Statutory definition

“A silent partnership agreement takes effect when one party promises to contribute to the other party's business and the parties promise to distribute profits arising from that business.”

A silent partnership agreement is between a contributing silent partner and an operator conducting business with that contribution. Commercial Code Article 535 provides that it takes effect through promises of contribution and profit distribution.

Overview

Who owns contributed funds and business rights and obligations: the operator or the silent partner?

Commercial Code Article 536 first provides for ownership of contributions:

“A silent partner's contribution belongs to the business operator.”

Money and other property contributed by a silent partner become the operator's own property. The Article also prescribes partners' rights and obligations, prohibiting the following:

“A silent partner may not manage or represent the business operator.”

The silent partner is also separate from the operator in relations with third parties.

“A silent partner has no rights or obligations toward third parties in respect of the operator's acts.”

However, where a silent partner permits use of the partner's surname or full name in the operator's trade name, or permits the partner's trade name to be used as the operator's, Commercial Code Article 537 may impose joint and several liability for debts arising after that use.

How does a silent partnership agreement end?

The Commercial Code separately prescribes termination rights and events ending the agreement. For termination where no duration is specified and similar cases, Article 540 states:

“Where the agreement specifies no duration or provides that the partnership lasts for a party's lifetime, either party may terminate it at the end of a business year, provided six months' notice is given.”

The same Article allows termination at any time for unavoidable reasons, regardless of whether a duration is specified. Separately, Article 541 provides for ending the agreement upon completion or impossibility of the business, the operator's death or adjudication of commencement of guardianship, or commencement of bankruptcy proceedings for the operator or silent partner. Upon termination, Article 542 provides for return of contribution value:

“When a silent partnership agreement ends, the operator must return the value of the silent partner's contribution. However, if losses have reduced the contribution, return of the remaining balance suffices.”

Where is withholding on silent partnership distributions prescribed?

Profit distributions under silent partnership agreements are addressed across several Income Tax Act provisions. Article 161, prescribing domestic source income for nonresidents and foreign corporations, lists the following as domestic-source income:

“Profit distributions received under a silent partnership agreement (including equivalent agreements prescribed by Cabinet Order) in respect of contributions to a person conducting business in Japan.”

For domestic corporations, Article 174 includes silent partnership profit distributions in the tax base. For payers' withholding obligations on payments to residents, Article 210 provides:

“A person paying a resident in Japan a profit distribution under a silent partnership agreement (including equivalent agreements prescribed by Cabinet Order) must withhold income tax upon payment and remit it to the national government by the tenth day of the month following the month of withholding.”

Articles 211 and 213 prescribe calculation of the tax. Check the National Tax Agency's published figures for actual rates.

How does the silent partner's identity change the applicable provisions?

Whether the silent partner is a resident, Non-resident, domestic corporation or foreign corporation changes the statutory framework to examine. The Income Tax Act defines a resident as an individual domiciled in Japan or continuously resident there for at least one year to date, and a nonresident as any other individual. The Corporation Tax Act defines a domestic corporation as one having its head office or principal office in Japan, and a foreign corporation as any other corporation.

Income Tax Act Article 164 prescribes calculation of nonresidents' income tax as follows:

“Income tax imposed on a nonresident shall be calculated by applying Subsection 1 of the following Section (Aggregate taxation of nonresidents' income) to the domestic-source income specified for the category of nonresident listed in each of the following items.”

The Article additionally provides:

“Where a nonresident listed in any of the following items has domestic-source income specified in that item, income tax imposed on that nonresident shall, in addition to the preceding paragraph, be calculated by applying Section 3 (Separate taxation of nonresidents' income) to the domestic-source income specified in that item.”

For nonresidents with permanent establishments, the paragraph provides:

“Domestic-source income listed in Article 161(1)(viii) through (xvi), excluding income falling within item (i) of that paragraph.”

For nonresidents without permanent establishments, it provides:

“Domestic-source income listed in Article 161(1)(viii) through (xvi).”

Profit distributions under silent partnership agreements under Article 161 appear in both categories. The withholding obligation itself is prescribed by Income Tax Act Article 212 for payments to nonresidents, foreign corporations and domestic corporations, separately from Article 210 for residents.

