Basic Legal Information on Japan – Foreign Direct Investment in Japan
This is the sixth in a series of articles from GVA LPC providing basic legal information to foreign companies and individuals that are planning to do business in Japan. This series of articles will highlight Japanese laws and regulations which are central to their need to smoothen their business venture into the Japanese market.
For foreign companies that intend to invest in companies located in Japan, the provisions of the Foreign Exchange and Foreign Trade Act ("Foreign Exchange Act") plays a major role in regulating their investment activities in Japan. In this article, it will focus on (i) the definition of ‘Foreign Direct Investment,’ (ii) outline prior notification and post-investment report schemes for Foreign Direct Investment, (iii) explanation on ‘Designated Business Sectors’ and procedures for prior notification, (iv) explaining some of the practical points to note subsequent to the amendment of the Foreign Exchange Act.
The Foreign Exchange Act was enacted in 1949 and applies to foreign trade involving the movement of funds, goods, or services between Japan and foreign countries and also foreign currency transactions between residents. According to Article 1 of the Foreign Exchange Act, the purpose of this act is “to enable proper expansion of foreign transactions and the maintenance of peace and security in Japan and the international community through the minimum necessary control or coordination of foreign transactions, and thereby to ensure the equilibrium of the international balance of trade and stability of currency as well as to contribute to the sound development of the Japanese economy.” The Foreign Exchange Act has been amended four times (2002, 2004, 2017, and 2019).
In 2017, the following amendment was made to the Foreign Exchange Act.
The following amendment was made in 2019.
II. Definition of Foreign Direct Investment
1. Foreign Direct Investment, etc.
According to Article 26, Paragraph 2 of the Foreign Exchange Act and Article 2, Paragraph 16, Item 1-7 of Cabinet Order on Foreign Direct Investment, Foreign Direct Investment, etc. is defined as transactions or actions to be made by the foreign investor as follows (summarized based on the document on “Q&A for the Foreign Exchange Act” provided by Bank of Japan).
As described in (2) above, it could be said that transferring the outstanding stocks or equity of the unlisted company in Japan from other foreign investors to foreign investors is considered as a specified acquisition and does not fall under the definition of Foreign Direct Investments, etc. It should be noted that prior notification is still required even if such transfer falls under the category of specified acquisition.
Looking at the definition of Foreign Direct Investment, etc., the scope of the Foreign Direct Investment is wide and includes not only general investment but also the establishment of branch offices, factories, and other offices, a loan that meets certain requirements, and acquisition of corporate bond. For this reason, it is understandable that “etc.” was attached after the phrase Foreign Direct Investment in the Foreign Exchange Act. To understand the meaning of Foreign Direct Investment, etc. it is required to identify the foreign investor to whom it will be subjected to.
2. Foreign Investor
According to Article 26, Paragraph 1, of the Foreign Exchange Act, foreign investor falls under the category as follows (summarized based on the document, “Q&A the Foreign Exchange Act” provided by Bank of Japan).
The definition of a foreign investor seems very abstract, and it is difficult to understand its extensional meaning. The “Rules and Regulations of the Foreign Exchange and Foreign Trade Act” published by the Ministry of Finance on April 24, 2020 (“document provided by the Ministry of Finance”) provides a clear explanation for the definition of a foreign investor. Please refer to the diagram below.
[Diagram 1] Scope of Foreign Investor
There are at least 2 points to note as follows when determining whether the company falls under the category of a foreign investor.
First, even if a foreign corporation establishes its subsidiary in Japan and invests in such a subsidiary, such a subsidiary will also be considered as a foreign investor as long as the foreign company holds 50% or more of stocks of such subsidiary or of which majority of officers are non-resident. To determine whether the company falls under the category of a foreign investor, it is necessary to pay attention to not only the location of the company but also whether a non-resident or foreign company takes control of deciding the vehicle.
