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
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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