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Korean Tax Newsletter (August, 2014)

Korean Tax Newsletter is a monthly publication of Deloitte Anjin LLC. We hope you will find useful information in this newsletter.

On August 6, 2014, the Ministry of Strategy and Finance announced proposed revisions to the tax laws that generally would become effective as from 2015 unless specified otherwise. Changes are proposed to the Corporate Income Tax Law (“CITL”), Individual Income Tax Law (“IITL”), Tax Incentive Limitation Law (“TILL”), International Tax Coordination Law (“ITCL”), Value Added Tax Law (“VATL”), National Tax Basic Law (“NTBL”), etc. The major proposed revisions are summarized below. It should be noted that the proposals are not final and may be subject to change or be deleted during the legislative process.


Corporate Income Tax Law

Earnings Accumulation Tax Regime

A company, which is a member of a group restricted from cross-shareholdings of another affiliate or with net equity in excess of KRW 50 billion, would be subject to Earnings Accumulation Tax (“EAT”). The EAT can be avoided or mitigated if a company uses its accumulated earnings for investment, payroll increase, dividends, etc. The purpose of this new tax regime is to encourage a company to spend earnings on making more investments, increasing employee payroll and paying more dividends. This new tax regime does not apply to entities classified as a Small and Medium-sized Company (“SMC”).

According to the proposed CITL, a company subject to this tax regime can select one of the following taxation methods:

  • (A) [{Current year income x standard rate (a)(60~80%)} – (investment, payroll increase, dividends)] x 10%
  • (B) [{Current year income x standard rate (b)(20~40%)} – (payroll increase and dividends)] x 10%

Details on standard rate (a) and (b) will be stipulated by the CITL Presidential Decree.

EAT regime would take effect for the fiscal year beginning on or after January 1, 2015 and until the fiscal year to which December 31, 2017 belongs.

Special rule on depreciation of facilities of SMC

SMC would be afforded more flexibility in terms of selecting the useful life for depreciation of facilities. Under the proposed revision, SMC can elect the useful life within the range between 50% and 150% of the facility’s standard tax useful life; and hence, more deprecation deduction can be claimed in the early life of the asset.

For this special rule to apply, the conditions are as follows: facilities must be acquired between October 1, 2014 and December 31, 2015, and the amount of facility investment in the current year should exceed that of the prior year.

Increase in base tax deduction limit on entertainment expenses for SMC

Base deduction limit on entertainment expenses for SMC is currently KRW 18 million (for non-SMC, it is KRW 12 million). The proposed CITL revision increases SMC’s base deduction limit to KRW 24 million.

Changes on indirect foreign tax credit

A Korean parent company which receives dividend from its foreign subsidiary can claim an indirect foreign tax credit (“IFTC”) with respect to underlying income taxes paid by its foreign subsidiary. To be eligible for such IFTC, the Korean parent company will have to hold directly at least 25% (currently 10%) of the voting shares of the foreign subsidiary under the proposed revision of the CITL.

Additionally, the current CITL allows for a company to claim 50% of foreign income taxes paid by its second-tier foreign subsidiary as IFTC. However, the proposed revision of the CITL abolishes the IFTC on foreign income taxes paid by the second-tier foreign subsidiary.

Changes on calculation of foreign tax credit limit

For the purpose of calculating foreign tax credit limit in a situation where a company receives foreign source income from two or more countries, under the current CITL it can select the foreign tax credit limitation calculation either on the basis of country-by-country calculation, or on a combined total basis. The proposed revision of the CITL abolishes the latter method.

Expansion of reporting obligation on investment in overseas real estate

Under the current CITL, a domestic company is required to submit financial information of its overseas subsidiaries (e.g., statement of foreign subsidiaries, financial statement schedule, statement of foreign business office, etc.) to the tax office. The proposed revision shall newly require a domestic company to report details of direct investment in oversea real estate.


Individual Income Tax Law

Criteria for determination of a tax resident

The term “resident” means an individual who has a domicile in Korea or an individual who has a place of residence in Korea for 1 year or more. The following individuals are deemed to have a residence in Korea:

  • Individual who has an occupation that requires him to reside in Korea for 1 year or more
  • Individual who is deemed to reside in Korea for 1 year or more taking into consideration family, occupation, property, etc.

The proposed revision of the IITL reduces the 1-year threshold to 183 days.


