Tokyo, Oct. 8 (Jiji Press)–Two Japanese company executives were indicted in August for allegedly dodging income tax by exploiting the so-called angel tax system, a preferential program designed to spur investment in startups. The case has laid bare structural weaknesses in the incentive, notably a deduction cap so generous that it makes abuse very lucrative. Investment in Name Only The Yokohama District Public Prosecutors Office charged the 55-year-old former president of a barbecue restaurant chain operator based in Yokohama, eastern Japan, and a 42-year-old company executive who was an acquaintance of his with violating the income tax law. The former president sold his stake in the chain operator to a rival barbecue chain based in Kasugai, Aichi Prefecture, central Japan, in April 2023, netting a gain of some 2 billion yen, according to people familiar with the matter. He would normally have owed about 300 million yen in income tax. Instead, he applied for a special provision covering investment in “pre-seed”- and “seed”-stage startups under the angel tax system, which allows investors to deduct money put into startups that have yet to commercialize their businesses from capital gains on share sales, with up to 2 billion yen a year exempted from tax altogether. He claimed to have put the money into a startup linked to the other executive, thereby escaping income tax. In reality, there was no trace of the funds ever being used for the startup’s activities, and most of the money was channeled back to another company connected to the former president. The other executive is believed to have devised the scheme. “This case is only the tip of the iceberg,” one of the people said. “Abuse of the angel tax system is unlikely to be limited to a single instance.” “Far Too Large” Deduction Cap Introduced in 1997, the angel tax system initially centered on deferring the timing of taxation. The special deduction provision was created under the fiscal 2023 tax reform to encourage investment in startups at the pre-commercialization stage, which have limited means of raising funds. Conditions have been set for eligible investment targets, including that they be small and medium-sized enterprises that have been in operation for less than five years and are running operating losses. In fiscal 2024, some 7,500 investments worth a combined 18.5 billion yen or so made use of the angel tax system, according to the Ministry of Economy, Trade and Industry. Experts are now urging the government to tighten the system, warning that features such as its high deduction cap leave it open to abuse. “The eligibility requirements are lax, and as long as the paperwork is in order, companies other than those expected to generate innovation can also become investment targets,” said Shigeki Kunieda, a professor of public finance at Chuo University’s Faculty of Law and a former Finance Ministry official well-versed in the system. Kunieda voiced concern that the effects of such investment on startups have not been verified and that investors may pick targets purely for the purpose of tax avoidance or tax savings. He also criticized the 2-billion-yen deduction cap as “far too large,” saying, “At a time when the light tax burden on high-income earners has become an issue, this system undermines fairness.” “Unless the system is revised, such abuses will not be stamped out,” he said. END [Copyright The Jiji Press, Ltd.]
