JAPAN Law and Practice Contributed by: Mikito Ishida (Mori Hamada & Matsumoto) and David Azcu (Simpson Thacher & Bartlett LLP), Mori Hamada & Matsumoto
2.10 Anticipated Changes for Funds Some of the precise rules related to the amendments of the FIEA mentioned in 2.9 Rules Concerning Ser- vice Providers are yet to be finalised and are likely to be updated in the future.
3.5 Rules Concerning Permanent Establishments Please see 2.4 Tax Regime for Funds . 3.6 Taxation of Carried Interest
FSA Notice on Tax Treatment of Carried Interest Under Japan’s tax regime for partnership funds, where the carried interest allocated under the waterfall provi - sions of a limited partnership agreement (LPA) differs from a strict pro rata distribution based on each part - ner’s contributions, the distribution must be justified by demonstrating “economic rationality” in relation to the partnership’s business. Until recently, however, the meaning of “economic rationality” had not been clearly defined. This issue has been particularly important for individuals serv - ing as fund managers, since taxation for individu - als depends on the classification of income (unlike the uniform corporate tax rate). A key question has therefore been whether carried interest received by individuals should be taxed as capital gains from the transfer of shares, or instead as business income or miscellaneous income arising from compensation for services rendered to the partnership. On 1 April 2021, the FSA sought clarification from the National Tax Agency (NTA) on the concept of “eco - nomic rationality” in relation to carried interest. The FSA subsequently published a notice outlining the NTA’s response, the key points of which are summa - rised below. Basic Principles Under the guidance provided by the NTA, economic rationality must be assessed in light of the specific terms of each partnership agreement. That said, where the following conditions are satisfied, economic rationality will generally be recognised, and taxation on fund managers will follow the distribution ratios set forth in the partnership agreement. With respect to the partnership agreement and the fund manager: • the execution of the partnership agreement and the management of partnership assets must comply with applicable laws and regulations; and
3. Fund Managers 3.1 Origin of Promoters/Sponsors of Alternative Funds
Sponsors of a Japanese private equity fund have typi - cally been Japan-based entities. However, in recent years, there has been a notable increase in the num - ber of non-Japanese private equity sponsors estab - lishing Japan-related funds. Japanese LLPs have become increasingly common as the management entity used for such funds, and are particularly favoured where individual fund managers intend to receive carried interest from the fund. 3.2 Legal Structures Used by Managers It has been fairly common for domestic sponsors of Japanese private equity funds to act directly as the general partner of the managed fund, notwithstanding potential risks around liability. More recently, however, there has been a trend toward adopting a manage - ment company structure, under which a dedicated management company is established to manage and operate the fund business, with separate gen - eral partner vehicles formed for each separate fund or vintage. This structure allows for clearer segregation of responsibilities and better risk management and ring-fencing of liabilities across multiple funds. 3.3 Regulatory Regime for Managers Please see 2.1 Types of Alternative Funds and Struc- tures and 2.2 Regulatory Regime for Funds . 3.4 Tax Regime for Managers There is no special tax regime applicable to fund man - agers in Japan. For the tax treatment of carried inter - est allocated to individual fund managers, please see 3.6 Taxation of Carried Interest .
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