Tax Incentive Limitations Law

Payroll tax credit

Under the proposed TILL, a business which increases payroll of its employees would be eligible for the payroll tax credit if it satisfies the following conditions:

  • Payroll increase rate of current year exceeds the average payroll increase rate of prior three years
  • Number of regular employees of current year is equal to or more than that of the prior year

Payroll tax credit is computed as follows:

[Average payroll in current year – average payroll in prior year x (1 + average payroll increase rate for prior 3 years)] x number of employees in prior year x tax credit rate (*)

(*) 5% for large-size company, 10% for SMC and mid-size company

Change in tax credit for investment in employment creation

Under the current TILL, tax credit for investment in employment creation (“TCIEC”) currently consists of a base rate (which is not applicable if there is a decrease in employee headcount in the current year as compared to the prior year), and an additional rate applicable in proportion to the increase in employee headcount. In total, the tax credit rate ranges from 4% to 7%, depending on the size and location of the company.

Under the proposed revision, the base rate and additional rate are adjusted as follows:

(Unit: %)

Classification Large company Mid-size company SMC
Within SMA Outside SMA Within SMA Outside SMA Within SMA Outside SMA
Base rate 1 → 0 2 → 1 2 → 1 3 → 2 4 → 3 4 → 3
Additional rate Service Industry 3 → 5 3 → 6 3 → 5 3 → 6 3 → 5 3 → 6
Other 3 → 4 3 → 5 3 → 4 3 → 5 3 → 4 3 → 5
Total tax credit rate Service Industry 4 → 5 5 → 7 5 → 6 6 → 8 7 → 8 7 → 9
Other 4
5 → 6
5 6 → 7 7 7 → 8

* SMA stands for Seoul Metropolitan Area.

Increase in tax credit rate for investment in productivity improvement facilities

Under the current TILL, tax credit rate for investment in productivity improvement facilities for SMC and non-SMC is 7% and 3% of the investment amount, respectively.

Under the proposed revision, tax credit rate for investment in productivity improvement facilities for mid-size company would increase from 3% to 5%.

Increase in tax credit rate for third-party logistics expenditures

Under the current TILL, a manufacturing company can claim a tax credit for third-party logistics expenditures at 3% of incremental third-party logistics expenditures if the following conditions are satisfied:

  • Third-party logistics expenditure ratio (i.e., third-party logistics expenditures / total logistics expenditures incurred) in the current year exceeds 30%; and
  • Third-party logistics expenditure ratio of the current year is not less than that of the prior year

The proposed TILL raises the tax credit rate from 3% to 5% for SMC, while maintaining the 3% credit rate for non-SMC.

Changes in criteria for SMC classification under the TILL

The proposed revision of the TILL simplifies the criteria for SMC.

Criteria Current Proposed
Company volume
  1. Number of regular employees, or
  2. Equity capital, or
  3. Sales revenue within the threshold prescribed by the Small and Medium Company Basic Law (“SMCBL”)
  1. <To be abolished>
  2. <To be abolished>
  3. Sales revenue (threshold will vary depending on the type of business)
Graduation of SMC

If any of the following exceeds the limit below, it is treated as non-SMC:

  1. Number of regular employees: 1,000
  2. Equity capital: KRW 100 billion
  3. Sales volume: KRW 100 billion
  4. Total asset: KRW 500 billion

If any of following exceeds the limit below, it is treated as non-SMC:

  1. <To be abolished>
  2. <To be abolished>
  3. Same
  4. Same


Special rule on depreciation for service sector

Service sector will be eligible for more flexibility in terms of selecting the useful life for depreciation of facility. Under the proposed revision for the special depreciation rule, useful life within the range between 60% and 140% of the facility’s standard tax useful life can be elected. This special depreciation rule applies to facilities acquired between January 1, 2015 and December 31, 2015. In order to apply this rule, facility investment must increase for two consecutive years.

Extension of application of flat income tax rate for foreign employees

Under the current TILL, a foreign employee can apply for a flat tax rate of 17% (18.7% including the local income surtax) for five years from the date of commencement of service in Korea, but this flat tax regime is scheduled to sunset on December 31, 2014.

Under the proposed revision of the TILL, such incentive would be available for foreign employees of qualified corporate headquarters (i.e., a company performing support or coordination for core business functions such as business strategy, HR management, R&D, etc. of a global company) without sunset clause. The proposed revision would also extend the sunset clause of the current flat tax regime by two years to December 31, 2016 for foreign employees of non-headquarter companies.

New tax incentives for stock exchange between companies

Under the proposed revision of the TILL, in case where a controlling shareholder of a company which is under restructuring (e.g., special agreement with creditor banks standing council, court receivership, financial restructuring agreement, etc.) acquires new shares in exchange of existing shares, capital gains tax on disposal of existing shares can be deferred until the newly acquired shares are disposed. Tax deferral is permitted when the controlling shareholder and its related party transfer all of their existing shares and in return take shares in other companies according to the financial restructuring plan.

