Japan Braces for Rise in Capital-Gains Tax; Investors Worry Over Impact on Stock Market; a Special Deal for Retail Investors

September 12, 2013, 1:07 p.m. ET

Japan Braces for Rise in Capital-Gains Tax

Investors Worry Over Impact on Stock Market; a Special Deal for Retail Investors

KANA INAGAKI

TOKYO—As it works its way back toward a five-and-a-half year high reached in May, Japan’s stock market faces a new headwind as the government moves forward with a planned doubling of tax rates on capital gains and dividends. Government officials and brokerages are betting that a new program will offset any negative impact from the higher rates, as well as aiding the economy by encouraging more people to invest in shares. The initiative—heavily marketed with images of cuddly dogs and the endorsement of baseball star Ichiro Suzuki—allows smaller retail investors to buy stocks tax-free, albeit with a number of strings attached.Still, some investment advisers caution that the jump in the capital-gains tax rate—to 20% from 10%—scheduled to take place on Jan. 1 could unleash an equity selloff just as the Nikkei Stock Average looks ready to take flight again following a sharp correction from a historic rally earlier this year.

“Please be careful since the supply and demand condition for stocks could deteriorate from the end of November to December,” Makoto Hasegawa, director of equity sales at Daiwa 8601.TO -0.44%Securities Co., warned at a recent investment seminar. He said large stockholders such as company owners could dump shares at the end of the year to lock in gains at lower tax rates.

Japanese regulators say that many institutional investors won’t be directly affected by the increase, but some asset managers are worried because their retail clients could dump mutual funds. That would weigh on prices of not only small and midcap stocks, but also the large blue-chip stocks favored by foreign investors.

“I’m not ruling out the possibility that the broader market could be weighed down” by the tax increases, said Naoki Fujiwara, a fund manager at Shinkin Asset Management Co., which manages around $6.5 billion in assets.

The concern over the investment taxes—as well as the more prominent issue of whether to proceed with a planned doubling of the sales tax—illustrates the dilemma facing Prime Minister Shinzo Abe as he tries to stimulate Japan’s economy while keeping the government’s debt burden from becoming overwhelming.

The finance and economy ministries, along with many prominent economists, say the higher sales tax is crucial to curbing Japan’s mammoth pool of sovereign debt, currently twice the size of gross domestic product. But some of Mr. Abe’s closest advisers warn that the move will crimp household consumption just as his package of stimulus measures appears to be pulling the nation’s economy out of a long slump.

The decision to raise the capital-gains tax is based partly on a calculation that the market will gain more from targeted incentives aimed at broadening the base of small investors than from the existing lower rates, which have largely benefited a relatively small number of big retail investors.

That logic flows from Japan’s experience in 2003, when the capital-gains rate was cut to the current 10% from 26%. While the 2003 reduction was followed by a market rally, officials say it did little to expand Japan’s narrow investor base of elderly, wealthy individuals. Since the early 1990s collapse of Japan’s asset bubble, most retail investors have been hesitant to buy into the Tokyo stock market, and share ownership has been considerably less common than in the U.S.

More than half of Japan’s household financial assets, which total nearly $16 trillion, remain locked in savings accounts. Only 12% of the total is invested in stocks and mutual funds, compared with 46% in the U.S., according to the Bank of Japan.

One key goal of “Abenomics”—Mr. Abe’s economic program—has been to persuade investors to pull their money out of safe, low-return investments such as cash and government bonds, and to take more risk in stocks. The shift is seen as vital for re-energizing markets and companies.

One potential spur is the Bank of Japan’s effort to end more than a decade of deflation, creating 2% inflation within two years. If the bank succeeds, or people think it will, that would make holding cash less attractive and prompt investors to seek higher-yielding assets.

Officials see the new targeted tax breaks—offered through new Nippon Individual Savings Accounts—as encouraging small investors to take on that additional risk. “By working to expand the retail investor base through NISA, we hope to aid the money shift” from savings to investments, said Koichi Taguchi, executive director in charge of sales planning at Daiwa, Japan’s second-largest brokerage in terms of revenue. Only Nomura Holdings Inc. is larger.

Modeled after Britain’s Individual Savings Accounts, the NISA program will allow individuals to invest up to ¥1 million (about $10,000) a year in a tax-free account for up to five years, starting Jan. 1. Funds in those accounts can be invested in instruments ranging from individual stocks to mutual funds, exchange-traded funds and real-estate investment trusts. No taxes are due on the account when the five years ends, and investors are free to open a new NISA when their original one expires. The program runs through the end of 2023.

With registration kicking off in October, brokers and banks have unveiled a splashy marketing blitz of train posters, television commercials and weekend seminars. Estimating based on the usage of the British program, the Japanese government projects the tax-free accounts will have some ¥25 trillion in them by 2020, a shift of nearly 3% of household savings. Nomura Asset Management Co. estimates there will be around 16 million NISA users, about 15% of Japan’s population aged 20 years or older.

The new program has persuaded Mika Asano, a 30-year-old employee at an information-technology firm, to consider buying stocks for the first time. She said she recently headed straight from work to Daiwa’s evening seminar to learn about NISA.

“I’ve never invested before, but it sounds like a good deal to start off with if ¥1 million is going to be tax-free,” Ms. Asano said after the seminar. She is thinking of using a portion of her savings—¥100,000 to ¥200,000—to initially invest in mutual funds and will eventually aim to pick out individual stocks on her own.

But the tax-free accounts come with strings that may put off some investors. Unlike in the U.K, investors can’t trade frequently within their NISA accounts, since they lose their tax-free status once shares are sold, even in the middle of the five-year period.

Investors also can’t use losses made in NISA to offset gains in regular accounts.

Rather than bringing new investors into the market, the accounts may end up mainly drawing interest from existing investors seeking tax savings.

Miharu Sato is considering opening a NISA, but she isn’t planning to dig into her savings account to do so. Instead, the 52-year-old housewife said she intends to use around ¥500,000 currently invested in REITs, while she will continue trading stocks in am ordinary, taxable account.

“A 20% capital-gains tax is quite big. But I buy and sell all the time so I wish I could do that with NISA as well,” Mrs. Sato said.