U.S. Companies in Japan

An existing YK will be automatically converted to a Kabushiki Kaisha (KK).  A KK is a corporation under the check the box (“CTB regulations”).  Complex and expensive restructuring may be necessary for American companies that formed YK’s in the past.

Corporate Vehicles
Current Japanese corporate law offers two primary corporate entities, a KK or a stock corporation and a YK or a limited liability company. Both provide shareholders with limited liability. For US investors, the decision to form a KK or a YK depended upon specific considerations:

 *   different treatment for US federal income tax purposes; and
*    dissimilar reputation in the Japanese business world.

A KK has been regarded as more respectable than a YK among Japanese businesses and the general populace.  However, many American investors have conducted Japanese business as a YK in order to elect to be treated as a partnership or a pass-through entity for US tax purposes.  For the same reason, many American investors use a YK as a vehicle for portfolio investments.

Japanese corporate law is undergoing a major transformation in order to modernize the corporate environment due to changing socio-economic conditions.  The new law will remove the YK law and provide that all YK’s existing as of the effective date of the new legislation will be automatically converted to KK’s under the new corporate law.

A KK that has been converted from a YK pursuant to this new legislation must include the phrase "
Yugen Kaisha" in its name and be known as a "special Yugen Kaisha" (Tokurei Yugen Kaisha or “TYK”).  The new law would permit a special Yugen Kaisha to retain its structure under the old YK Law.  In effect, there would be few differences between the old YK and the new TYK.

The proposed changes to the Japan’s corporation laws were tendered to the Diet in March 2005.  It is unclear whether the proposals will be approved by the Diet;  however, it appears likely that the proposed legislation will be approved without significant change and that the effective date will be in 2006.

Impact of the Proposed Laws
Under current U.S. tax regulations, a YK may elect to be treated as either a partnership or a corporation for U.S. tax purposes.

A KK is a corporation under the CTB regulations and cannot elect to be taxed as a partnership.  The transformation of a YK to a TYK under the new law may be treated as an alteration to an entity classified as a corporation by operation of law.  In that event, the CTB regulations could mandate the transformation of a YK into a TYK as a transfer of assets to a new foreign company in exchange for stock in such company.  That transaction could generate recognition of a taxable gain by the YK shareholders due to the deemed disposition of property to the TYK.  In particular, the transformation of a YK with US shareholders into a KK would fall under Internal Revenue Code section 367(a).

There is a possibility that a YK, after transformation into a TYK to be reorganized as another new entity called a Godo Kaisha (GK, or a joint company) that will be created by the new proposal as a Japanese equivalent of an American limited liability company (“LLC).

However, a GK may not be cost effective as a result of various practical problems.  In particular, reorganization may be subject to the Japan registration tax equivalent to .15% of the stated capital of the GK.  In addition, the reorganization of a YK into a GK would generate costs such as the broad need to revise documents such as contracts, bank and other commercial accounts, signs,  forms, invoices, advertising materials and all other documents showing the corporate name and other publication costs.

Because of the likelihood of passage, American and other foreign companies need to review the various impacts of the changes on their Japanese YK’s.  It is conceivable that the IRS may promulgate a grandfather clause focused upon YK’s previously treated as partnerships for US income tax purposes, no one can confirm such an enactment.