For transactions involving the indirect sale of Japanese real estate using tokutei mokuteki kaisha (“TMK”) structures, it is a common strategy for exiting investors to claim a Japanese Capital Gains Tax (“CGT”) exemption under the relevant tax treaties. This is done to mitigate any exit taxes on gains derived from the indirect sale of a TMK structure by offshore investors.
However, the assessment of CGT exemption claims ultimately remains at the discretion of the Japanese National Tax Agency (“NTA”). As such, there is a potential risk that the exiting TMK investors may not be able to qualify for the CGT exemption which could lead to the NTA imposing CGT on the investor’s gains as well as interest and penalties.
Let’s take a closer look at two possible scenarios.
Scenario 1: Setting Aside Proceeds to Cover Potential Tax Risk
One solution for the investors is to set aside a portion of the proceeds for a certain period (e.g. 5 to 7 years after the sale) to cover such potential tax liability. However, this will involve the locking up of cash which will affect the returns for investors and prevent a “clean exit”.
Scenario 2: Using Tax Liability Insurance
When tax liability insurance is utilized, the coverage de-risks the transaction by transferring such CGT tax liabilities to an insurer. This can provide comfort to investors and facilitate the completion of the deal.
Moreover, with tax liability insurance in place, the investors will be able to make a “clean exit” and unlock valuable cash for reinvestments or distributions.
As shown in the diagram below, the process of obtaining a tax liability insurance policy can run parallel to the transaction timeline so that the policy can be incepted on or before the signing date.
Figure１: Process and timing considerations for tax liability insurance
To help ensure the tax insurance policy is aligned to the investor’s interests, Marsh’s Private Equity and M&A (PEMA) team should be involved as soon as possible in the deal process.
How Marsh can help
Since 2007, Marsh Asia PEMA team has helped many enterprises in the region manage their transaction risks with our advisory and brokerage services. With our well-established relationships with global carriers, our team can help clients assess, identify, and secure the appropriate level of tax liability insurance coverage during the M&A process, as well as provide timely claims advocacy and management services.