The Rise of the Partnership economy

2015.01.10Rev.3

Jun Saito

1

Gist

2

You can lead a horse to water, but you cannot make him drink.

You can give him a tax incentive, but you cannot make him do an innovation.

May I be excused first?

3

In the 13th century, Thomas Aquinas recognized:

"Now, a private society is one which is formed for the purpose of carrying out private objects; as when two or three enter into partnership with the view of trading in common.“

Contra impugnantes Dei cultum et religionem, Part 2, ch. 8 (Opera omnia, ed. Vives, Vol. 29, p. 16).

Cited in 1891 Vatican by Leo XIII encyclical Rerum Novarum paragraph 51.

4

Private, Public

5

Japanese Society Western Society

State = Public

People = Private

State Non-State (Church)

People

Public

Private

The Rise of the Partnership economy

2015.01.10

Jun Saito

6

Revival

Abstract

U.S.A.-IRS-SOI Integrated Business Database (IBD) has been developed to provide evidence that businesses do, in fact, pursue optimal organizational structures. They have conducted a big-data calculation on vast tax return data which have been filed by whole business entities from 1980 through 2008. The main conclusion is:

The share of all net income generated by flow-through businesses has more than doubled since the early 1980s; the flow-through share of net income grew from 20 percent in 1980 to 60 percent by 2008.

We can reword flow-through into partnership and non-flow-through into corporate. So, we can say in other words, the fall of corporate business and the rise of partnership business have remarkably happened in the past of about thirty years.

The question is “Why? Why it has happened?” To look for the answer, the author will show differences between corporate and partnership. Let us discuss them and find the answer. My favorite answer is: Difference in Motivation, I mean:

A partnership is more self-motivated They produce goods and services which they want and like. A corporate, however, is motivated by others’ demand, namely money or profit. They want money or profit, more than what they produce.

7

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

The flow-through share of net income grew from 20 percent in 1980 to 60 percent by 2008

Sh

are

s o

f U

S A

ll B

usi

ne

ss N

et

Inco

me

flow through entity

corporate tax entity

Data Source ：　 Internal Revenue Service, Statistics of Income, Integrated Business Data, www.irs.gov/taxstats/bustaxstats/

Net Income = 0.3 trillion $2008

Net In-come = 3 tril-lion $

8

9

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 20110

500,000

1,000,000

1,500,000

2,000,000

2,500,000

Number of LLC and C-Corp （ 1992-2011）

LLC

Data Source: http://www.irs.gov/uac/SOI-Tax-Stats-Integrated-Business-Data and http://www.irs.gov/uac/Tax-Stats-2

: the most popular partnership

: the most popular corporate

10

Differences between Corporate and Partnership 　 rev.7

No. Item Corporate Partnership1 capacity ownership

entitycontract entity

courtsaccessible entity

accounting entity

ownership entity

contract entity

courtsaccessible entity

accounting aggregate

2 liability in default limited liability 　 The net asset in balance sheet is the solvency margin.

limited liability by at-risk amount(*)

(*) ； 1) cash contributed to partnership, 2) adjusted basis of contributed asset, 3) partner’s personally pledged amount

3 going concern or not going concern not-going concern, term company or at-will company

4 accounting mandatory accrual accounting freedom of accounting. However, collectively proper incomes shall be distributed to the partners.

5 Who has the power to recognize taxable

income?

the state, the tax authority. In tax accounting, the statutory useful life of depreciable assets are legally set. So, the depreciation costs are automatically accrued by rule.

the partners. (So, a tax sheltering is possible.) But for collectively proper accounting, the state should judge the tax shelter abusive. In other words, a tax sheltering is recognized lawful when the activity has economic substance.

