As experienced investors in Japanese real estate know, the Tokutei Mokuteki Kaisha (TMK) is the Japanese entity used by most investors to acquire and hold large real estate assets due to its favorable tax treatment. It is also well known that the TMK is a highly regulated entity, and the laws and regulations governing the TMK are rife with traps for the unwary. For investors in Japanese data centers who use the TMK as their investment vehicle, a couple of these traps arise because of the high value of the TMK’s movable assets (i.e., the data center fit out) in relation to its immovable assets (i.e., the land and the core and shell of the data center).
Under the Japanese Law Regarding Liquidation of Assets (TMK Law), a TMK is required to entrust its assets with a Japanese trustee, subject to certain specified exceptions. One of these exceptions to this entrustment requirement applies to immovable assets (the real estate). If the data center fit out is considered as a part of the immovable assets or assets that are ancillary to the immovables, the data center fit out is not required to be entrusted.
However, due to (1) the high value of the data center fit out compared to the value of the immovables and (2) the relative ease with which it is possible to separate the fit out from the immovable assets, it is difficult to consider the fit out as a part of the immovable assets or assets ancillary to the immovables. If the fit out is deemed to be independent and separate from the immovable assets into which it is installed, the fit out should be entrusted with a trust company. However, Japanese trustees are often unwilling to accept the entrustment of fit out assets for operational reasons. In such case, it will be necessary to form another entity to take title to the fit out. Such other entity will lease the core and shell from the TMK and install and own the fit out directly.
Another issue relates to whether the TMK can take advantage of certain reductions in registration and acquisition taxes imposed on the acquisition of its immovable assets. As of April 2024, a TMK can reduce such taxes by approximately 1.8% of the assessed value of the land and 2.4% of the assessed value of the building comprising the data center (investors should confirm the applicable taxes with their tax advisors). To qualify for such reduction in taxes under the TMK Law, the value of the TMK’s immovable assets must comprise at least 75% of the TMK’s total assets. For most real estate assets, this is not an issue, but the high value of the fit out may cause a TMK to fail to meet the 75% valuation threshold. Since the tax reduction is substantial, this is another reason why an investor may choose to use another entity to take title to the fit out.
While using an entity other than the TMK to own the fit out is not fatal for a data center investment, it does add costs and complications for the investor. Most investors would prefer to avoid additional such cost and complexity, but in some cases it cannot be avoided.
Morgan Lewis is well positioned to assist with data center questions relating to the Japan market, with the recent addition of industry-leading real estate partners Gerald “Jerry” Fujii and Naoki Ueyama to its Tokyo office. Jerry and Naoki have been actively involved in data center development projects for lenders, developers, and operators, including helping to secure the first green loan and the first sustainability-linked loan that were used to finance data center developments in Japan.