Can an LLP be considered as a pass-through entity?

There were some arguments whether a Delaware Limited Liability Partnership (LLP) should be treated as a pass-through entity or not. If it is regarded as a pass-through entity, income or loss made through an LLP has to be included in Japanese taxable income.

As of today (May 2018), it is regarded as a pass-through entity.

There have been several contradicting rulings by Japanese courts but recently in 2017, Japanese Supreme Court gave the decisive ruling that sent many in Japanese and US tax community in panic.

デラウェア州LPSの法人該当性が争われた事案~平成27年7月17日最高裁判決

Japanese Supreme Court rules that a Delaware limited partnership is a corporation

Then, after strong criticism and the change in the tax law that limits loss from partnership for passive members, the National Tax Agency announced a memo in “English” saying that
a Delaware limited partnership is fiscally transparent. (It is rare to make its official announcement not in Japanese. Some people think that it is too embarrassing for Supreme Court if NTA denies their ruling in Japanese.)

Now we have the conclusion here. An LLP can be treated as a pass-through entity.

It affects your tax situation if you do business or invest into something through an LLP. If you are an active partner, your loss in the partnership can be offset against your Japanese loss.

10 steps to reduce inheritance (estate) tax for business owners

There are many options you can take to reduce your inheritance tax. Here are basic steps to reduce the tax. Inheritance tax offers many tax deductions or discount under certain situations. But as a basic, the fundamental aspects should be addressed first.

Basics

1) Estimate your inheritance and see how the tax will be reduced if certain conditions are met. You need to know first what are there and how much they are for each items. Without knowing that, you will never know what options are available to reduce your tax. For example, if you take over parent’s (or parent in law) house and will live there with your resident address moved, you will get 80% discount on the valuation of its land.

2) Those tax benefits are only available if its split of the estate is agreed by the deadline of the tax filing (10 months). It is recommended to prepare an agreement in advance among heirs. For example, it is necessary to have an agreement of the split and actually live there by the deadline of the filing to take the above mentioned 80% discount on the land valuation.

Possible options to reduce tax

The below are real world feasible steps to reduce the tax. Some of them require to set up a co:

1) Buy life insurance by parents money. The money received from insurance is still to be counted as taxable base, you will get deduction of the taxable asset by 5 million yen times number of heirs. If the insurance money is 30 million yen, which should be close to the amount that was paid from the decedent money, you have already reduced taxable base by 20 million yen (presuming that the number of heirs is 4 for example).

2) Make gift to heirs every year. 1.1 million yen per year is tax free of gift tax by each person. This will reduce your taxable assets steadily. If you have 4 heirs and have 10 years before die, you will save 44 million yen in tax base (1.1M * 4 persons * 10 years).

3) Create a company and pay salaries to heirs. Real work has to be done to justify the salaries and keep its records of work. If you are a business owner, majority of your estate should likely come from the valuation of your own company. This is to reduce the valuation of the shares.

4) Create companies under names of heirs and pay fees to them. Again, real work has to be provided.

5) Borrow money to buy properties. Valuation of properties are usually much lower than its real market price. If you borrow money of 100 million yen to buy a condominium in Tokyo, the market price of the condominium may be still around 100 million yen but the valuation for the inheritance tax will likely be 70 million yen. You already manage to have reduced the tax base by 30 million yen.

6) Pay rents in advance or pay for other expenses to harm the balance sheet of the company. Then make gift to heirs in form of shares.

7) Make gift in form of properties to spouse for residence. It is tax free up to 20 million yen. It is a special tax benefit designed to stimulate the economy.

8) Same concept as the above. Your parent can make gift for your children’s education by 15 million yen. You need to open a special bank account for this education purpose and all the withdrawal from the account will have to be reported.

There is a rumor that the tax authority is considering revision on overseas property depreciation

I have not confirmed the source yet but there is a talking in tax community that the tax authority is considering to limit deductible depreciation expenses on overseas properties.

As you may know that second handed houses can be expensed over relatively shorter period. The depreciation expense are allowed to use the 20% of the original life year if it is older than the original life year.

For example, the life year defined for a wooden house by the tax law is 22 years. If you buy a wooden house which is older than 22 years, you are allowed to expense the cost of the house (except the land price portion) over 4 years through depreciation calculation (22 years * 20%).

If you buy a house of 60 million yen and if the house portion and the land portion can be split into 50:50, you can claim depreciation expense of 7.5 million yen (60 million * 0.5 / 4 years) per year over the next 4 years.

Because your rent income usually is much lower than this amount (let’s presume it will be 2.4 million yen a year), and you also have other expenses (let’s say 1 million yen), your loss will be 6.1 million yen (2.4M – 1M – 7.5M) that can be offset against other income (e.g. salary).

As you can see, it has huge impact to reduce your tax. On top of this, when you sell it, the tax rate on capital gain is only 20%. So, if you are in the higher tax bracket, say 50%), you save the income tax of 50% by the amount of loss, and when you sell it, you only have to pay 20%. It surely sounds like a very good deal, no?

The tax authority knows this and is said to be considering to stop this type of practice because this does not sound fair.

If it comes soon, the new restriction will come in by January 1, 2018. If you are thinking of buying a property because of the tax benefit, you may want to consider more on financial elements such as your future return on investment.

Japanese qualified stock options

With stock options being qualified, the gains will be taxed as capital gain (flat 20.42%) and it will be taxed only at the sales of the shares (as opposed to being tax at the exercise on the gain as salary income which is taxed with progressive tax rate).

Qualified stock option has to meet the following conditions:

1) Person to be vested are employee, director or executive director, not owning more than 1/3 of its shares,
2) Stock option has to be exercised after two years and within 10 years from the vesting date,
3) Strike price in total has to be within 12,000,000 yen per person,
4) Strike price has to be higher than the fair value at the time of vesting, and has to be granted for free,
5) Stock options cannot be transferable,
6) Once the stock are issued, it has to be managed by a qualified financial institutions, and
7) It has to be reported to the tax office by Jan. 31st of the next year (Shiharai chosho).

Please note that auditors or external consultants are not eligible for qualified stock option.