Japan Tax Reform Update: Major changes expected for foreign LPs investing in Japan

Japan is expected to introduce a major tax reform, the first since 2009, aimed at reducing permanent establishment (PE) risks for foreign limited partners (LPs) investing in funds managed by Japanese general partners (GPs). Key proposed changes include:

• Raising the ownership threshold for exemption from 25% to 50%.

• Allowing LPs to retain certain governance rights without triggering PE status.

• Removing restrictions on other PE-attributable income.

These reforms, to be under debate in the Diet this year, are anticipated to significantly ease inbound investment and fund structuring involving Japan.

Japan is expected to implement a major tax deregulation next year impacting foreign investors. This will be the first significant reform in this area since 2009 and is anticipated to have a meaningful effect on inbound investment and fund structuring involving Japan.

Current Position

Under the existing regime, foreign LPs investing in a fund managed by a Japanese GP are generally deemed to have a permanent establishment (PE) in Japan and may therefore be subject to Japanese income tax.

To qualify for the current exemption and avoid PE status, a foreign LP must satisfy all of the following conditions:

• No involvement in fund management or operations
  In practice, LPs often waive key governance or consent rights to mitigate PE risk.
• Ownership of less than 25% of the fund’s assets
  This creates challenges for concentrated investments, such as co-investments or fund-of-one structures.
• No other PEs in Japan
  This restricts the investor’s ability to invest in other Japanese funds or maintain a Japanese presence.
• Submission of a notification to perfect the exemption

Proposed Reforms by the Government on 26 December 2025

• Increase of the ownership threshold from 25% to 50%
  A significant improvement for investors.
• Exclusion of certain LP approval rights from “business execution”
  LP approvals relating to GP conflict-of-interest transactions will be excluded, allowing LPs to exercise customary governance rights without triggering PE risk.
• Removal of the restriction on other PE-attributable income
  Investors will no longer be prevented from investing in other funds or establishing branches in Japan.

The reform¹ is expected to be debated and legislated during this year's session of the Diet. Accordingly, from around the year after next, one of the most significant barriers to foreign LP investment into Japan is expected to be removed – an important development for inbound investment and fund formation.

Please note that capital gains tax may still apply to foreign investors unless the 25/5 exemption applies. In practice, exemption is often achieved through Japan’s extensive tax treaty network.

Ashurst Tokyo does not provide tax advice. We remain available to support you with structuring considerations, documentation updates, and execution planning for upcoming raises or co-investments.