Proposals in Japan to allow the use of foreign company shares in stock-for-stock deals with domestic entities will be ineffective because the government will not remove prohibitive tax burdens. The Ministry of Economy Trade and Industry (Meti) sent a draft law allowing all-share transactions by foreign companies to the Cabinet at the end of January. But while this sets an important precedent in theoretically allowing triangular merger structures for the first time, local sources said the absence of a tax-deferral provision will deter international investment in distressed or undervalued Japanese companies to help their restructuring.
To make domestic stock-for-stock transactions viable, tax for recipient shareholders is deferred. Foreign observers had hoped for the same treatment for cross-border deals, but Japan's tax ministry blocked this part of Meti's original plan.
This will place foreign companies at a "significant competitive disadvantage", according to the American Chamber of Commerce in Japan (ACCJ).
The tax obstacle could scupper moves in Japan to improve the environment for cross-border mergers and acquisitions. This improvement is essential if foreign investment is to double from Y6.5 trillion ($54 billion) to Y13 trillion by 2008, in line with the pledge by prime minister Junichiro Koizumi in a speech on January 31.
"This is an ambitious goal if Japan does not keep increasing M&A volume substantially," said Nicholas Benes, president of JTP Corporation, an M&A advisory boutique. "Since more than half of such cross-border volume worldwide includes non-cash swap consideration, and that requires tax deferral to occur for the most part, there is a complete disconnect here. Is Japan serious about increasing foreign direct investment or having it be a part of the revitalization process? Based on this, it does not seem so."
The ACCJ is calling for changes to the Commercial Code and tax laws to accord foreign companies the right to make tax-deferred share exchanges. "This measure would do much more to bring American investment to Japan."
It is unlikely that any amendments will be made before 2004, when further Commercial Code reforms are expected.
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