Introduction
While Japan’s economy is still recovering from the global financial crisis, Islamic financing steadily increases its presence in the Japanese financial market. This article aims to give an overview of notable developments in 2010 as well as to explain prospective legal and tax reforms expected in 2011.
2010 — A review
Nomura Sukuk
The issuance of Sukuk by Nomura Holdings was no doubt one of 2010’s hottest topics regarding Islamic finance in Japan. While there have been previous Japan related Sukuk issuances, such as the launch of the CP/MTN program by Aeon Credit Service and Toyota Financial Services Corporation, respectively, these issuances were implemented by the Malaysian subsidiaries of these companies. The Nomura issued Sukuk is considered to be the first Sukuk issued by a Japanese issuer, and can therefore be deemed as a significant event in the history of Islamic finance in Japan.
It has been observed that the Nomura Sukuk was sold only to investors outside Japan. A reason for this might be the absence of special tax treatment of dividends from Sukuk, i.e, taxation of dividends from Sukuk in Japan is not currently equivalent to the taxation of interest from bonds/notes. This issue must be solved as soon as possible so as to facilitate the issuance of Sukuk by Japanese issuers since they would likely see Japanese investors as major prospective subscribers/purchasers. Whether and how far the reform set out in the Outline of FY2011 Tax Reform (see 2011 — Preview below for details)) would address this issue remains to be seen.
Establishment of Malaysian Subsidiaries of Japanese Megabanks
Following the amendments to the Ordinance for Enforcement of the Banking Law/Insurance Business Law in 2009, which allows Japanese banks and insurance companies to provide a certain range of Islamic financial services through their subsidiaries, The Bank of Tokyo-Mitsubishi UFJ (BTMU) obtained in 2009 a license for an Islamic window from the Malaysia International Islamic Financial Centre. It was also announced in June 2010 that commercial banking licenses will be issued to the wholly owned subsidiaries of the other two Japanese megabanks (Mizuho Corporate Bank (Mizuho) and Sumitomo Mitsui Banking Corporation (SMBC)) by Bank Negara Malaysia. It seems that all three megabanks, with the assistance of their alliances with local Islamic financial institutions (BTMU with CIMB Group, Mizuho with Maybank Group and SMBC with RHB Capital (RHB Banking Group)), are trying to step up their presence in the Islamic finance market.
2011 — A preview
Prospective Tax Reform on Sukuk Dividends
In countries with established Islamic finance practices, it is widely accepted that the tax treatment of dividends from Sukuk should be equivalent to that of interest from bonds/notes so as to create a level playing field for both products, which is normally achieved through tax reform. In this regard, the outline of FY2011 tax reform issued by the ministry of finance on the 16th December 2010 (Outline) provides, among others, that dividends and redemption profit on book entry quasi bond trust beneficiary interest in a specified purpose trust shall fall within the scope of tax exemption currently applicable to interest on book entry bonds/notes if necessary amendments to the Asset Securitization Law (Law no.105 of 1998, as amended) are made.
While the aforesaid provision is thought to have been included in the Outline in response to a proposal from the finance service agency of Japan, which primarily requested the equivalent treatment between dividends from Sukuk and interest from bonds/notes, the scope of Sukuk covered by this provision is still unclear. If this provision relates only to Sukuk structured in the form of a specified purpose trust under the Asset Securitization Law, the impact of this reform might be very limited since dividends from Sukuk currently issued [many of which are issued via declaration of trust by a foreign special purpose vehicle (SPV)] would fall outside the scope of this tax exemption. We have to closely watch how this provision in the Outline will be reflected in the prospective amendments to the relevant tax legislations later this year.
“The GK-TK structure is one of the major schemes used by a foreign investor in investing in Japanese real properties”
Prospective Amendments to Real Estate Specified Joint Business Law
The GK-TK structure is one of the major schemes used by a foreign investor in investing in Japanese real properties. Under a GK-TK structure, a limited liability company (godo kaisha) (GK) acquires trust beneficiary interest in real property trust by using the proceeds of the loan advanced by lenders and the proceeds of tokumei kumiai (TK) investment, which is a contractual arrangement whereby an investor contributes cash to a business operator and receives its share of the profit gained from the business.
Under a GK-TK structure, the GK does not normally acquire real property in the form of fee simple since doing so would trigger licensing requirements under the Real Estate Specified Joint Business Law (Law no.77 of 1994) (RESJBL).
The RESJBL requires an entity that acquires fee property by using the proceeds of equity investment (including TK investment) to first obtain a license, which the requirement is fairly onerous and costly. Due to this licensing requirement, however, the properties that trustees are reluctant to accept (such as grandfathered properties and properties in rural areas) fall outside the subject of investment via the GK-TK structure, which effectively results in the reduction of investment opportunities for investors.
“The creative efforts of such market participants would also be important in increasing the investment of Islamic money in the Japanese real estate market”
To address this issue, certain amendments to the RESJBL were proposed by the committee on real estate investment market strategy, which is a private advisory panel of the minister of land, infrastructure and transportation. The committee proposes, among others, that if an acquisition entity delegates its entire investment capacity to a licensed asset manager, the acquisition entity will be exempted from the aforementioned licensing requirement.
While it is still unclear whether and when this proposal would be implemented, particularly under the current unstable political circumstances, this proposed amendment, if implemented, would provide further investment opportunities and greater flexibility in structuring to Islamic investors.
It should be noted, however, that in conjunction with the support by governmental measures such as the regulatory reforms discussed above, innovations by market participants are also critical in enhancing the utilization of Islamic finance in Japan. The creative efforts of such market participants would also be important in increasing the investment of Islamic money in the Japanese real estate market.
Conclusion
The recent developments discussed above have led to an increased recognition of Islamic finance practices in Japan. The proposed taxation and regulatory reforms with respect to Islamic financing have left little doubt that the Japanese government sees such types of financial practices and instruments as material parts of the financial market in Japan. Moreover, Islamic financial transactions carried out recently, such as the Nomura Sukuk, indicate that the private sector has also recognized the emerging importance of such practices.
The foregoing notwithstanding, it will take additional measures from both the government and private market participants to further enhance the standing of Islamic finance in Japan. The government, undoubtedly, should recognize more Islamic financing methods through further regulatory reform, and expand the scope of Islamic finance related business permitted to Japanese financial institutions. The private sector should endeavour to engage in more transactions that use such practices and consider creative approaches in conducting transactions. Only through the continued efforts of both the government and market participants will Islamic finance truly make a breakthrough in Japan’s financial market.
Naoyuki Kabata
Partner
Anderson Mori & Tomotsune
Website:
www.amt-law.com