TRIANGULAR MERGERS DEBATE REACHES THE END GAME

C O N F I D E N T I A L TOKYO 006993 SIPDIS SIPDIS FOR EAP, EAP/J AND EB/OIA PASS USTR FOR CUTLER/BEEMAN E.O. 12958: DECL: 12/15/2016 TAGS: EINV ECON JA SUBJECT: TRIANGULAR MERGERS DEBATE REACHES THE END GAME Classified By: Ambassador J. Thomas Schieffer for reasons 1.4 (b/d). ¶1. (C) Summary: The triangular mergers debate is reaching the end game. A formal announcement from the ruling party's tax policy committee on the issue of tax deferral for stock swaps will likely come December 14. Chief Cabinet Secretary Shiozaki on December 11 called on the panel to ensure that the new tax rules were compatible with Japan's FDI goals. Separately, the LDP Commercial Law Subcommittee has signaled that it will reject demands from the Japan Business Federation (Keidanren) for stricter controls on what types of foreign stock can be used for cross-border mergers. This "final" result is marginally better than the bureaucratic position presented by METI two weeks ago but does not fulfill the commitments to open the M&A market that the GOJ has reiterated for several years now. This disappointing outcome on the Abe Administration's first action on FDI also demonstrates the need for continued attention and political commitment from senior political leadership so those elements in Japan's political and economic establishment opposed to reform cannot successfully undermine needed initiatives. End Summary ¶2. (C) Embassy staff, including the Ambassador, over the past three weeks intensively lobbied senior GOJ officials, key Diet members and leaders of the Japanese business community seeking a positive outcome to internal discussions on drafting final rules for cross-border M&A stock swaps (triangular mergers),including tax deferral. We were assisted in this effort by the timely visits of several high-level Washington-based USG officials, including economic sub-cabinet participants, who raised our concerns with Vice or deputy Ministers at METI, MOF and MOFA; the Prime Minster's Special Economic Advisor; the minister for economic and fiscal policy; the LDP party leadership; the chairman of Keidanren and in the sub-cabinet discussions themselves. The Ambassador met December 11 with CCS Shiozaki, who admitted he had been busy with other issues but was now focused on the triangular merger issue. He said he planned to meet with METI Minster Amari and former Foreign Minister Machimura, chairman of the LDP Tax Panel's Working Group. At a press briefing that same afternoon, Shiozaki called on tax panel members to ensure any new tax rules were compatible with the GOJ's goal of increasing Japan's FDI and contributed to Japan's economic recovery. The statement received prominent press coverage and a strong negative response from Keidanren. Tax Panel Appears to Have Gotten the Message - Sort Of -------------- -------------- ¶3. (C) METI's Director for Trade and Investment Facilitation called in EconCouns December 12 to explain what he described as the tax panel's final proposal on tax deferral. A formal announcement is set for December 14. The proposal, while not as flexible as METI's original August request to Ministry of Finance (MOF),is significantly better than a "secret" inter-ministerial agreement of December 1. METI separately briefed ACCJ, the European Union Mission and the European Business Council. ¶4. (C) According to the draft proposal provided by METI (copy emailed to EAP/J on December 12) the Japanese tax authorities would automatically presume the required "business relativeness" between the acquiring and target companies exists if the companies continue to conduct business as a single entity after the merger. The deferral criteria the subsidiary would have to fulfill also would be set out in a MOF ordinance early next year giving much needed transparency to the process. However, according to METI, the LDP panel continues to express concern about the use of "paper companies" in M&A transactions and, so, the new rules would require the special vehicle Japanese subsidiary to have 1) an actual "base" of business activity in Japan, e.g. a physical office, 2) executives and/or employees and, 3) "actual business operations". The third point is particularly problematic because in most cases the subsidiary will only be established to fulfill a requirement under the company law for a vehicle within Japan to effect the stock swap. As one contact at the Cabinet Office who helped design the provision while he was in METI told us, the subsidiary was only to exist to effect the swap and any discussion of its business attributes, rather than that of the foreign