My Despair at Davos – The Capital Gains of Foreign Investors

Right now, I am on a flight returning to Japan from the Davos forum. At last year's conference I vigorously wrote a column every day, but this time I wasn't able to write a single one throughout the entire event. I stayed in the same hotel and did pretty much the same kind of things. I'm trying to sort out why I wasn't able to get any columns written.

Come to think of it, there was a reason, a nagging anxiety in the corner of my mind. It started at the end of last year and as the new year approached this anxiety became increasingly intense. Why am I so down? There is something unsettling about the tax system reform currently under deliberation by the government. It might be hard to understand why I'm disturbed by the amended tax system, but the framework for reform includes a provision for increasing the taxes on the capital gains of foreign investors. This managed to slip through the LDP Tax Commission and cabinet meetings with hardly any debate.

Accordingly, this amended tax system is likely to go into effect starting April 1 of this year. I will explain later, but there will be huge repercussions across the venture capital industry should this happen.

I learned about this amended tax system last November, on the 26th. The Ministry of Economy, Trade and Industry contacted the Japan Venture Capital Association, where I serve as a director. I quickly expressed my discontent with this reform and at the same time contacted people related to buyout (private equity) funds who would be significantly affected by this. It was a major issue.

I'll explain the details later, but in terms of the capital gains of foreign investors, if certain conditions are met, they essentially pay the tax in their own countries. In other words, when Japanese investors invest in foreign countries, they only pay tax in Japan. In the same way, when foreign investors invest in Japan they pay the tax in their own countries, not in Japan.

This certainly does not eliminate the obligation to pay taxes. You are, in principle, taxed in your country of residence. This global standard is observed in all major countries, such as the US, the UK, Germany and so on. Because of this global standard, foreign funds can freely move back and forth across borders. From the perspective of the principle of reciprocity, this is an appropriate commercial practice.

Now, however, the Japanese Taxation Authorities have gone beyond this principle to strengthen taxation. It is believed that this approach sprang in part from not having been able to tax foreign investors at Shinsei Bank. I seem to remember the tenor of the argument in the Diet was something like, "Given all the tax revenues thrown into Shinsei Bank, why shouldn't foreign investors be taxed when they turn a profit?"

At that time, my own thinking about this argument had been, "Why make this the issue, when the problem of throwing so much tax money comes in the first place from the faulty measures and policies of the Japanese financial authorities, particularly when the revitalization of the Long-Term Credit Bank of Japan benefited all of Japan?" No doubt as a Japanese citizen, this did not feel right. However, in regard to Shinsei Bank, surely criticism should have been leveled at the Financial Supervisory Agency for setting such a low price and going so far as to promise a special agreement called a warranty against defects (cancellation right). If the principle of reciprocity operated in terms of the tax system, one would consider this to be appropriate; this would also be true from the perspective of global standards.

Any way you look at it, the taxation authorities have now chosen to ignore this standard and have suggested introducing a new taxation rule, which could be simply stated, "Foreigners investing in Japan must pay taxes in Japan. And, in accordance with the taxation treaty, they should receive a tax refund in their own country." If this happens, foreign investors from countries that are not parties to this taxation treaty will have to pay taxes both in Japan and in their own country, thereby facing double taxation. Moreover, pension funds and university (endowment) funds which make up half of all investors are, in the first place, exempt from capital gains tax. So they can't receive any tax relief; this amounts to having tax revenue sucked from them into Japan without any possibility of receiving a refund.

If they are taxed without receiving refunds, they must consider the amount of tax they pay in Japan (about 20–30%) as a cost. From the point of view of a fund investor working his guts out to obtain the best possible return, the increased cost of taxation is a bitter pill to swallow. From the point of view of foreign investors, should this amendment pass, it would make better sense to invest in other countries like Europe, the US, and other parts of Asia like China and India then rather to waste time investing in Japan. They are not the ones who will ultimately be in trouble. They can just quit investing in Japan altogether. Their investment in Japan is only 2 or 3% of their overall investment anyway; it's a pity but it would be easy to let go of Japan.

The taxation authorities are probably trying to increase tax revenue with this reform, but in reality they are doing the opposite. Needless to say, if they introduce this policy, investment into Japan will fall and the flow of foreign funds necessary for creating and revitalizing Japan's industries would stop; one could predict that revenue would decrease as a result of this tax.

