Japan May Eliminate Key Capital Gains Tax, Opening Gigantic Door For Foreign Investment

Japan’s government officials are talking about nixing a 40% capital gains tax for most foreign investors, which would open a huge door to foreign investors in a country that badly needs fresh capital.

A senior trade ministry official told Bloomberg News that the government is planning talks with state-owned sovereign wealth funds from Saudi Arabia, United Arab Emirates, Qatar and Kuwait to sketch more favorable investment conditions on Japanese soil.

“This is a significant step,” Hideki Hashiguchi, chairman of the Japan chapter of the Alternative Investment Management Association, told Bloomberg. “Japan is at a crossroad in becoming a leader in Asia with its financial industry, and such changes will definitely provide a positive impact for the private equity industry and overseas investors.”

Japan has one of the highest capital gains taxes, which throws another wet blanket on desire to invest in an economy that’s a year-deep into recession and has a bleak 2009 outlook.

Only 4% of the funds managed by Japan’s active private-equity and venture-capital comes from over countries. Compare that with the 75% in the United Kingdom, 60% in the European Union and 20% in the United States, The Wall Street Journal reported.

The tax alteration could come as early as April 1 and boost investment from foreign funds by as much as 400% in the next few years, the official said.

For the sovereign wealth funds, this story is all too familiar. They have been actively investing in a variety of industries worldwide since the U.S. mortgage meltdown began and ensuing global credit crisis sunk property and stock values around the world.

In the past two years, Middle East sovereign wealth funds provided pre-bailout capital to financial-sector heavyweights such as Citigroup Inc. (C), UBS AG (UBS), Morgan Stanley (MS) and Merrill Lynch & Co. Inc.

Of course, Merrill Lynch went under and the other banks are struggling to recover, compelling evidence that the sovereign wealth funds may have struck to early.

But this time, valuations are much lower and - if Japan’s Parliament passes the measure - the lack of a capital gains tax would make Japan, the second largest economy in the world, also one of the cheapest places to invest.

“We want to increase the flow of risk capital into Japan, especially from long-term investors like sovereign-wealth funds,” Tetsuya Hamabe, a director in Japan’s Ministry of Economy, Trade and Industry’s industrial finance division, told The Journal.

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