Second, in a case where a foreign company invests in a fund through a limited partnership that was formed in Japan. If the amount invested by such a foreign corporation is less than 50% of the fund, it should not be a problem. Nevertheless, it is assumed that the investment amount exceeds 50% of the threshold value if a foreign corporation responds to the capital call by collecting funds after the foreign corporation invests. In such a case, the fund is considered foreign investment. Therefore, a person, who conducts business as an operating partner in fund management, needs to pay attention to the setting of investment amount committed by foreign corporations.
Ⅲ. Prior notification and Post-Investment Report scheme for Foreign Direct Investment
When a foreign investor conducts activities under Foreign Direct Investment, etc. the foreign investor must (1) file a prior notification before transaction or investment (“prior notification”) or (2) file a Post-Investment Report after transaction or investment (“Post-Investment Report) to the Minister of Finance and the competent minister for the business via Bank of Japan, except for those procedures are not required.
It must be noted that foreign investors must file a prior notification or Post-Investment Report for Foreign Direct Investment, etc. If the foreign investor is a non-resident, notification or report shall be filed by a representative. In this case, a power of attorney is not necessary to be attached to the notification or report.
IV. Designated Business Sectors and procedures
Prior notification for Foreign Direct Investment, etc. is required if the investee company conducts business activities that fall under any of the following.
1. Designated Business Sectors
The most important thing to keep in mind is “Case No. 2” of the above when determining the necessity of filing a prior notification. Thus, it is very important to understand what Designated Business Sectors is when considering whether prior notification is required for what scenarios.
Designated Business Sectors is specified by the Minister of Finance and the competent minister for the business under the provision of Article 3, Paragraph 3, of Cabinet Order on Foreign Direct Investment (“Provisions concerning Designated Business Sectors”) and it is published in the form of Diagram 1 to 3. Among those Designated Business Sectors, sectors handling weapons or nuclear weapons must be treated carefully from the viewpoint of national security, and they are considered as core sectors. If a foreign investor would like to invest in investee companies in which business activities are in core sectors, they are likely to be subjected to Exemption Conditions on Core Sector’s Business Activities.
Since the Designated Business Sectors covers 155 types of industries in total, please refer to documents provided by the Ministry of Finance for the outline of the Designated Business Sectors.
[Diagram 2] Designated Business Sectors
From Diagram 2 above, it can be seen that Designated Business Sectors covers a wide range of industries; thus, a foreign investor needs to consider whether they invest in an Investee Company that conducts business activities in the Designated Business Sectors before they invest. It is recommended for a foreign investor to refer to the list of listed companies with Designated Business Sectors published by the Ministry of Finance so that they can use the list to determine whether they will be required to file a prior notification for the investment; however, they must note that the list is not created under provisions of laws and regulations. Therefore, it is likely that some of those listed companies may already have engaged in Designated Business Sectors that they have not yet announced to the public, but it is not certain whether the foreign investor will be held responsible for the failure of filing a prior notification if it is found that foreign investor invested in the investee company which conducts business activities in the Designated Business Sectors after investing.
Then again, a foreign investor is required to determine whether unlisted companies conduct business activities in Designated Business Sectors on their own when investing in unlisted companies. In that regard, they can refer to the matrix of goods and techniques as listed in the website of Security trade control which is published by the Ministry of Economy, Trade, and Industry, or “Japan Standard Industrial Classification” provided by the Ministry of Internal Affairs and Communications.
Foreign investors are required to collect information from the investee company properly through due diligence, as they, at their own discretion, need to determine whether the investee company is conducting business activities in Designated Business Sectors. If it is difficult for them to determine whether the investee company conducts business activities in Designated Business Sectors based on the information that they collected from the investee company, it is recommended that they will ask the governmental body having jurisdiction for more information by phone as it may be useful to them.
The scope of designated business sectors has been expanded for cybersecurity-related businesses following by the amendment of the Foreign Exchange and Foreign Trade Act. It is recommended for a foreign investor to refer to the Document provided by the Ministry of Finance.