The claw back provision (which will lead to assessment of deferred tax amount and interest) would apply if any of the following occurs: i) a new company which is in the same type of business as the previously disposed company is created in the company group within three years after the shares were transferred, or ii) the controlling shareholder reacquires the shares in the previously disposed company within 3 years after the shares were transferred.


International Tax Coordination Law

Strengthening of taxation on offshore donation

Where a resident in Korea donates his/her offshore property to a non-resident, the resident donor is subject to the gift tax. However, if the donation is taxed in a foreign jurisdiction, the current ITCL exempts the gift tax of the donor in Korea.

Under the proposed revision of the ITCL, if donor and donee are related parties, the donor would be subject to Korean gift tax with respect to the donation of offshore property, even if the donation is taxed in a foreign jurisdiction. According to the proposed revision, in this case, the donor would be able to claim a foreign tax credit on the gift tax paid overseas.

Strengthening of criteria under thin capitalization rule (“Thin-cap”)

If a foreign invested company borrows from a foreign controlling shareholder (“FCS”), or from a third party with FCS’s guarantee, and the amount borrowed exceeds 300% (or 600% for financial company) of its equity (or contributed capital if greater than equity), a portion of interest expense on borrowings which exceed 300% (i.e., for non-financial companies) of FCS’s share in the borrower company’s equity is disallowed for deduction and reclassified as dividend.

Under the proposed revision of the ITCL, the definition of loan from FCS will expand to include loans from relatives of FCS. The thin cap ratio for non-financial companies will be lowered from 300% to 200% under the proposed revision of the ITCL.

Introduction of advance pricing adjustment system between national tax and customs

Under the proposed revision of the ITCL, a taxpayer can apply for unilateral Advance Pricing Agreement (“APA”) and Advance Customs Valuation Arrangement (“ACVA”) at the same time.

In such case, the commissioner of National Tax Services and the commissioner of Korea Customs Services shall discuss and determine the valuation method and appropriate range of taxable price.


Value Added Tax Law

Reduction in scope of VAT-exempt finance/insurance services

Under the current VATL, finance/insurance services are eligible for VAT exemption. The proposed revision of the VATL reduces the scope of VAT-exempt finance/insurance services to broaden tax base and enhance fairness in taxation among similar services. In this regard, fee for certain services which are outside the essential scope of finance/insurance services in nature will be newly subject to VAT.

This revision will take effect on transactions commencing on or after July 1, 2015. Details on the scope of such VAT-able services will be stipulated by the Presidential Decree of the VATL.


National Tax Basic Law

Extension of Statute of Limitations (“SOL”) period on cross-border tax evasion

Under the current NTBL, the SOL for tax assessment is 5 years (10 years in case of fraud or other unjust acts) for national taxes other than gift and inheritance tax. The proposed revision extends the SOL to 15 years for unjust acts involving international transactions to further sustain the ability to tax offshore tax evasion.

Stiffer penalties for failing to report or underreport for cross-border tax evasion

Under the current NTBL, the maximum penalty for failure to report or under-reporting taxable income with unjust acts is 40%. The proposed revision of the NTBL increases the penalty to 60% for unjust acts involving offshore transactions.

Extension of due date for filing amended returns

Under the current NTBL, the due date for filing amended returns to reduce tax base or claim tax refund by a taxpayer is three years from the original tax filing due date. The proposed revision of the NTBL extends the due date to 5 years to further protect or improve taxpayers’ right. 

Proposed Revisions to Korean Tax Laws for 2014

Classification of income on delayed payment to ship building company (Josim2013Bu2926, 2014.6.24).

The Tax Tribunal (“TT”) issued its decision on the income classification of indemnity payment.

The case concerns a shipbuilding company (A) which indemnified a foreign ship owner (B) due to (A)’s delay in the delivery of ships it built. Company (A) regarded the indemnity as a sort of penalty and thus classified it as a Korean-source “Other Income” of Company (B).
Company (A) later filed an amended return to seek refund on the withheld tax by asserting that the nature of this payment should not be regarded as penalty for breach of a contract, but as a discount attributable to minor difference from initial contract terms which should not trigger withholding tax in Korea. Company (A) also argued that even if the payment is penalty in nature, (B) can treat the receipt of such payment as business profits generated in the ordinary course of business. Therefore, withholding tax of 2% should have been applied.

TT, however, made the judgment that the payment should fall under the category of “Other Income”, rather than business profit, on the basis that the breach of contract in this case is purely of temporary or incidental nature not in the ordinary course of business.

Updates of Tax Rulings and Cases
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