6 pass through or not not pass through. The state levy tax both on corporate income and on dividends to shareholders. (double taxation)

pass through. A partnership shall file the information return to the tax authority about the annual income. In the dissolution, the partners shall liquidate the partnership and shall separately pay taxes on the finally distributed incomes. (single taxation)

7 share transferability freely transferable transferable

8 What are the contributions and distributions in?

in cash or cashable property collectively in kind

9 purpose of company profit. motivated by demands of people at large.

economic substance. motivated by the partners’ own demand.

10 collaboration type arm’s length non-arm’s length, closely held company

Lawful tax shelterSupreme Court of the United States,

1935

• For a business reorganization to affect tax liability, the reorganization must have economic substance, not be merely an attempt to reduce tax.

• However, "the legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted".

A pronouncement decided in the case: Gregory v. Helvering, 1935

11

But, a mere tax shelter is harmful to social economy, because…

12

offset deduction

Self-motivated things to do are important.

You can lead a horse to water, but you cannot make him drink.

You can give him a tax incentive, but you cannot make him do an innovation.

13

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

-2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

Cost Effectiveness (Net Income/Cost)

Partnership（除く個人事業）Corporate

Data Source : IRS-SOI-IBD Table 1 www.irs.gov/file_source/pub/irs-soi/80ot1all.xls ）

141986, PAL rule: Passive activity loss can be offset only by passive activity gain.

Bill Clinton administration

1996, Check the Box rule: A business entity that is not per se corporation is classified as a partnership for federal tax purposes, unless an election is made for the entity to be classified as a corporation. (default = partnership)

So, what has happened in 1991? Collapse of Soviet Union?

So, what has happened in 1991?• Information Technology revolution? Indeed, it has

begun about 1991.

• But, also in Japan it has happened. Still, Japan…

15

Non-K.K. are 2-digit less than K.K.

16

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

K.K.

1212503

1191680

1235720

1171114

1310520

1210010

1215015

1369953

1250514

1055543

992293

931967

920328

903080

897675

Yu-Gen

386486

413519

420626

431879

449401

470455

475298

452389

374410

331056

293880

270191

241143

233601

219568

Go-Do(J-LLC)

NaN NaN NaN NaN NaN NaN NaN 4066 9557 10785 13667 15772 18756 23025 29836

Go-Shi

8367 9830 10397 10495 10345 9977 9625 7933 7933 6999 6056 5473 5009 4799 4425

J-LLP

NaN NaN NaN NaN NaN NaN 366 1781 1725 1715 1650 1540 1537 1458 1378

Go-Mei

1463 1521 1507 1484 1538 1567 1369 1442 1326 1210 1066 1088 946 941 1002

316

3,162

31,623

316,228

3,162,278

Number of Japanese Company (1999-2013 ）Data; Ministry of Justice in Japan, http://www.moj.go.jp/TOUKEI/ichiran/touki.html

K.K.: Japanese most popular corporate

Again, what has happened in 1991?

• My guess: Some drastic change in social thought?like…

17

Dignity is prior to JusticeIt doesn’t mean selfishness is prior to fairness.

• Even prior to the logic of a fair exchange of goods and the forms of justice appropriate to it, there exists something which is due to man because he is man, by reason of his lofty dignity. Inseparable from that required "something" is the possibility to survive and, at the same time, to make an active contribution to the common good of humanity.

1991 Vatican Encyclical Centesimus Annus paragraph 34

18

New Priority of Norms

19

Origin of Innovation

20

Let us discuss.

Thank you.

21

Hereafters are O-MA-KE.

22

In the first, Microsoft, YouTube, Facebook, and etc. had startuped in partnership tax entity.

23

PartnershipInvestments could be easily compensated for by tax.

Nonlisted Listed

Corporate

Transition of firm form in object economy

Transition of funder

　　　　　

←0→

Time

Time

Darwin’s Ocean(vulnerable to sudden death)Death Valley

gain

loss

Devil’s River Secular world

1976, partnership 2001, LLC 2005, LLC

Transition of founder in monetary economy

Partnership

Investments could be easily compensated for by tax sheltering.