A corporate silent partner that is a specified partner under Article 67-12 is subject to loss-recognition restrictions where liability for partnership business or trust debts is substantively limited to the value of partnership property, or business property for silent partnerships, or trust property, or another case prescribed by Cabinet Order applies.

For foreign corporations, the corporation tax base itself is determined by domestic-source income category. Corporation Tax Act Article 141 provides:

“The tax base for corporation tax on a foreign corporation's income for each business year shall be the income amount relating to domestic-source income specified for the category of foreign corporation listed in each of the following items.”

Article 138 divides domestic-source income into several items, separately listing permanent-establishment-attributable income and income from operating or holding assets in Japan. For the latter, it provides:

“Income arising from the operation or holding of assets in Japan (excluding income falling within Article 161(1)(viii) through (xi) and (xiii) through (xvi) of the Income Tax Act (Domestic-source income)).”

Article 177 of the corporation tax Order lists assets whose operation or holding generates this income and provides:

“Income arising from the operation or holding of the following assets (excluding income falling within Article 161(1)(viii) through (xi) and (xiii) through (xvi) of the Income Tax Act (Domestic-source income)) shall be included in domestic-source income listed in Article 138(1)(ii) of the Act.”

For treaty application and cases involving permanent establishments, see the separate articles tax treaty and Branch Permanent Establishments.

Points that require care in practice

• Income Tax Act Articles 161, 174 and 210 all use wording equivalent to “silent partnership agreement, including equivalent agreements prescribed by Cabinet Order,” while Article 212 references the relevant part of Article 161. The scope of equivalent agreements depends on the Order and must be checked there.
• Article 212 covers domestic-source income under Article 161(1)(iv) through (xvi) for nonresident payments, and items (iv) through (xi) or (xiii) through (xvi) for foreign corporation payments. Silent partnership distributions under Article 161 fall within both ranges.
• Withholding may be affected where a silent partner is from a treaty country or has a permanent establishment. These matters must also be checked.

How do the circulars classify silent partnership distributions?

Income Tax Basic Circular 36/37 Common-21 classifies distributions received by silent partners from operators as follows:

“Profit distributions received from the operator shall be miscellaneous income. However, ... where the partner is considered to jointly manage the business with the operator, such as by making important management decisions, ... income shall be business income or another category according to the operator's business.”

Note 2 to that circular states:

“Where distributions from the operator are a fixed amount or a fixed percentage of contributions regardless of business profits, they constitute income from lending money.”

For the operator's necessary expenses, Income Tax Basic Circular 36/37 Common-21-2 provides:

“Profits distributed by the operator to silent partners under 36/37 Common-21 shall be included in necessary expenses in calculating the operator's income from that partnership business.”

For corporate partners' or operators' gross income and deductions, Corporation Tax Basic Circular 14-1-3 states:

“Where a corporation is a silent partner, ... profits or losses shall, even without actual distributions or loss payments, ... be included in gross income or deductible expenses. Where a corporation is the operator, ... profits distributable or losses chargeable to silent partners under the agreement shall be included in deductible expenses or gross income.”

What amendment or addition history appears for these circulars?

Income Tax Basic Circular 36/37 Common-21 shows amendment by 2005 Kako 2-39, and 36/37 Common-21-2 shows addition by the same notice. Corporation Tax Basic Circular 14-1-3 shows amendments by 2005 Kaho 2-14, “XV,” and 1980 Chokuho 2-15, “XXXIII.”

What happens when investing in a foreign partnership?

Income Tax Basic Circular 36/37 Common-19, Note 1, and Corporation Tax Basic Circular 14-1-1, Note, define the scope of Civil Code partnerships, etc. as follows:

“Civil Code partnerships, etc. means ... and similar arrangements overseas.”

Silent partnership agreements are outside that definition and are separately addressed by Income Tax Basic Circular 36/37 Common-21.