parent, was based on a false premise and bound to lead to a bad conclusion. Nevertheless, the last minute public intervention by Chief Cabinet Secretary Shiozaki in the debate seems to have been very important in avoiding more egregious restrictions that had been under consideration until late last week. ¶5. (U) On December 8, the LDP's Commercial Law Subcommittee also took a positive step on the related issue of the level of shareholder approval needed to conclude a triangular merger. The Committee appears to be moving toward rejecting Keidanren's call for tighter restrictions on triangular mergers including requiring super-majority or "special resolution" (tokkushu ketsugi) approval for any deal using non-Japanese stock or requiring the stock used in such transactions to be listed on a Japanese exchange. Subcommittee chairman Tanahashi told reporters that most members oppose Keidanren's demand and that, "No one objects to the direction the discussion is heading." Keidanren Continues to Urge Tougher Rules -------------- ¶6. (U) On December 12, the Japan Business Federation (Keidanren) issued a new set of proposals calling for tighter rules against corporate takeovers. In addition to repeating its standard positions in favor of tough criteria for tax deferral for cross-border and shareholder approval of cross-border stock swaps, the Federation also urged the government to make it more difficult to launch hostile take-over bids (TOBs) and called for a security review of proposed deals that involve sensitive technology similar to the U.S. CFIUS review process. (A summary translation of the Keidanren proposal has been e-mailed to EAP/J.) Triangular Mergers Raised at the Sub-cabinet -------------- ¶7. (SBU) Deputy National Security Advisor McCormick and Deputy U.S. Trade Representative Karan Bhatia raised the triangular merger issue at the December 6-7 economic sub-cabinet meetings and, separately, with GOJ counterparts. Their key message was U.S. concern that the tax law amendments under discussion by the GOJ may result in different tax treatment for new foreign investors compared to those with established subsidiaries. The United States hoped any new tax rules governing cross-border mergers would be consistent with the government's FDI policy. ¶8. (SBU) Deputy Foreign Minister Yabunaka said the GOJ was aware of U.S. concerns and reiterated the Abe administration's firm support for increased FDI. Trade Vice Minister Kitamura emphasized that discussions within the government were based on the principle of applying the same treatment for foreign and domestic mergers. In doing so, Japan will do its best not to create unnecessary obstacles to cross-border triangular mergers. MOF's Senior Deputy Director General of the International Bureau, Rintaro Tamaki, said the Ministry would not prejudge the ruling party's discussion of the subject but it saw three separate but related aspects to the issue: tax treatment for shareholders, deferral of capital gains at the corporate level and treatment of dividends. MOF has tried in its presentations to the LDP to make these distinctions clear. ¶9. (SBU) McCormick also raised the issue with Prime Minister Abe's Special Advisor for Economic Affairs Takumi Nemoto and Deputy USTR Bhatia spoke privately with Vice Minister Kitamura on December 6. Nemoto reiterated the government's commitment to promotion inward FDI but did not address the specific issue of triangular mergers. Kitamura repeated METI's points made earlier that to go further than the December 1 inter-ministerial compromise would require a major overhaul of the logic of the Japanese tax system and would take a multi-year effort. ...And with Key Parliamentarians -------------- ¶10. (SBU) U.S. Ambassador for APEC, and U.S. Chair of the U.S. Japan Investment Working Group, Michael Michalak also discussed tax deferral for triangular mergers with key Diet members during his December 4-5 visit. LDP Tax Policy Research Committee Working Group Chairman Nobutaka Machimura met Ambassador Michalak December 4. Machimura said he was not entirely clear on the status of the issue but understood it as an effort to prevent the misuse of "paper companies." He immediately called an official in one of the ministries. (It was not clear whether he was talking to someone in METI or MOF, but appears to have been METI based on Machimura's subsequent remarks.) After his call, Machimura indicated that Keidanren's belief that "paper companies" could hurt the interests of Japanese industry was the source of the new position. He added that METI does not entirely share that opinion and that the latest proposal should address