MW-84 -- Taking on Taxes

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J@pan Inc Magazine Presents:
M O N E Y W A T C H
Weekly Financial Commentary from Tokyo
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Issue No. 84
Monday, July 12, 2004
Tokyo

CONTENTS
@@ VIEWPOINT: Taking on Taxes

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@@ VIEWPOINT: Taking on Taxes

One of the major contributors to the advances in equity markets in
Japan this year has been increased interest from individual investors
The Nikkei estimates that 32 percent of all trading to the end of June,
excluding trading done by brokerage house dealers, was by retail
investors. This can be attributed to a variety of reasons, including
improved dividend policies, a reduction in cross-shareholdings and
stock splits reducing the minimum investment unit.

These investors are known for their fickleness, and any significant
change in market sentiment might see many investors withdraw. Much of
their activity consists of purchases into market declines and sales
into rallies. However, there are an increasing number of financial
products that promote a longer term view for investments, and we
are hopeful that likely changes in taxation of investment income will
promote a broader view of investment opportunities.

Currently, Japan's taxation of income from financial investments is
a muddle of different tax rates and regimes. Most, but not all, interest
income is subject to withholding tax at source of 20 percent; dividends
can be taxed at rates of up to 50 percent -- a ridiculous situation
given that the dividend is paid out of income that has typically
already been taxed at 42 percent; and while the tax rates from gains
on the sale of listed shares can now be taxed at a rate as low as
10 percent, there are still a variety of rates and net losses
that cannot be offset against other types of income.

The mere complexity of the current rules is often cited as a reason
for the general lack of investment in higher risk and more complex
financial products. In particular, the inability to offset losses
from trading in shares against other income from investments
continues to limit investment in shares.

The new measures being discussed, which are expected be effective from
January 1, 2005, are likely to abandon the current approach in favor
of consolidating all income from financial investments in one
category that will, in principle, be taxed at 20 percent. This means
that losses from investments in shares can be offset against
interest and dividend income.

However, these measures are still limited in their application, and
there are other areas that need urgent attention to reduce and
rationalize the tax burden on income from investments.

The measures define the scope of investment income too narrowly: they
do not include income from investment in commodities and various
financial products, golf club memberships, or real estate (although
we do like the current system of taxation of real estate that allows
losses to be offset against other categories of ordinary income,
including salaries -- we don't want to lose our deduction for
the depreciation of wooden houses). With interest rates still at
historical lows, and dividend payouts from Japanese corporates low
by international standards, there is not a lot of benefit in
allowing losses from investment in shares to offset just these
categories of income.

Maybe more urgent are some changes to the basic taxation of
corporations -- and measures to eliminate the double taxation that
does so much damage to the return on investments.

As any entrepreneur in Japan will tell you, the first thing that
could be done is to eliminate the anachronistic and patronizing
rule on directors' bonuses. More relevant to investment income
would be the immediate introduction of a domestic limited partnership
vehicle that is flow-through for tax purposes, and recognition of
flow-through treatment for foreign limited partnerships. This
is essential to increase the options for structuring complex
investments.

We're not asking for tax holidays or shirking the honor of
contributing to the support of Japan's bureaucracy: we just
want to limit to once the times that the same item of income is
subject to tax. We often suggest that issues like this will be
considered in the next few years, but it's time to stop talking
and to take some real measures to reduce the tax burden on
investors.

-- John Charles-Decourcy

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STAFF
Written by John Charles-Decourcy (jcd@japaninc.com)

Edited by J@pan Inc staff (editors@japaninc.com)

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