Japan Inc is getting its groove back. An overlooked policy change could be a driver.
Japanese companies have been posting a wave of positive data. Machinery orders — a key indicator of companies’ future capital spending — in August rose 12.6 percent year-on-year to the highest level in a decade, data showed yesterday, much faster than forecast. Several analysts had expected orders to fall.
Meanwhile, corporate investment shot up last quarter to the fastest pace in more than a decade as profits climbed 18 percent.
Firms are planning to spend even more and business confidence is rising, the Bank of Japan’s Tankan survey showed.
All of the good news comes as manufacturing activity slows worldwide and the US-China trade war delays investment.
On Tuesday, the IMF cut its outlook for the global economy. Japan must be doing something right.
Has Japan Inc had a sudden change of heart after years of pressure to loosen the purse strings and trim its heaps of cash? Or are corporations finally taking advantage of their next-to-nothing cost of capital?
Neither. A much more likely reason for the remarkable numbers from Japan’s industrial sector is Japanese Prime Minister Shinzo Abe’s tax reform package that quietly kicked in this year. Unlike US President Donald Trump’s straight-out tax cut, this is a credit or incentive.
Here is how it works: Companies’ effective tax rate can drop to as low as 20 percent from 29.74 percent if they hike wages, train employees and boost “high quality” domestic investment in the Internet of Things, information technology and automation.
The policy also provides a special depreciation allowance for investing in related assets and facilities, with a minimum outlay of ￥50 million (US$442,000).
A fixed-asset tax on new equipment would also be waived.
It is not all carrots: Big firms cannot get the research-and-development (R&D) credit if they do not reinvest their profits, and the incentives are only available for three years.
The relief comes at a time when governments globally have been slashing corporate taxes. Although the effective rate has ticked down over the past decade, Japanese companies have long endured one of the highest burdens in the world.
Part of this is because Japan’s corporate-tax system is complicated and differs by a company’s size, income and location. That has created distortions in investment and financial decisions.
Now Japan Inc is reinvesting the cash it hopes to rake in — the primary basis of the tax breaks.
That is unlike its peers in the US, which have shoveled their savings toward paying down debt, raising wages and bonuses, and stock buybacks.
This likely explains the surge in capital spending, as firms upgrade equipment and attempt to take advantage of the reform while it lasts.
For one of Japan’s largest machinery companies, Keyence Corp, the effective tax rate has dropped about 6 percentage points over the past three years, while total R&D expenditure rose 16 percent last year — although it is still low as a portion of sales. Operating profit per employee has also risen.
At Fanuc Corp, a company that makes machines for almost every big factory floor, R&D as a portion of sales has risen to almost 7 percent and its effective tax rate is already close to 26 percent. Like other machinery companies, its returns on invested capital have climbed sharply over the past year.
There are even nascent signs of an uptick in labor productivity. An index for sectors including electrical parts and devices rose 7.8 percent and one for machinery rose about 5 percent in July on the year.
Meanwhile, the Topix’s machinery index is trading at 17 times its one-year forward price-earnings multiple — a 6 percent discount to its five-year average. Returns on equity are at a 13 percent premium.
If Abe’s tax breaks are starting to work, investors should hope that companies ride the policy as long as possible. They should also keep an eye on firms that are happy to simply grow their piles of cash.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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