For taxation of foreign-law entities, the court's published summary of the Supreme Court, Second Petty Bench, judgment of July 17, 2015 (2013 (Gyo-Hi) No. 166; prior instance: Nagoya High Court 2012 (Gyo-Ko) No. 8) states:

“Whether an entity established under foreign law ... constitutes a foreign corporation should first be determined by examining (i) whether ... it is clear beyond doubt that legal status equivalent to a Japanese corporation is granted or not granted. If that cannot be determined, examine (ii) whether it is a bearer of rights and obligations ... capable of itself being a party to legal acts and bearing their legal effects.”

The court's published summary reads:

“A limited partnership established under the Delaware Revised Uniform Limited Partnership Act ... constitutes a foreign corporation, and ... an investor in the investment business relating to that rental business ... cannot deduct losses arising in calculation of the rental business's income from the investor's own income.”

Legal basis

• Commercial Code, Article 535(1) (Silent partnership agreements) / Quoted wording: “A silent partnership agreement takes effect when one party promises to contribute to the other party's business and the parties promise to distribute profits arising from that business.”
• Commercial Code, Article 536(1) (Silent partners' contributions, rights and obligations) / Quoted wording: “A silent partner's contribution belongs to the business operator.”
• Commercial Code, Article 536(2) (Silent partners' contributions, rights and obligations) / Statutory wording: “A silent partner may contribute only money or other property.”
• Commercial Code, Article 536(3) (Silent partners' contributions, rights and obligations) / Quoted wording: “A silent partner may not manage or represent the business operator.”
• Commercial Code, Article 536(4) (Silent partners' contributions, rights and obligations) / Quoted wording: “A silent partner has no rights or obligations toward third parties in respect of the operator's acts.”
• Commercial Code, Article 537(1) (Liability of a silent partner authorizing use of the partner's name, etc.) / Statutory wording: “Where a silent partner permits use of the partner's surname or full name in the operator's trade name, or use of the partner's trade name as the operator's trade name, the partner is jointly and severally liable with the operator for debts arising after such use.”
• Commercial Code, Article 540(1) (Termination of silent partnership agreements) / Quoted wording: “Where the agreement specifies no duration or provides that the partnership lasts for a party's lifetime, either party may terminate it at the end of a business year, provided six months' notice is given.”
• Commercial Code, Article 540(2) (Termination of silent partnership agreements) / Statutory wording: “Regardless of whether a duration is specified, either party may terminate the agreement at any time for unavoidable reasons.”
• Commercial Code, Article 541(1) (Events ending silent partnership agreements) / Statutory wording: “In addition to cases under the preceding Article, a silent partnership agreement ends upon the following events.”
• Commercial Code, Article 542(1) (Return of contribution value upon termination) / Quoted wording: “When a silent partnership agreement ends, the operator must return the value of the silent partner's contribution. However, if losses have reduced the contribution, return of the remaining balance suffices.”
• Income Tax Act, Article 161(1)(xvi) (Domestic-source income) / Quoted wording: “Profit distributions received under a silent partnership agreement (including equivalent agreements prescribed by Cabinet Order) in respect of contributions to a person conducting business in Japan.”
• Income Tax Act, Article 174(ix) (Income tax base for domestic corporations) / Statutory wording: “Profit distributions under silent partnership agreements (including equivalent agreements prescribed by Cabinet Order; the same applies in Article 176(2) (Special taxation of interest, etc. relating to trust property)).”
• Income Tax Act, Article 210(1) (Withholding obligation) / Quoted wording: “A person paying a resident in Japan a profit distribution under a silent partnership agreement (including equivalent agreements prescribed by Cabinet Order) must withhold income tax upon payment and remit it to the national government by the tenth day of the month following the month of withholding.”
• Income Tax Act, Article 211(1) (Tax withheld)
• Income Tax Act, Article 212(1) (Withholding obligation) / Statutory wording: “A person making payment in Japan to a nonresident of domestic-source income listed in Article 161(1)(iv) through (xvi) (Domestic-source income), excluding income prescribed by Cabinet Order, or to a foreign corporation of domestic-source income listed in items (iv) through (xi) or (xiii) through (xvi), excluding income covered by Article 180(1) (Special taxation of domestic-source income of foreign corporations with permanent establishments), Article 180-2(1) or (2) (Special taxation of interest, etc. relating to trust property), or prescribed by Cabinet Order, must withhold income tax upon payment and remit it to the national government by the tenth day of the month following the month of withholding.”
• Income Tax Act, Article 212(3) (Withholding obligation) / Statutory wording: “A person paying a domestic corporation in Japan interest, dividends, supplementary benefits, interest payments, profits, gains, profit distributions or prizes listed in the items of Article 174 (Income tax base for domestic corporations), excluding those covered by Article 176(1) or (2) (Special taxation of interest, etc. relating to trust property) or Article 177 (Special taxation of dividends, etc. on shares in wholly owned subsidiaries, etc.), must withhold income tax upon payment and remit it to the national government by the tenth day of the month following the month of withholding.”
