unclear. Whether overseas investors may be considered "Special
Investors" will depend on the scope of the definition of
"Special Investor."
Issues with
the New Scheme
Notification. While the amendment appears to
lighten the requirements by replacing the need for a license with a
notification to the authorities, the business at issue is, in fact,
subject to the supervision of the competent government agencies
through such notification. More specifically, the business is
subject to prescribed supervision including the inspection of
premises by the competent ministry for the Special Business
Operator.
License for
Contract. Any contract executed by the Special Business
Operator is required to conform to the standard contract submitted
for the license of the Item 3 RE Business Operator. Any
modification of the standard contract requires permission. As a
result, there is a concern that the terms of the contract will
become rigid, and flexible investment will be impossible.
Real Estate
Brokerage Business Law. In the supplementary provisions of
the current revised bill, the Real Estate Brokerage Business Law[9]
("RE Brokerage Law") will also be revised in regard to
"Special Business Operator," and the application of the
licensing requirement under the RE Brokerage Law will continue to
be excluded.
However, there will
be partial application of the RE Brokerage Law for a "deemed
registered real-estate transaction manager." The main
provisions to be applied are the obligation to make a business
security deposit (Art. 25), the restriction on special provisions
for warranty against defects (Art. 40), and the obligation to
maintain security deposits and so on. A business security deposit
(JPY 10 million for headquarters) will need to be considered as an
additional investment cost.
Comparison
with Other Schemes
Comparison
with TMK Scheme. The TMK scheme is a scheme permitted
under the Asset Liquidation Act and is used by overseas investors
as a way to obtain tax advantages with certainty. However, strict
procedures for the submission or change of the asset liquidation
plan in accordance with the Asset Liquidation Act are required, and
fulfilling the conduit requirements—such as the issue of
specified bonds—is also required. Accordingly, with regard to
development deals or deals where numerous properties will be
acquired several times, the current trend leans toward the adoption
of the GK/TK (trust beneficial interest) scheme, which allows for
greater freedom. In contrast, the GK/TK scheme (real asset) does
not seem to offer sufficient flexibility to be an adequate
replacement for the TMK scheme.
Comparison
with GK/TK (Trust Beneficial Interest) Scheme. One
important merit of the GK/TK (trust beneficial interest) scheme is
the amount of freedom in the creation of schemes; however, the
GK/TK (real asset) scheme under the Real Estate Specified Joint
Enterprise Act greatly diminishes such merit. Also, the advantage
of transfer tax (if acquired in the form of a trust beneficial
interest, there is no real estate acquisition tax as long as it is
held in the form of a trust beneficial interest), is no longer
available. On the other hand, trust commissions are unnecessary in
the case of the GK/TK (real asset) scheme. Overall, it is critical
to weigh the various considerations when contemplating the use of
the GK/TK schemes.
Conclusion
Before overseas
investors begin considering the implications of the amendment to
the Joint Enterprise Act, it would be important to know whether
overseas investors could qualify as "Special Investors,"
the definition of which is not yet available. Even if overseas
investors could be considered as "Special Investors," the
amendment appears to be of limited use as the legal requirements
remain strict. For the time being, making investments in real
estate in Japan remains a challenge to overseas investors, who are
unable to take advantage of the TMK scheme and the GK/TK (trust
beneficial interest) scheme.
Lawyer
Contacts
For further
information, please contact your principal Firm representative or
one of the lawyers listed below. General email messages may be sent
using our "Contact Us" form, which can be found at www.jonesday.com.
Masatomo
Suzuki
Tokyo
+81.3.6800.1817
msuzuki
jonesday.com
Tsuyoshi
Oyama
Tokyo
+81.3.6744.1650
toyama
jonesday.com
Jones Day
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[1] A
tokutei mokuteki kaisha ("TMK") is a special
Japanese corporate entity that may be established under the Act on
Liquidation of Assets (the "Asset Liquidation Act") for
the purpose of effecting the securitization of various assets
(including real property, claimable assets, and certain shares in
corporations, among others). If a TMK meets certain requirements
and declares at least 90 percent of its annual distributable income
as dividends, the TMK may treat the declared dividends as
deductible expenses and thus may be a tax-conduit entity.
The equity of the TMK consists of specified equities and preferred
equities. A TMK can be incorporated by specified equity. In order
to form the equity portion of the capital structure, however, the
TMK subsequently issues preferred equity securities (which are
equivalent to preferred shares of a stock corporation). In addition
to specified equity securities and preferred equity securities, the
TMK ordinarily issues specified bonds and/or borrows specified
loans for the purpose of acquiring assets or further developing the
same.
The Asset Liquidation Act requires a TMK to file with the Financial
Services Agency ("FSA") through the Local Financial
Bureau a business commencement notification, together with the
articles of incorporation and an asset liquidation plan
("ALP"), before proceeding with an asset liquidation
transaction. The TMK must conduct its asset liquidation business in
accordance with the ALP and may engage in ancillary businesses, but
no other kinds of businesses.
[2] Under
the GK-TK scheme, (i) a Godo Kaisha ("GK") is
established under the Companies Act of Japan to be an SPV for the
purpose of holding an asset or assets (typically, trust beneficial
interest in real property), (ii) an equity investor or investors
(the "TK Investor") enter into an anonymous partnership
agreement (tokumei kumiai agreement; the "TK
agreement") as described in the Commercial Code (Act No. 48,
1899) with the SPV, as a TK operator, to inject funds to the SPV
for the acquisition of the SPV's asset, and (iii) an asset
manager is appointed to provide asset management advice or make
decisions on behalf of the SPV.
[3] Act
Concerning Designated Real Estate Joint Enterprises (Law No. 77 of
1994, as amended; "Joint Enterprise Act").
[4] In
regard to solicitations overseas, the Joint Enterprise Law does not
apply. However, it is unclear to what extent the evasion of such
regulations will be used by funds conducting large-scale investment
activities in Japan.
[5] Only
24 companies, including major real estate companies, construction
companies, and developers, are actually operating (56 companies
with prefectural governor licenses) as of March 31, 2013.
[6] Such
license shall be obtained by a real estate specified joint
enterprise operator, and not by the Special Business
Operator.
[7] In the
case of the GK/TK (trust beneficiary interest), it is necessary to
pay trust commissions, while real estate acquisition tax will not
apply. In the case of the GK/TK (real estate), real estate
acquisition tax applies, while no trust commissions are payable.
Those cost factors will be another factor in choosing the
scheme.
[8] Such
business categories have been added to account for the reality that
the unspecified business operator will itself conduct such
business.
[9] Real
Estate Brokerage Business Law (Law No. 176 of 1952, as
amended).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.