Never an easy market for premium car makers, Japan has become an even tougher battleground after a green tax incentive introduced in April left all foreign car brands neatly outside the fence.

It's a daunting prospect when sales of foreign-branded passenger cars -- synonymous with high-end in Japan -- are already down almost 30 percent in the year to date to just 59,659 units -- way down from a peak of 299,000 units for all of 1996.

What's more, strict mileage rules for a separate scheme that rewards consumers up to 250,000 yen ($2,500) to replace vehicles older than 13 years mean fewer than 40 percent of foreign cars are eligible, versus nearly 90 percent of domestic cars.

The policies rankle foreign carmakers because Japan's fuel economy standards are based on an arcane testing method that critics say hardly resembles real-life driving.

Overseas carmakers could tune their cars to get better results -- Toyota's new Prius gets the equivalent of 89 mpg under Japan's measurement but only 50 mpg in the United States -- but that would take months, not to mention extra engineering costs.

It's a non-tariff barrier that the government has put in, Volkswagen (VOWG.DE: Quote, Profile, Research, Stock Buzz) Japan President Gerry Dorizas said at his office in the upscale Akasaka area in central Tokyo.

It's creating a buyers' market that has forced even the luxury brands to come out with discounts. Volkswagen doesn't want to take that road -- it would destroy our value and image.

Indeed, a dozen import brands, from Daimler's (DAIGn.DE: Quote, Profile, Research, Stock Buzz) Mercedes-Benz and Audi (NSUG.DE: Quote, Profile, Research, Stock Buzz) at the high end all the way down to Fiat (FIA.MI: Quote, Profile, Research, Stock Buzz), Peugeot and Citroen, are dipping into their own coffers to match or exceed the government's stimulus.

This is the situation we have to work with, said Dominique Boesch, head of Audi Japan, which is knocking 250,000 yen off of 19 models that meet Japan's fuel economy standards for 2010.

It's the clear direction from the government and we have to adapt to this environment.

The Japanese auto lobby expects the government's incentives to limit the fall in passenger cars to about 7 percent in the financial year to March 2010.


An unfavorable taxation system is the last thing importers need in a market that is already unkind to luxury cars.

Japan levies nine different taxes on car owners at purchase and during ownership in a complex system that makes expensive cars even costlier. Automobile-specific taxes run as high as 38 times those of Western countries, according to the Japan Automobile Importers Association.

If you spend 7 million yen ($70,000) for a car and you have to come up with another 500,000 yen ($5,000) just to put the car on the street, this is a lot of money, said Daimler Japan President Hans Tempel. 

That makes you think twice. At the end of the day you start thinking (of taxes) not in percentage terms but in cash, said Tempel, who himself spared little cost to launch the new E-Class in Tokyo's posh Ginza district last month, offering a live cello performance, refreshments and hors d'oeuvres.

Tempel said these extra taxes on Mercedes' cars could be 50 percent higher than in Germany and more than four times the cost in the United States. That, and the existence of a huge and unique segment of 660cc vehicles that get preferential tax treatment in Japan has meant that premium cars make up just 7-8 percent of the overall market.

In the U.S., (this ratio) is about 12 percent and in Europe it's about 16 percent. (Japan's taxes are) limiting the potential development of a naturally sized premium market, Tempel said.


Nevertheless, import brands have little choice but to bite their tongue and endure the apparent injustice because they see no legal case against the policies. That's especially true when scrappage incentive schemes adopted in some European nations are also visibly skewed to aid the locals.

We in Europe are very good at shooting ourselves in the foot, or at least not acting in unison, said Anthony Millington, director-general of the European Automobile Manufacturers Association's (ACEA) office in Tokyo.

The moment you start beating your drum and saying, 'Why haven't you followed Germany's good example,' (the trade ministry) is quite capable of turning around and saying, 'What about France? Or others?'

So we have tried to put the best face on it to try and use the razzmatazz that's been created by the scheme to drum up more consumer interest, he said.

Discounts will come out of importers' own pockets, but the stronger yen can provide some wiggle room, he said.

So what's in store for premium cars?

It's still early days, Millington said.

So far, we're pretty much retaining our market share. But when the market share is at rock bottom, it's difficult to be doing worse. A rock is a hard place.