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

Japan's government is contemplating tax incentives for the sale of non-core business operations, aiming to expedite corporate restructuring and foster industry consolidation, according to sources familiar with the matter. This proposal could serve as a significant step in Prime Minister Sanae Takaichi's endeavor to enhance corporate governance reforms.

Under the proposed scheme, corporate entities could postpone paying a portion of their taxes on gains from such sales indefinitely, under the condition that the proceeds are utilized within a few years to acquire businesses that align with their core operations and that the companies pledge to invest in these businesses. The proposal is anticipated to be included in the tax reform recommendations, which are due at the close of this month.

Before a final tax reform package for the subsequent fiscal year is approved, the specific details of the initiative will be determined. The plan is inspired by Germany's tax reform of the early 2000s, which largely exempted corporations from taxes on gains from share disposals, thereby facilitating the dismantling of the country's complex web of cross-shareholdings and facilitating companies' ability to restructure their business portfolios.

Non-core businesses often remain stagnant within vast Japanese conglomerates due to the taxes levied on gains from divestitures, which discourages the transfer of assets to owners who are better equipped to generate value from them. Consequently, this results in inefficient allocation of capital. A recent government study discovered that approximately 65 percent of the capital invested by Japanese companies remains lodged in ventures that do not yield their cost of capital, which effectively offsets the value generated by high-performing units.

This trapped capital is viewed as impeding growth investment and exerting pressure on long-term corporate value. Japan has previously implemented several initiatives to foster business overhauls, including spin-off tax rules in 2017 and a partial spin-off regime in 2023; however, the actual number of business divestitures benefiting from these rules has remained limited.

A 2020 industry ministry report revealed that Japanese companies frequently lack clear divestment criteria and have historically prioritized maintaining corporate size, employment, and stability over portfolio reshaping. If enacted, the proposed tax reform is likely to stimulate the already robust M&A activity in Japan. Deal activity involving Japanese companies last year almost doubled from the previous year to reach a record $353 billion, with divestitures of Japanese businesses accounting for $44.7 billion of this total.