On April 1, 2021, the Japan Financial Services Agency (the “Japan FSA”), and the National Tax Authority (the “NTA”), respectively made an announcement regarding the use of a Special Limited Partner (the “SLP”) by Japan resident investment professionals (“Japan PMs”) to receive carried interest in limited partnership funds i (“LP Funds”). The announcement is currently in Japanese only and can be accessed via the following links: (FSA website ; NTA website).
The historical use of the SLP structure to receive carried interest is not uncommon in investment funds industry. As a matter of default, whereby carried interest is received by a Japan PM as salary (including bonus), such carried interest will be subject to standard progressive income tax rate in Japan, which can be as high as 55.945%. However, by having the Japan PM subscribe to the LP Fund as an SLP and through proper structuring, any carried interest received by the Japan PM may be treated as significantly lower capital gain rate of 20.315%.
In their respective announcements, the Japan FSA and NTA sought to provide further guidance and clarity on the use of SLPs by Japan PMs in relation to the receipt and taxation of carried interest. In such announcement, through reference to a specific fact pattern as an example, further guidance was given regarding certain factors and considerations by which a SLP could qualify for the capital gains treatment in relation to carried interest received.
It is worth noting that we do believe that the specific fact pattern described in the announcement does require further clarification. For example, in the cited fact pattern of the announcement, reference was made to the SLP having some type of involvement or participation in the management of the LP Fund. Similarly, in the fact pattern, the general partner of the LP Fund is registered with the Japan FSA as a discretionary investment manager. As no further information was provided in the announcement with regards to the specific details of the various enumerated qualifications in the fact pattern, we believe that further details on the specifics of these qualifications will be necessary as Japan PMs seek to properly structure their LP Funds to be aligned with the cited fact pattern.
It is yet unclear as to the specific manner by which the Japan FSA and the NTA are going to enforce this prescribed treatment of the carried interest. The Japan FSA noted its plans to subsequently publish a form of check sheet for the Japan PMs to complete in connection with their personal income tax return. This check sheet is anticipated to provide more information as to the necessary factors for PMs to treat any carried interest received as an SLP as capital gains.
As a final point, we do believe that it is important to stress that the cited case study was intended as an example of one structure by which a Japan PM may treat their received carried interest as capital gains as other structures are viable. In other words, fund structures that are not identical to the cited example fact pattern in the announcement should not be automatically viewed as being inappropriate for the contemplated capital gains tax treatment by the Japan PMs.
We will continue to pay close attention to any new developments and look forward to providing you with further updates. If you have any questions or would like more information on this Client Alert or wish Withers to make a comment on your behalf, please contact any of the following Withers attorneys:
[i] It should be noted that for the purposes of this announcement, both Japanese partnerships (kumiai) and foreign partnerships are intended to be covered.