Incidentally, the scale of our Globis Fund is currently 20 billion yen, but 90% of this comes from foreign investment. The reason is simple. When the fund was set up in 1999, only 2 billion yen, 10% of the total, could be raised domestically. I traveled all around the country visiting institutional investors many times, but at that time they were not interested in venture capital in Japan, and except for a few investors, I was refused left and right.

That's why I went on long overseas business trips (refer to column "The End of The Long Road") (Japanese) to raise funds. As a result, a 20-billion-yen fund came into being, we invested in a great many companies, and we were able to contribute to the revitalization of Japanese industries. (Refer to Column: "Works Applications' IPO".)

This new policy would essentially cut off this flow of foreign funds into Japan. Why had I sweated blood and tears to explain the appeal of the Japanese market to foreign investors? I was beside myself with despair. To be honest, I wasn't that bothered about the impact on my own fund. More important was the fact that Japan would lose trust. We surely we don't want Japan to be thought of as bizarre and lacking in common sense.

Feeling I had to do something to have this capital gains taxation on foreign investors withdrawn from the amended tax system, I met with LDP politicians and visited the Finance Ministry from last year until this year, but to no avail. That's why I am so depressed. I felt that if this bill went ahead, we would be abandoned by foreign investors and the flow of foreign funds into Japan would stop. I felt I had to do something.

I managed to get an appointment with the section manager in charge at the Ministry of Finance the day before I traveled to the Davos forum. I went to meet him accompanied by top executives from major private equity companies. I was very grateful that he made time for us when he was so busy. However I was not at all placated. I have included in this column the letter of thanks I sent to him. This sums up how I feel right now.

N.B. In this extract the phrase, "pass through" is used; under this new taxation measure, funds are subject to taxation if they acquire more than 25% of the shares of a company. Just as in domestic investment partnerships, funds do not pay taxes on the investment, meaning that the fund itself is not directly taxed; the tax burden is instead passed on to each participant in the fund. In terms of international finance, this "pass through" tax is abnormal and lacking in common sense. I apologize for using this technical jargon.


Subject: Thank you for the meeting

Thank you very much for making time for us in your busy schedule. You permitted me to meet with you just one day after speaking on the phone, and I am deeply grateful. At the same time, I think that you will appreciate the gravity of this matter given the fact that the presidents of Unison, Carlyle, MKS and JP Morgan all cleared their own schedules to attend the meeting on such short notice.
I understand your position, as you so kindly explained when we met. I cannot, however, go along with it. Here are the points in which I see huge gaps between our thinking.

1) The Problem of Pass-Through Taxation
I think the idea to levy taxes on the capital gains of LP Funds is, from the perspective of international commercial financial practice, absurd and bereft of common sense. If this kind of measure were to be adopted, serious misgivings would emerge toward Japanese policies, and there is a possibility that the flow of foreign funds into Japan would stop. In fact, I have actually heard that major American pension funds are thinking about stopping their investments into Japan. Please carefully reconsider your proposal from this point of view.

2) The Perspective of the Principle of Reciprocity
Under the principle of taxation in country of residence, Japanese investors enjoy the benefit of not having to pay taxes in foreign markets like the UK and the US. What would it mean to have a one-way taxation on capital gains only in Japan? How would the governments of the US and Europe react?

3) Relating to Invest Japan Policy
Through this measure, it is clear that investment from overseas would drastically decrease. I encounter investors on a daily basis and I fully understand the situation. By the way, in the case of GLOBIS, 18 billion yen of our 20 billion yen venture capital fund comes from foreign funds. Let it suffice to say that through this measure, I believe foreign investment in future funds would certainly shrink to zero. You may be thinking that there is no need to worry since the US is protected by the taxation treaty, but this is not the issue at hand; the issue is our own stance. Surely investors will lose their desire to invest in a Japanese market that adopts this sort of measure, which is simply abnormal and without any common sense. I feel that this goes completely against the Invest Japan policies of the Koizumi Cabinet.

