In 2006, the Japanese Commercial Code underwent the most significant set of changes since its inception. Up until that point, the basic corporate forms available to businesses in Japan were the (i) corporation (kabushiki kaisha, or “KK”), (ii) limited liability company (yugen kaisha, or “YK”), (iii) limited partnership company (goshi kaisha) and the (iv) general partnership company (gomei kaisha). The 2006 amendments, which codified the “Japanese Companies Act” to deal specifically with company formation, organizational, management and administrative issues, essentially folded the existing limited liability company (YK) into the corporation (KK) and established a new limited liability company (the godo kaisha, or “GK”) in its place, while a related law that went into effect just before those amendments in 2005 introduced a new limited liability partnership (yugen sekinin jigyo kumiai) to the non-corporate forms already available under Japanese law.

The GK was based loosely on the limited liability company under U.S. law and was heralded, and continues to be referred to, as the “Japanese LLC”. From the beginning, it was meant to offer the most significant features of its American counterpart – namely, (i) limited liability (limited to the amount of the member’s investment) and (ii) pass-through tax treatment for members. The intent was to bring Japanese company law more in line with popular modern-day corporate forms and open up additional options for structuring and investment in Japan.

Unfortunately, this proposal was met with serious resistance, in particular with respect to the proposed tax status for the new Japanese LLC. Historically in Japan, entities that enjoy a separate legal existence have always been subject to a corporate tax at the corporate level, and the support for the Japanese LLC was not strong enough to overcome the presumption that pass-through tax treatment should only be available for non-corporate associations / partnerships. The result is that Japanese LLCs do not benefit from pass-through tax treatment under Japanese law as the LLC name would suggest.* This is a major source of misunderstanding for foreign investors, who assume, as one would expect, that a Japanese LLC would naturally possess the salient features of its similarly-named American counterpart.

The compromise for the somewhat handicapped Japanese LLC was the introduction of a limited liability partnership (the yugen sekinin jigyo kumiai, or simply, the “Japanese LLP”). The Japanese LLP provides limited liability (limited to the amount of the member’s investment) and pass-through tax treatment for members but, importantly, is not recognized as a corporate form. In other words, unlike its American counterpart, it is not treated as a distinct entity with a separate legal existence and therefore cannot be a party to agreements, cannot acquire rights or be subject to liabilities in its own name, and cannot, except in certain circumstances, be a named plaintiff or defendant in lawsuits.** At its core, it is treated as an association – a group of individuals acting together for a common purpose. Here again, the naming is a major source of misunderstanding for foreign investors, who understandably assume that the characteristics of the Japanese LLP would generally map to those of its similarly-named American counterpart.

Anyone considering establishing a company or partnership in Japan will want to take the time to due diligence the various options to select the most appropriate form in light of their particular business and tax circumstances. Please contact us at Jackson Sogo so that we can assist you in that process.

* Note, however, that a taxpayer may “check-the-box” to treat a Japanese LLC as a pass-through entity for U.S. federal tax purposes.

** These issues are not insurmountable. For example, members of an LLP may enter into contractual arrangements on behalf of the LLP. Property registered in the name of a member on behalf of the LLP is also considered to be jointly held by the members of the LLP. However, the lack of corporate form can complicate the process, and some banks and creditors may be unwilling to do business with an LLP due to their unfamiliarity with the form.

**** The information provided within this client alert is provided for informational purposes only and does not constitute legal advice. Copyright Jackson Sogo. All rights reserved.

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