Korean Tax Newsletter (January, 2015)

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

Multilateral competent authority agreement on automatic exchange of financial account information

The Ministry of Strategy and Finance (“MOSF”) has signed the multilateral competent authority agreement on automatic exchange of financial account information at a signing ceremony which was held in Berlin on October 29, 2014. The purpose of this agreement is to agree on the specific process for automatic exchange of information between countries, and the contracting countries will exchange the financial account information annually based on the Common Reporting Standards (“CRS”) which was designed by the OECD fiscal committee in February, 2014. As the exchange of information with many countries becomes possible under this agreement, the MOSF plans to strengthen the international cooperation to prevent the offshore tax evasion based on the agreement with other contracting countries from 2017 (for USA to be from 2015 under the agreement for automatic exchange of information between Korea and US).

Simplified Advance Pricing Arrangement for foreign invested companies

The National Tax Service (“NTS”) announced a plan to support foreign invested companies by introducing Simplified Advance Pricing Arrangement (“APA”) which will decrease uncertainty on transfer pricing and tax audit burden in the future. The Simplified APA will be processed within one year. APA is an agreement in advance on the transfer pricing methodology for cross border related party transactions. Once APA is approved, taxpayers can be free from the transfer pricing audit risk for 3 to 5 years. In spite of such benefit, in practice APA has been utilized mostly by large companies due to high cost and long processing period. NTS will review the application for the simplified APA and shorten the processing period to one year, once small and medium sized foreign invested companies with KRW 50 billion or less of sales revenue apply for unilateral APA with minimal required documents such as company information and business structure. NTS estimates that approximately 76% of foreign invested companies in Korea will be eligible for the simplified APA.

News from tax authorities

On December 3, 2014, the National Assembly approved, with some revisions, the tax reform proposals for 2014 submitted by the MOSF. The approved tax laws are the Corporate Income Tax Law (“CITL”), Personal Income Tax Law (“PITL”), Tax Incentive Limitation Law (“TILL”), International Tax Coordination Law (“ITCL”), Value Added Tax Law (“VATL”), and National Tax Basic Law (“NTBL”). These revisions to the tax law will be generally effective for tax year beginning on or after January 1, 2015 unless otherwise noted.

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 investment, payroll increase and dividends. This new tax regime does not apply to entities classified as a Small and Medium-sized Company (“SMC”).
According to the revised 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.

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% (previously 10%) of the voting shares of the foreign subsidiary under the revised CITL.

Increase in base tax deduction limit on entertainment expenses for SMC.

Base deduction limit on entertainment expenses for SMC was previously KRW 18 million (for non-SMC, it is KRW 12 million). The revised CITL increases SMC’s base deduction limit to KRW 24 million, while the base deduction limit for non-SMC remains unchanged.

Expansion of reporting obligation on investment in overseas real estate and penalty increase

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 revised CITL shall newly require a domestic company to report details of direct investment in overseas real estate. In addition, in case of the failure of the report of overseas real estate information, a penalty can be imposed up to 1% of the acquisition value of overseas real estate, which is capped at KRW 50 million.

Personal Income Tax Law

Criteria for determination of a tax resident

Under the previous PITL, a resident is defined as 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; and
  • Individual who is deemed to reside in Korea for 1 year or more taking into consideration family, occupation, property, etc.

According to the revised PITL, the 1-year threshold will be lowered to 183 days.

Tax Incentive Limitation Law

Payroll tax credit

Under the revised 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; and
  • 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, and 10% for SMC and mid-size company

Change in tax credit for investment for employment creation

The tax credit for investment for employment creation (“TCIEC”) 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 previous TILL.

Under the revised TILL, the base rate and the additional rate are adjusted as follows:

(Unit: %)

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

* SMA stands for Seoul Metropolitan Area.