4) The Issue of Falling Tax Revenue
If the flow of investor funds dries up, one cannot of course expect any increase in tax revenues. What will happen is that the flow of funds will simply stop, and any further stimulation for creating and revitalizing industries will stagnate. That means you could expect an overall loss in tax revenue.

For several years now I have been flying around the globe extolling the virtues of investing in the Japanese market. This measure would render my efforts fruitless, and as a Japanese citizen, I would be extremely embarrassed if Japan ended up being seen as an abnormal country without a shred of common sense. Up until now, I have never criticized government policies, but if it appeared that this measure will go forward, then for the sake of Japan I will feel obligated to do everything I can to prevent its passage.

I am writing this email in-flight during a business trip to Europe. The Davos forum starts next week. Participants will include representatives from the private equity industry, high-ranking government officials from around the world, persons from the Japanese financial world, Japanese policy-makers, and the mass media. I intend to explain the situation to all these people and to do whatever I can to see this measure stopped. I will do so because I believe stopping this measure is the right thing for Japan. Although my efforts may seem paltry, I want to do the best I can for Japan.

I fully understand your position, but by all means please bear in mind again these arguments, and I implore you to adopt appropriate measures.

January 20, 2005
Yoshito Hori


During the Davos forum I vigorously explained my stance to very many people. I shared my written opinion with former Foreign Minister Junko Kawaguchi, Democratic Party of Japan Parliamentarian Motohisa Furukawa, Keizai Doyukai (Japan Association of Corporate Executives) chairman Kakutaro Kitashiro, the president of JETRO, the Nikkei and Asahi Newspapers, and even with foreign investors. Then to help people to grasp the magnitude of this problem, I posed a question to a Japanese high-ranking government official during the session on Japan at the Davos forum, asking, "What it would mean to implement measures contrary to the Invest Japan Policy?" At the lunch session regarding private equity, I raised my hand and brought the issue to the fore.

During the Davos forum, a report arrived from Japan that the bill was already in its final stages. Once it reached the Diet there would be no way to stop it. I thought I had to do something, and so I left one day early from Davos to return to Japan. That was a shame as I had been looking forward to seeing the Bolshoi Ballet, which was scheduled to perform on the last day.

I am writing this column on the flight, as I am convinced it is necessary to stop Japan from "going to the dogs."

January 29, 2005
On the flight
Yoshito Hori

Mr. Yoshito Hori established GLOBIS Management School in 1992 and GLOBIS Capital Partners in 1996. In 2003, GLOBIS started its original MBA program which, in 2006, received accreditation from the Japanese Ministry of Education and gained “university” status. GLOBIS started a part-time MBA program in English in 2009 and a full-time MBA program in English in 2012.

A Harvard MBA graduate and former Sumitomo Corporation employee, Mr. Hori founded the Entrepreneurs’ Organization (EO) Japan Chapter in 1995 and became the first board member from Asia in charge of Asia Pacific region in 1996. He also served on the World Economic Forum (WEF)’s New Asian Leaders Executive Committee and Global Agenda Council on New Models of Leadership, as well as the Harvard Business School Alumni Board from 2005 to 2008. Currently, Mr. Hori is a board member of the Keizai Doyukai (Japan Association of Corporate Executives), and serves as co-chair of WEF’s Global Growth Companies.

In 2008, he launched the G1 Summit – a Japanese version of the WEF’s annual Davos forum. This led to the foundation of G1 Summit Institute in 2013, which Mr. Hori serves as Representative Director.

Just days after a huge earthquake struck northeast Japan in March 2011, Mr. Hori launched Project KIBOW to support the rebuilding of the disaster-affected areas. The following year Project KIBOW was incorporated as the KIBOW Foundation, which Mr. Hori serves as Representative Director.

An avid enthusiast of the Japanese game Go since age 40, Mr. Hori has been Director of the Nihon Ki-in (Japan Go Association) since June 2013.

Since October 2013, Mr. Hori has hosted a weekly TV program in Japan called Nippon Mirai Kaigi (Japan Future Conference). He has authored several books including Visionary Leaders who Create and Innovate Societies, Six Dimensions of Life, and My Personal Mission Statement.

Mr. Hori received his BS in Engineering from Kyoto University and his MBA from Harvard Business School.

He is an avid swimmer and enjoys spending time with his family, especially his five sons.

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