• Income Tax Act, Article 213(1)(i) (Tax withheld)
• Income Tax Act, Article 213(2)(ii) (Tax withheld)
• Act on Special Measures Concerning Taxation, Article 67-12(1) (Special taxation where partnership business, etc. incurs losses) / Quoted wording: “Specified partners (partners under partnership agreements, including similar prescribed persons and, for silent partnership agreements, etc., contributors and successors to their contractual positions ... other than partners who personally conduct ... and other partners prescribed by Cabinet Order ...).”
• Act on Special Measures Concerning Taxation, Article 67-12(3)(i) (Special taxation where partnership business, etc. incurs losses) / Quoted wording: “Partnership agreement: partnership agreements prescribed in Civil Code Article 667(1), investment limited partnership agreements prescribed in Article 3(1) of the Investment Limited Partnership Act, similar foreign agreements (including those prescribed by Cabinet Order), and silent partnership agreements, etc.”
• Act on Special Measures Concerning Taxation, Article 67-12(3)(ii) (Special taxation where partnership business, etc. incurs losses) / Quoted wording: “Silent partnership agreements, etc.: silent partnership agreements (including equivalent agreements prescribed by Cabinet Order) and similar foreign agreements.”
• Act on Special Measures Concerning Taxation, Article 67-12(1) (Special taxation where partnership business, etc. incurs losses) / Quoted wording: “Where liability for debts of the partnership business under the agreement or the trust is substantively limited to partnership property value (for silent partnership agreements, etc., business property) or trust property value, or in other cases prescribed by Cabinet Order.”
• Income Tax Act, Article 2(1)(iii) (Definitions) / Quoted wording: “An individual domiciled in Japan or continuously resident there for at least one year to date.”
• Income Tax Act, Article 2(1)(v) (Definitions) / Quoted wording: “An individual other than a resident.”
• Corporation Tax Act, Article 2(iii) (Definitions) / Quoted wording: “A corporation having its head office or principal office in Japan.”
• Corporation Tax Act, Article 2(iv) (Definitions) / Quoted wording: “A corporation other than a domestic corporation.”
• Income Tax Act, Article 164(1) (Taxation methods for nonresidents) / Quoted wording: “Income tax imposed on a nonresident shall be calculated by applying Subsection 1 of the following Section (Aggregate taxation of nonresidents' income) to the domestic-source income specified for the category of nonresident listed in each of the following items.”
• Income Tax Act, Article 164(2) (Taxation methods for nonresidents) / Quoted wording: “Where a nonresident listed in any of the following items has domestic-source income specified in that item, income tax imposed on that nonresident shall, in addition to the preceding paragraph, be calculated by applying Section 3 (Separate taxation of nonresidents' income) to the domestic-source income specified in that item.”
• Income Tax Act, Article 164(2)(i) (Taxation methods for nonresidents) / Quoted wording: “Domestic-source income listed in Article 161(1)(viii) through (xvi), excluding income falling within item (i) of that paragraph.”
• Income Tax Act, Article 164(2)(ii) (Taxation methods for nonresidents) / Quoted wording: “Domestic-source income listed in Article 161(1)(viii) through (xvi).”
• Income Tax Act, Article 212(1) (Withholding obligation) / Quoted wording: “Domestic-source income listed in Article 161(1)(iv) through (xvi) (Domestic-source income).”
• Income Tax Act, Article 212(1) (Withholding obligation) / Quoted wording: “Domestic-source income listed in items (iv) through (xi) or (xiii) through (xvi) of that paragraph.”
• Corporation Tax Act, Article 138(1)(i) (Domestic-source income) / Statutory wording: “Where a foreign corporation conducts business through a permanent establishment, income that should be attributable to that establishment if it were an enterprise conducting business independently of the corporation, considering its functions, assets used, internal dealings with the corporation's head office, etc. (its head office, branches, factories and equivalent facilities prescribed by Cabinet Order other than that establishment; the same applies in the following paragraph and Article 139(2)), and other circumstances, including income from transfer of the permanent establishment.”
• Corporation Tax Act, Article 138(1)(ii) (Domestic-source income) / Quoted wording: “Income arising from the operation or holding of assets in Japan (excluding income falling within Article 161(1)(viii) through (xi) and (xiii) through (xvi) of the Income Tax Act (Domestic-source income)).”
• Corporation Tax Act, Article 141 (No heading) / Quoted wording: “The tax base for corporation tax on a foreign corporation's income for each business year shall be the income amount relating to domestic-source income specified for the category of foreign corporation listed in each of the following items.”
• Order for Enforcement of the Corporation Tax Act, Article 177(1) (Income from operation or holding of assets in Japan) / Quoted wording: “Income arising from the operation or holding of the following assets (excluding income falling within Article 161(1)(viii) through (xi) and (xiii) through (xvi) of the Income Tax Act (Domestic-source income)) shall be included in domestic-source income listed in Article 138(1)(ii) of the Act.”

