Before the new Corporate Law took effect Monday, one article was viewed with a wary eye by foreign-affiliated firms: No. 821.

Article 821 deems firms to be illegal if they mainly operate in Japan but their head office is a paper company overseas for the purpose of evading laws and taxes here.

Article 821 also stipulates “Foreign firms that have their main office in Japan or whose main purpose is to operate in Japan, cannot continue to operate in Japan.”

This wording has foreign-run firms shaking in their boots.

“The reason it became such a big issue is because many foreign-affiliated firms, including securities houses, have head offices (on paper) in places like Hong Kong or in the Cayman Islands,” said Jun Niiya, president and CEO of PaddleOut Inc., a consulting firm. “That’s over 30 out of the 40 some foreign securities firms in Japan. After the introduction of Article 821, they fear they will be mistakenly deemed illegal.”

Recalling when many foreign brokerages tried to enter Japan in the 1980s, European Business Council policy director Jacob Edberg noted it was actually the Finance Ministry that initially recommended that they set up head offices for their Japanese operations outside Japan.

“Around the 1980s, when many foreign securities firms entered Japan, it was quite difficult to set up a corporation here, because there were rules that the security business entity and banking business entity had to be separately established,” he said.

Edberg said legitimate foreign firms abide by the laws and duly pay their Japanese corporate and other taxes with the money they make here.

Acting on requests from the international business community, including the American Chamber of Commerce in Japan and the EBC, the government took steps to ease the concerns of foreign firms, announcing that Article 821 will not apply to the vast majority of them, such as ACCJ and EBC member firms.

“It’s quite normal for a country to regulate a company that was established under foreign law,” a government official said, noting Article 821 is not a new concept. “Article 821 only took over the role of Article 482 in the old law.

“Even if a foreign company has its head office abroad and operates overseas and not just in Japan, this is not illegal” both under the old and new laws, the official said, stressing that most foreign firms operating in Japan have nothing to worry about.

Although the anxiety of foreign firms seems to have abated after the government’s explanations, some still hope Article 821 will ultimately be struck from the law.

A U.S. government official who asked not to be named said that as long as Article 821 remains, it will continue to be a source of uncertainty.

Silvia Kofler, head of the press section of the Delegation of the European Commission to Japan, said, “If this situation is not cleared up, it will not be favorable for foreign investment (in Japan).”

Because the Diet has rejected a proposal to delete Article 821, the government said it will not happen “unless the situation drastically changes.”

“There are many ambiguous clauses in Japanese law, and this is just one of them,” said lawyer Maki Kumagai, who specializes in corporate law. “I don’t know whether the Justice Ministry has the time to make an amendment, but if many companies feel (negatively) affected by (Article 821), it’s an issue that needs to be addressed.”

Some critics say that instead of Article 821, a separate law like the U.S. Sarbanes-Oxley Act of 2002 should be enacted to set strict punishments against corporate managers who conduct fraud and other illegal acts.

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