concerns held by the ACCJ. (Comment: it did not.) At the end of the meeting, Machimura acknowledged that the issue was very complicated and that he would look into it further. ¶11. (SBU) Meeting with Michalak on December 6, Upper House LDP Secretary-General Toranosuke Katayama indicated that the LDP Tax Policy Research Committee had only just been briefed on the issue of tax deferral for triangular mergers and had yet to begin actual discussions. He believed, however, that the Committee would reach a decision on the issue early in the week of December 11, with a formal decision to be issued December 14 or 15. ¶12. (SBU) Katayama confirmed that there were two different opinions within the Japanese Government on the tax deferral issue. Prime Minister Abe wanted to increase flows of FDI into Japan while METI had come under pressure from Keidanren, some of whose members feared being bought out by major foreign firms. Katayama indicated that the Committee would need to find some common ground between the two positions but, as of that moment, no decision had been reached. He promised to convey Michalak's concerns to the other Committee members. Lobbying METI -------------- ¶13. (SBU) Yamamoto emphasized to Ambassador Michalak on December 5 that Japanese law only permitted mergers between Japanese companies, which is the reason the triangular merger mechanism was developed. Nevertheless, even Japanese firms could not expect tax deferral on a stock swap transaction unless they could show "synergy" (jigyourenkeisei) emerging from the deal. Yamamoto acknowledged that a "paper company" subsidiary would have a difficult time showing the synergy needed to qualify for tax deferral. A company would have to demonstrate some sort of "reality" -- ideally through revenues or, at least, the prospect of revenues -- in order to be seriously considered in this respect. Michalak stressed that the "single body" (ittai) concept floated earlier in the year, which would consider the Japanese subsidiary and its foreign parent as a single entity for purposes of determining synergy, would be a better way to address this issue. ¶14. (SBU) Yamamoto replied that in the case of a "paper" subsidiary, the foreign parent company effectively merges with the Japanese target firm. As a result, the Japanese authorities want to see the "reality" of the parent firm in Japan before addressing the question of synergies for tax purposes. He noted that, in any case, the tax ordinances would apply some conditions to qualify for deferral. Michalak emphasized that the effective elimination of the possibility of tax deferral would prevent new investors from entering the Japanese market via mergers and acquisitions. Yamamoto said he would look into the issue further but added that METI's longstanding position was opposed to the establishment of "paper companies." Comment -------------- ¶15. (C) As the first concrete action of the Abe Administration's policy on foreign direct investment, and more generally regulatory reform in the international arena, the decision on tax deferral for triangular mergers is a distinct disappointment, and it is far from clear whether the compromise that emerged, and MOF's future regulations on the subject will allow such investment to actually take place. This experience demonstrates both the continued power of these political and business elements opposed to reform and the need for constant attention from Japan's senior reform-minded political leadership to keep them in check. As we've reported previously, the Abe administration's commitment to economic reform remains uncertain. Although the public rhetoric of the prime minister and his key lieutenants tends to be robustly pro-reform, and ardent reformers have been placed especially in key second tier positions within the government, recent decisions made by the GOJ a willingness to compromise that undercuts the PM's stated objectives. The decision on triangular mergers joins the recent gas tax issue and the return of the postal rebels to the LDP as signals that the GOJ's commitment to reform is less than firm. Distraction with other issues at the top presents a ready opening for influential opponents of reform to use Japan's cumbersome regulatory process to undermine needed initiatives to further open the Japanese economy, even in the face of clear political direction and popular support for change. PM Abe's popularity ratings have taken a sharp hit as a result. We are concerned that his administration may not be able to fulfill his stated commitment to further open the Japanese market to foreign investors and providers of goods and services. SCHIEFFER