Supporting circulars and court decisions

• Income Tax Basic Circular 36/37 Common-21 (Partners' income under silent partnership agreements) / Quoted wording: “Profit distributions received from the operator shall be miscellaneous income. However, ... where the partner is considered to jointly manage the business with the operator, such as by making important management decisions, ... income shall be business income or another category according to the operator's business.”
• Income Tax Basic Circular 36/37 Common-21, Note 2 (Partners' income under silent partnership agreements) / Quoted wording: “Where distributions from the operator are a fixed amount or a fixed percentage of contributions regardless of business profits, they constitute income from lending money.”
• Income Tax Basic Circular 36/37 Common-21-2 (Operators' income under silent partnership agreements) / Quoted wording: “Profits distributed by the operator to silent partners under 36/37 Common-21 shall be included in necessary expenses in calculating the operator's income from that partnership business.”
• Corporation Tax Basic Circular 14-1-3 (Profits and losses under silent partnership agreements) / Quoted wording: “Where a corporation is a silent partner, ... profits or losses shall, even without actual distributions or loss payments, ... be included in gross income or deductible expenses. Where a corporation is the operator, ... profits distributable or losses chargeable to silent partners under the agreement shall be included in deductible expenses or gross income.”
• Income Tax Basic Circular 36/37 Common-19, Note 1 (Attribution of partnership business profits, etc.) / Quoted wording: “Civil Code partnerships, etc. means ... and similar arrangements overseas.”
• Corporation Tax Basic Circular 14-1-1, Note (Attribution of profits, etc. from Civil Code partnership business) / Quoted wording: “Civil Code partnerships, etc. means ... and similar arrangements overseas.”
• Supreme Court, Second Petty Bench, judgment of July 17, 2015 (2013 (Gyo-Hi) No. 166) / Quoted summary: “Whether an entity established under foreign law ... constitutes a foreign corporation should first be determined by examining (i) whether ... it is clear beyond doubt that legal status equivalent to a Japanese corporation is granted or not granted. If that cannot be determined, examine (ii) whether it is a bearer of rights and obligations ... capable of itself being a party to legal acts and bearing their legal effects.”
• Supreme Court, Second Petty Bench, judgment of July 17, 2015 (2013 (Gyo-Hi) No. 166) / Quoted summary: “A limited partnership established under the Delaware Revised Uniform Limited Partnership Act ... constitutes a foreign corporation, and ... an investor in the investment business relating to that rental business ... cannot deduct losses arising in calculation of the rental business's income from the investor's own income.”