JAPAN Law and Practice Contributed by: Mikito Ishida (Mori Hamada & Matsumoto) and David Azcu (Simpson Thacher & Bartlett LLP), Mori Hamada & Matsumoto
• the fund manager must contribute capital (cash or other assets) to the partnership. With respect to profit distributions, carried interest must be expressly provided for in the partnership agreement’s profit distribution provisions. With respect to economic rationality: • the terms and conditions relating to the distribution of profits under the partnership agreement must not be arbitrary; • the terms of the partnership agreement must be generally consistent with prevailing market prac - tice; and • the fund manager must make substantive contribu - tions to the partnership’s business. With respect to non-arbitrary distribution conditions, the notice clarifies that such conditions require that the partnership agreement must have been entered into with the consent of all partners, and that the part - nership must have multiple partners with potentially conflicting interests. The notice clarifies that the requirement that terms of the partnership agreement must be generally consist - ent with prevailing market practice references a widely used distribution structure, including a hurdle with a catch-up followed by an 80/20 split. Since this water - fall is fairly standard in the industry, funds that follow this model would likely be deemed to be in conformity with market practice. In light of the NTA’s response, carried interest received by individual fund managers will, in principle, likely be taxed as capital gains or losses arising from the transfer of shares, rather than as income arising from compensation of services, if the following conditions are met: • the partnership has multiple partners with divergent interests; • the general partner properly fulfils its obligations as the general partner of the partnership; • the partnership agreement clearly specifies how carried interest will be allocated; and
• the profit splits and core economics of the fund do not materially depart from prevailing market practice. Ancillary Documents The FSA has also published some additional clarifica - tion relating to the notice: • “Check Sheets” to confirm that the conditions for carried interest treatment are satisfied; and • “Calculation Sheets” to break down carried interest income. The FSA requests that these documents be attached to the final tax return for the fiscal year in which carried interest is reported. 3.7 Outsourcing of Investment Functions/ Business Operations Under the FIEA, in principle, investment management can only be delegated to an entity that is registered as an IMBO, and investment advice can only be pro - vided by an entity that is registered as an investment adviser. By contrast, the outsourcing of other busi - ness operations is generally permitted. A number of service providers in Japan offer outsourcing solutions, particularly for fund administration and related opera - tional support. For recent regulatory developments concerning the outsourcing of middle- and back-office operations, please refer to 2.9 Rules Concerning Service Pro- viders . 3.8 Local Substance Requirements Japan does not adopt economic substance doctrine or economic substance tests. Please see 2.8 Local/ Presence Requirements for Funds for the require - ments regarding the appointment of a Japanese rep - resentative by an Article 63 Exempted Operator. 3.9 Change of Control As a general matter, private equity funds operating under the Article 63 Exemption are not required to report changes in their shareholders. By contrast, a party that becomes a major shareholder ( shuyō kabunushi ) of an IMBO registered under the
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