Japan is seeking to invigorate economic growth by encouraging startups, but the relatively paltry tax breaks it offers investors compared with other countries like the US threaten to limit its ambitions.
(Bloomberg) — Japan is seeking to invigorate economic growth by encouraging startups, but the relatively paltry tax breaks it offers investors compared with other countries like the US threaten to limit its ambitions.
“The US has a system of incentives that works,” said Masaaki Taira, a ruling Liberal Democratic Party lawmaker involved with policymaking on new ventures. “Japan has been very rigid and imposed so many conditions that people don’t get the full benefit of capital gains.”
Struggling with a far lower business entry rate than the US or Europe, Prime Minister Fumio Kishida’s government in 2022 launched a five-year plan to encourage new ventures. It set a goal of becoming Asia’s biggest startup hub by offering ¥1 trillion ($7.2 billion) in support and human resource development, as well as easing access to visas for entrepreneurs.
More funds have been established to invest in startups — a record ¥877 billion was raised last year according to INITIAL, an economy ministry-linked platform that offers information, analysis and support for new ventures.
The absence of tax breaks on capital gains has disappointed investors who had hoped for a system resembling the setup in the US where returns for so-called “angel” investors can be as much as 100% free of federal taxes. Japan’s capital gains tax rate is just over 20%.
Japanese angel investors get a tax deduction on initial investments in startups, but in principle they lose it when they sell.
One idea adopted by France, which has also struggled to encourage new businesses, was to make it easier for ordinary individuals to invest in startups. The French government in 2013 introduced tax breaks for capital invested in startups by individuals through funds, helping to funnel more cash into the struggling sector.
Japan has its own system for individuals to invest in startups via funds, but the total number of investors per fund is limited to 49, meaning it’s less likely to be affordable for a broad swath of the public.
The capital gains levy is not the only tax headache facing startups. A surprise announcement that certain types of stock options were subject to income tax — at a rate of up to 55% — hit share prices earlier this year.
The move severely damaged Japan’s attractiveness as a startup hub, according to Wolfgang Bierer of consulting firm Endeavor SBC KK.
“On the one side the government is giving subsidies or grants and then they want to get the money back through taxes,” he said. All potential factors that could deter entrepreneurs need to be considered, or the sector won’t grow as expected, he added.
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It’s unclear whether reductions in capital gains taxation on investment in startups are on the cards in the near future. The Cabinet Secretariat has said it wants to cut taxes on stock options and make them easier to use.
Tomoya Suzuki of NLI Research Institute said the government may have been too worried about planned spending increases on defense and childbirth policies to take any bold steps that might reduce tax revenues.
Taira of the LDP favors more incentives as the country approaches its annual tax discussions, saying there’s a need to overcome Japan’s tendency to treat everyone the same.
“There’s a culture of disliking disparities,” he said. “Investors and entrepreneurs who take risks should be rewarded.”
–With assistance from Isabel Reynolds.
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