When starting a business, you would ordinarily use a corporation, right?
Especially when several people are starting one together, many do not consider any other option.
After all, structures other than stock companies can be hard to understand.
But there is actually one powerful option beyond a stock company that you should know about. No corporate tax is imposed at the partnership level for civil-law partnerships and similar arrangements that have no legal personality.
Its name is the “investment partnership.”
The Difference Between a Corporation (Company) and a Partnership
A company has something called “legal personality.” Put simply, legal personality allows it to enter into various contracts in the company’s own name.
A partnership does not have “legal personality.” Accordingly, there are various ways to enter into contracts, such as having a representative sign them.
What Is an Investment Partnership?
An investment partnership is a structure that pools funds, invests them in businesses or assets, and distributes profits to the investors based on their investment ratios or other criteria. It has no legal personality and, in substance, exists only as a contract. Its investors may be corporations or individuals. What is commonly called a fund is also one type of investment partnership.
Because civil-law partnerships and similar arrangements do not have “legal personality,” the partnership itself is not subject to corporate tax. Instead, pass-through taxation applies: no matter how much profit the partnership earns, the partnership itself is not taxed, and the investors are taxed. This is also a major advantage. Conversely, losses are also attributed to the investors, although limits on the amounts deductible for individual income tax or corporate tax purposes depend on the members’ attributes and the type of partnership (the tax-saving arrangements using aircraft operating leases that were popular some time ago fall into this category).
Types of Investment Partnerships
There are various investment structures. These include civil-law partnerships, silent partnerships, investment limited partnerships, limited liability partnerships (the Japanese version of an LLP), special purpose companies, investment corporations, and investment trusts, among many others. There are also many investment partnerships established under foreign laws.
Now, let us look at the particularly important civil-law partnership, silent partnership, investment limited partnership, and limited liability partnership.
Civil-Law Partnership
A civil-law partnership is a contract under the Civil Code in which two or more investors agree to contribute capital and conduct a business jointly.
In other words, you might picture each investor as also being a joint business operator. Forming a civil-law partnership requires at least two investors. The contract lists the names of all investors and makes clear how much each has contributed.
One advantage of a civil-law partnership may be that, because you manage the business yourself, you can keep track of it. However, one of the investors (joint business operators) needs to be an expert in the business receiving the investment. Otherwise, a civil-law partnership made up of amateurs will not work well.
The disadvantage is unlimited liability: the investors bear unlimited responsibility.
One example of a civil-law partnership is a production committee used in film production and similar projects. Operating a production committee as a civil-law partnership is part of Japanese business culture. In Europe and the United States, where raising money tends to be the stronger focus, other structures may be preferred.
Silent Partnership
A silent partnership is a contract under the Commercial Code in which an investor contributes capital to an operator’s business and receives a distribution of the profits generated by that business.
Unlike in a civil-law partnership, the investors do not participate in management. Everything is entrusted to the operator. In addition, each silent partnership agreement is a one-to-one contract between an investor and the operator, and an investor does not know who else has invested. This is why its Japanese name, tokumei kumiai, literally means “anonymous partnership,” although it is usually called a silent partnership in English. As a result, there is one contract for each investor.
The advantages of a silent partnership may be that the business can be left to a professional operator and that the unlimited liability that is a disadvantage of a civil-law partnership becomes limited liability, with each silent partner liable only up to the amount invested.
The disadvantage of a silent partnership may be that, because the investors do not participate in management and their relationship with the operator is therefore weak, attracting investors is difficult unless the operator has considerable credibility.
A representative example of a silent partnership is the “GK–TK scheme” used for solar power projects and the like.
Incidentally, although its Japanese name includes the word “anonymous,” it is a commonly used arrangement and is not inherently suspicious.
Investment Limited Partnership
When businesses sought to invest in shares and similar assets, they tended to avoid civil-law partnerships because of their unlimited liability. As this kept investment funds from being formed actively, the Act on Limited Partnership Agreements for Investment in Small and Medium-Sized Enterprises (now the Limited Partnership Act for Investment, commonly called the Fund Act) was enacted in 1998. This created the investment limited partnership, a form of civil-law partnership in which limited partners can have liability limited to the amount of their contributions.
However, the general partner bears unlimited liability for the partnership’s obligations, and several restrictions apply.
These restrictions include the following: eligible investments are exhaustively enumerated by law and include shares and corporate bonds of domestic corporations and certain foreign corporations, membership interests in Japanese limited liability companies (godo kaisha), and certain crypto-assets; an investment limited partnership must be audited by a certified public accountant or audit corporation; and, despite being an investment partnership, it must be registered with the Legal Affairs Bureau.
If anything, perhaps it is a structure closer to a silent partnership than to a civil-law partnership.
Limited Liability Partnership (Japanese LLP)
Like a civil-law partnership, a limited liability partnership assumes that the investors and managers will jointly operate the business, while its members have limited liability up to the amounts they contributed. The differences from a civil-law partnership may be that registration is required and that, with the consent of all members and a reasonable basis, the partners may set a ratio for allocating profits and losses that differs from their investment ratios (however, caution is required because a change made without a valid reason risks being denied for tax purposes).
The 2015 article stated the following:
When a business is operated through a corporation, corporate tax is imposed on the corporation’s profits, and income tax is then imposed when dividends are paid. Using an investment partnership results in pass-through taxation and allows corporate tax to be avoided, so it may be worth considering depending on the business. Recently, these structures appear to be popular not only for funds, but also for family-run businesses and inheritance-tax planning.
Please note that the conditions governing investment partnerships are complex, so if you are considering one, I strongly recommend consulting a professional.