[Diagram 3] Scope of specific cybersecurity-related businesses in Designated Business Sectors.
Especially, many unlisted companies so-called start-up companies conduct cyber-security related business as listed in diagram 3 above. Therefore, it should be noted that, in many cases, a foreign investor needs to file a prior notification when making an investment in start-up companies in Japan.
Nevertheless, if a business falls under the category of any of the following, then such business is not considered as Designated Business Sectors.
Further, a foreign investor is required to consider whether the business conducted by the relative company of the investee company falls under the category of Designated Business Sectors before filing a prior notification. If the joint venture, of which 50% or more of equity is held by a subsidiary of the investee company and/or the investee company, conducts business activities in Designated Business Sectors, it should be noted that prior notification is required.
2. Procedures for Filing a Prior Notification
The prior notification shall be filed to the Minister of Finance and the competent minister for the business via Bank of Japan in the format specified by the Order on Foreign Direct Investment six (6) months before transaction or investment.
It is prohibited to make Foreign Direct Investment, etc. for transactions requiring a prior notification until it has passed 30 days from the day when the Minister of Finance and the competent minister for the business receives the prior notification (“Acceptance date of notification”) (Article 27, Paragraph 2, of the Foreign Exchange Act). However, the prohibition period will be shortened to 2 weeks after the acceptance date of notification. (Article 10, Paragraph 2, Item 1 of Order on Foreign Direct Investment)
It should be noted that the foreign investor will be subjected to a criminal penalty if he or she fails to file a prior notification before making Foreign Direct Investments etc. even though he/she needed to file a prior notification before Foreign Direct Investments etc. According to Article 70, Paragraph 1, Item 22 of the Foreign Exchange Act, the Foreign Investor shall be punished with imprisonment with work for not more than three (3) years or a fine not exceeding one (1) million yen or fine may be imposed on the ground that he/she fails to file a prior notification.
Please refer to the flow chart below in the document provided by the Ministry of Financial for the necessity of filing a prior notification when a foreign investor acquires stocks of a listed company.
[Diagram 4] Prior notification for stock purchases for Listed Company
Please refer to the flow chart below for the necessity of fling a prior notification when Foreign Investor purchases stocks of an unlisted company.
[Diagram 5] Prior notification for stock purchases for Unlisted Company
As described in the flowchart above (Diagram 5), the criteria of investment ratio for Foreign Direct Investment includes investment made by a foreign investor who is considered as “Closely related Persons”. However, the problem is what exactly “Closely Related Persons” is. The definition of Closely Related Persons is very difficult to understand. To summarize this, Closely Related Persons is defined as a person who has a permanent economic relationship with a person performing Foreign Direct Investment, etc., its relative, and/or a person who is equivalent to thereof (limited to a person who falls under the category of a foreign investor)
“Closely-related Persons” is defined in detail in the document provided by the Ministry of Finance as follows.
[Diagram 6] Definition of Closely related Person
It is said that the latest amendment to the Foreign Exchange Act this time is to constrain activists of foreign investment, but this was never the official stand of the Japanese government. Regardless of the purpose of the amendment to the Foreign Exchange Act, it is certain that the amendment had an impact on the foreign investor, which in turn had an impact on the investee company too. Generally, the listed companies have a constructive dialogue with their stakeholders but use different approaches to stakeholder engagement depending on the ratio of shareholding of shareholders. However, if they are requested for equal treatment of stakeholders who only hold 1% of their stocks and stakeholder who have 10% of their stocks, companies will have to spend more time on stakeholder engagement and it will lead to a significant increase in man-hours to deal such engagement.
Please be informed that this article is merely for reference purposes and any opinions expressed in this article are personal opinions of the authors. it is advisable to consult a legal professional to understand in detail to what extent the amended Foreign Exchange Act would affect your investment activities in Japan.