Japan to exempt foreigners from corporate bond tax

* New scheme to cover bonds issued before March 31, 2013

* Step aimed at drawing overseas investors to corporate bonds

* Exemption from 15 pct tax on interest income starts June 1

* Follows tax breaks in past decade on JGBs, municipal debt

* Also covers Samurai bonds, convertible bonds

By Masayuki Kitano and Naoyuki Katayama

TOKYO, May 31 (BestGrowthStock) – Japan hopes to lure overseas
investors to corporate bonds by temporarily abolishing taxes on
interest income starting next month, but analysts say it may face
an uphill battle due to low domestic interest rates.

Out of some 68.1 trillion yen ($748 billion) in Japanese
corporate bonds outstanding as of March 2009, foreigners held a
mere 0.6 percent.

One reason, Japanese Financial Services Agency (FSA)
officials say, is that overseas investors have until now been
charged a 15 percent withholding tax on interest income they gain
from Japanese corporate bonds.

In contrast, overseas investors are in principle exempt from
paying such taxes in the United States, Britain, Germany and
France.

Japanese FSA officials say they hope the decision to abolish
the tax charged to overseas holders of corporate bonds starting
on June 1 will help change the picture.

“We do not have a numerical target for measuring success,”
Hironori Kawauchi, director of the FSA’s tax office, told Reuters
on Monday.

“But we are optimistically hoping that it will be possible to
achieve a situation where their performance, in the sense of
attractiveness to investors, will not be worse than other
financial products, such as stocks, government bonds or municipal
debt,” Kawauchi said, referring to Japanese corporate bonds.

The new tax exemption will cover corporate bonds that are
issued on or before March 31, 2013, even those that were issued
before June. The FSA will aim to eventually make the scheme
permanent, Kawauchi said.

LOW INTEREST RATES

The new scheme will also cover debt such as convertible
bonds, commercial paper, so-called “zaito” agency bonds issued by
government-affiliated agencies, and Samurai bonds —
yen-denominated bonds issued in Japan by non-Japanese entities.

Japan adopted similar tax exemptions for Japanese government
bonds in 1999, and for municipal bonds in 2007.

Analysts said a sudden influx of foreign money into Japanese
corporate bonds was unlikely, despite the new scheme.

Toshihiro Uomoto, executive director of credit investment
strategy and analysis for Nomura Securities, said the tax
exemption may help increase demand for Japanese corporate debt
among passive-strategy investors overseas.

“Some overseas investors conduct index-based investment in a
manner similar to the passive-strategy investment conducted by
Japanese pension funds,” Uomoto said.

Some benchmark bond indexes that such overseas
passive-strategy investors follow include Japanese corporate
bonds. But because of the taxation scheme, such foreign players
have avoided buying Japanese corporate bonds until now, choosing
to take exposure in JGBs instead, Uomoto said.

That may change, but the impact is likely to be limited to
corporate bonds with relatively large issuance lots, he said.

Uomoto and other analysts agree that the biggest hindrance to
overseas investment in Japanese corporate bonds is Japan’s low
interest rates, and the bonds’ low yield spreads over JGBs.

“I think this measure can be viewed very positively from the
standpoint of making it easier for overseas investors to enter
the market if interest rates were to rise in the future,” said
Hidenori Suezawa, chief strategist for Nikko Cordial Securities.

“But if you ask whether their (market) share will immediately
rise because of this, you have to wonder whether that will be the
case,” Suezawa said.

Indeed, overseas holdings of JGBs and municipal bonds remain
small even though foreigners are already exempt from taxes on
interest income earned on such bonds.

As of end-March 2009, in addition to holding only 0.6 percent
of Japanese corporate bonds, overseas investors held just 0.2
percent of the 66.7 trillion yen in Japanese municipal bonds
outstanding, and 7.1 percent of some 797.7 trillion yen in JGBs.

Such figures pale in comparison with the 25.2 percent
overseas players held in U.S. bonds including government and
corporate debt and 60.1 percent in British bonds, according to
data compiled by Japan’s FSA.

Investing Basics
($1=91.05 Yen)
(Editing by Chris Gallagher)

Japan to exempt foreigners from corporate bond tax