Increase in tax credit rate for investment in productivity improvement facilities

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

Special rule on depreciation for service sector

Service sector will be more flexible in terms of selecting the useful life for depreciation of facility. Under the revised TILL, special depreciation rule will be applied within the range stipulated in the TILL presidential decree (“PD”). 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

A foreign employee could 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 under previous TILL. This flat tax regime was scheduled to sunset on December 31, 2014.
Under the revised TILL, such incentive would be available for foreign employees of qualified regional headquarters without sunset clause. The revised TILL would also extend the sunset clause of the previous 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 revised TILL, in case where a controlling shareholder of a company which is under restructuring (e.g., through 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 can be 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 improvement plan.

The claw back provision (which will lead to assessment of deferred tax amount with interest) would apply if any of the following events 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 five years after the shares were transferred, or ii) the controlling shareholder reacquires the shares in the previously disposed company within five years after the shares were transferred.

International Tax Coordination Law

Introduction of advance pricing agreement system between national tax and customs

Under the revised ITCL, a taxpayer can apply for unilateral Advance Pricing Arrangement (“APA”) and Advance Customs Valuation Arrangement (“ACVA”) to the commissioner of National Tax Services 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.

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

Before the revision, 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 revised ITCL, the scope of loan from FCS will expand to include loans from relatives of FCS and the thin cap ratio for non-financial companies will be lowered from 300% to 200%.

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 in Korea. However, if the donation is taxed in a foreign jurisdiction, the previous ITCL exempts the gift tax of the donor in Korea.

Under the revised 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 revised ITCL, in this case, the donor would be able to claim a foreign tax credit on the gift tax paid in a foreign jurisdiction.

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 revised NTBL extends the SOL to 15 years for unjust acts involving international transactions to further sustain the ability to prevent offshore tax evasion.

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

Under the current NTBL, the maximum penalty rate for failure to report or under-reporting taxable income with unjust acts is 40%. The revised NTBL increases the penalty rate to 60% for unjust acts involving international 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 revised NTBL extends the due date to 5 years to further protect or improve taxpayers’ right.

Requirements to be qualified as a regional headquarter of global company and R&D center

In January 2014, the Ministry of Trade, Industry and Energy (“MOTIE”) announced a plan to revitalize foreign investment in Korea in order to induce new foreign investment. As part of this plan, the regional headquarter of global company and R&D center will be eligible for Korean tax incentives. On November 6, the MOTIE has issued new regulations on requirements to be qualified as a regional headquarter and R&D center under the Foreign Investment Promotion Law as follows:

[Regional HQ]

  • Global company, a parent company of Regional HQ, approved by Foreign Investment Committee, or with past five years’ average revenues exceeding KRW 3 trillion;
  • Regional HQ engages in business oversight/control activities over at least two overseas companies;
  • Total number of regular employees at the Regional HQ is greater than 10; and
  • Global company holds, directly or indirectly, 50% or more shares of the Regional HQ.

[R&D center]

  • The R&D center has five employees or more with either master’s degree or bachelor’s degree with a minimum of 3 years in R&D experiences;
  • Investment into R&D facilities is at least KRW 100 million or more; and
  • Foreigner holds at least 30% voting shares of the foreign invested company.

Revisions to the tax laws for 2015

Determination of effective tax rate under the CFC rule (Josim2013Bu4653, 2014.09.30)

The Tax Tribunal (“TT”) has made a decision on determination of the effective tax rate, which is generally calculated as an average effective tax rate of “recent 3 years”, under the CFC rule. In this case, a domestic corporation has actually conducted a business through fixed facilities in a tax haven country and changed its business activity to lease of equipment. The tax authority has assessed income tax based on the CFC rule, since the company’s main business is lease of equipment which is subject to CFC rule, regardless of whether the actual business operation is conducted through fixed facilities. The company argued that the determination of whether the company is subject to the CFC rule should be made based on the effective tax rate after the change of its business. However, the tax authority asserted that the period before the change of its main business would also need to be included in the “recent 3 years” for the computation of an average effective tax rate.

The TT judged that it is reasonable to interpret that the “recent 3 years” should include the period only from when the company changes its business subject to the CFC rule.

Updates of Tax Rulings and Cases

If you have any questions concerning the items in this month’s newsletter, please contact your tax advisor at Deloitte Anjin LLC or the following tax professionals.

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