Exclusive-Japan eyes tax breaks for non-core business sales in governance reform push, sources say

Japan's government is contemplating tax breaks for the gains derived from non-core business sales, a policy move that could hasten corporate restructuring and encourage industry consolidation, according to sources familiar with the matter. This proposal aims to alleviate a significant hurdle in companies shedding non-core businesses and reallocating capital towards growth sectors, potentially emerging as one of Prime Minister Sanae Takaichi's most impactful initiatives to promote corporate governance reform.

Companies could defer up to 30% of corporate tax on gains from non-core business sales indefinitely, provided they reinvest the proceeds within a few years in acquisitions aligned with their core operations and pledge to invest in those businesses. The proposal is anticipated to be included in the tax reform requests due towards the end of the month, with specifics to be finalized before the approval of a comprehensive tax reform package at the year-end.

This initiative is inspired by Germany's tax reform in the early 2000s, which largely exempted corporations from taxes on gains from share disposals, facilitating the dismantling of Germany's intricate network of cross-shareholdings and simplifying companies' business portfolio reshaping. Non-core businesses frequently become entangled within large Japanese conglomerates due to the taxation of gains from divestitures, which discourages asset transfers to more suitable owners capable of extracting maximum value.

Consequently, this results in inefficient capital allocation. A recent government study revealed that approximately 65% of Japanese companies' invested capital remains locked in businesses that do not generate returns commensurate with their cost of capital, thereby counteracting the value generated by higher-performing units. Such capital locked in low-return operations is viewed as impeding growth investment and exerting pressure on long-term corporate value.

While Japan has previously introduced several measures to foster business overhauls, such as spin-off tax rules in 2017 and a partial spin-off regime in 2023, the actual implementation of these strategies has been relatively scarce. A 2020 industry ministry report indicated that Japanese companies often lack clear divestment criteria and have traditionally prioritized maintaining group size, employment, and corporate stability over portfolio reshaping.

If enacted, this tax reform could likely stimulate the already robust M&A activity in Japan. Deal activity involving Japanese companies last year surpassed the previous year's record, with M&A transactions totaling $353 billion, of which $44.7 billion were attributable to divestitures of Japanese businesses.