US Partnership Tax Reform: A Catalyst for Innovation in Japan

1. US Partnership Tax ReformAn example of stimulus for innovation(*)…So? For Japan, what’s the use? Rev.3 2012 June 8 Jun Saito (a researcher on US partnership taxation) innovation(*): referring to not incremental innovation but disruptive innovation. The opinions hereinafter never represent official positions of my affiliated organizations, but are my personal opinions and thoughts.

2. Gist • US Partnership Taxation as an example of stimulus for innovation. How can we spark innovation, which isunpredictable? • So? For Japan, what’s the use?…Japan has just begun to struggle for satisfying “the prerequisites such as Civil Code”.

3. 1. US Partnership Taxation as an example of stimulus for innovation.

4. Innovation None of us can predict… What we can do is to spark the creativity and imagination of our people. Innovation "The first step in winning the future is encouraging American innovation. None of us can predict with certainty what the next big industry will be or where the new jobs will come from. Thirty years ago, we couldn’t know that something called the Internet would lead to an economic revolution. What we can do -- what America does better than anyone else -- is spark the creativity and imagination of our people. " ---President Barack Obama, January 25, 2011 http://www.whitehouse.gov/issues/economy/innovation In other words…Not authorized but glass-root challenges can beget innovation.

5. Innovation Unpredictable, so that… • Not grants but tax-breaks can be effective to stimulate innovation,because grants are paid to projects which are predicted, by authorities, to be successful. • Furthermore, not tax-breaks in corporate income tax but tax-breaks in partnership income tax can be effective to stimulate innovation,because in corporate tax accounting, R&D expenses and investment are designated and recognized, by the tax-authority, as taxable loss, while in partnership tax accounting , those are recognized, by the people, as taxable loss. The taxable loss reduces the income tax. So, In partnership accounting, the R&D expenses and investment could be easily compensated for by such tax reduction as scheduled by the people. It is not a corporate but a partnership that can stimulate innovation.

6. Tax-Book difference @ corporates • In corporate accounting business accounting  tax accounting,so that for instance “realized but not recognized loss” could happen in the tax accounting. In that case, profits @ book < taxable income. So, the corporate income tax could be unexpectedly high, because the corporate income tax is defined as statute rate × taxable income, not profits @ book. • In partnership accounting business accounting = tax accounting.R&D investments and expenses could be easily compensated for by such income deductions as scheduled by the people.

7. In the first, Microsoft, YouTube, Facebook, and etc. had startuped in partnership tax entity. 1976, partnership 2001, LLC 2005, LLC Transition of funder Transition of funder in monetary economy 　　　 ←0→ gain Time loss Transition of firm form in object economy Time PartnershipInvestments could be easily compensated for by tax. Nonlisted Listed Corporate Death Valley Darwin’s Ocean(vulnerable to sudden death) Devil’s River Secular world

8. Crowdfunding (for the stimulus example of the latest) (an example of loosening the criteria of compensation for investments) • Accredited investors:Those who are recognized, by IRS and SEC, as having “economic substance” when they equity invest in private companies. Accredited investors can legally use “tax shelters” such as aggregating cash-out and cash-in to zero-out (which means “taxable income = zero”). For many years, only accredited investors have been allowed to legally perform equity investing in private companies — and to receive accreditation, individuals must meet certain criteria such as having a net worth in excess of $1 million. • Blockers or Stoppers:A blocker or stopper is an entity inserted in a structure to change the character for tax purpose of the underlying income or assets, or both, to address entity qualification issues, to change the method of tax-return filing, or otherwise to get a result that would not be available without the use of more than one entity. http://techcrunch.com/2012/04/05/with-jobs-act-becoming-law-crowdfunding-platforms-look-to-create-self-regulatory-body/

9. Note that “proper profits” are plotted. Inter-company transactions are eliminated, so that double-counted profits are eliminated and brought back to the proper source.

10. Two types of Business Income Taxation

11. Partnership taxation • Limited longevity, which must accompany liquidation at final dissolution. As a result, annual tax levy is not necessary. Tax paying at the dissolution distribution is a must. • Non-recognition rule; IRC 721(contribution), 731(distribution) Gain or loss is not recognized by either a partnership or its partners on a contribution of property to the partnership in exchange for a partnership interest. IRC 721. As a result for instance, service contribution is not recognized as begetting transferential profits at the moment. A partner generally does not recognize gain or loss on the receipt of a cash distribution from a partnership. IRC731(a) • Freedom of accounting; IRC 703(b) A partnership generally is free to select its own accounting method, which may be different from that of its partners. As a result for instance, full expensing of investment, which is allowing investors to fully deduct the cost of an investment from taxable income, reduces the tax paid on the normal return to capital investment to zero, completely removing taxes from the investment decision. (Economic Report of the President 2007. Chapter3 page77.)

12. Note that “proper profits” are dealt with. Inter-company transactions are eliminated, so that double-counted profits are eliminated and brought back to the proper source.

13. Note that “proper profits” are dealt with. Inter-company transactions are eliminated, so that double-counted profits are eliminated and brought back to the proper source.

14. (History of loosening the criteria of compensation for investments) Main events in the reform history of US partnership taxation. | 14

15. 2 So? For Japan, what’s the use?… Japan has just begun to struggle for satisfying “the prerequisites such as Civil Code”. So, a lot of things to do before Japan can make use of it.

16. Japanese government has just begunCivil Code Reform http://www.moj.go.jp/ENGLISH/ccr/CCR_00001.htmlred parts marked by Jun Saito current (intact) Civil Code translated into English in 2007

17. history of Japanese civil code. |

18. And, finally start! Civil Code ReformIt’s just like Reconfirmation of good faith? current (intact) Civil Code translated into English in 2007 The origin of 「信義に従い誠実に」 was “bona fide”.But now 「信義に従い誠実に」 means, say, “with loyalty and sincerity”. It seems to me that it has different meaning from “good faith” or “bona fide”.

19. …and a quick digression Social Principles In particular,notlove-your-neighbors solidaritybutlove-your-enemies solidarity Not authorized but glass-root challenges can beget innovation. Any Investments could be compensated for by tax.

20. The intact-since-1896 Partnership Codes (1/3) In China and Taiwan, “partnership” is translated into 合伙 and 合夥. And 組合 seems to have different meaning from “partnership”. So,合伙 or 合夥 seem to be appropriate. 労務 doesn’t mean “service” but “labor”. 役務, e.g., may be appropriate.

21. The intact-since-1896 Partnership Codes (2/3)

22. The intact-since-1896 Partnership Codes (3/3)

23. While Rip Van Winkle slept for a hundred years, a busy worker US… or, a rootless wanderer …a busy worker US has evolved their partnership law into a new stimulus taxation for disruptive innovation. Now in US, almost any R&D investment could be automatically compensated for by such tax reduction as people schedule.

24. Answer to “So? What’s the use?” • If Japan wants to make use of US type stimulus for innovation, then the to-do-list is: • Reconfirm 19th century Western Civil Code. • Understand 20th century evolutions on US partnership taxation. • Modify them and apply to Japan.A long way to go. Thesis Anti-Thesis Syn-Thesis

25. a bit like Dialektik Über Vernunft und Religion Aufheben over Reason and Religion