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Korean Tax Newsletter (February, 2015)

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

On February 3, 2015, the Ministry of Strategy and Finance (“MOSF”) promulgated the revised Presidential Decree (“PD”) of the tax laws, including the PD of the Corporate Income Tax Law (“CITL-PD”), the PD of the Tax Incentive Limitation Law (“TILL-PD”), the PD of the Personal Income Tax Law (“PITL-PD”), the PD of the International Tax Coordination Law (“ITCL-PD”), the PD of the Value Added Tax Law (“VATL-PD”) and the PD of the National Tax Basic Law (“NTBL-PD”). The changes will generally be effective for a tax year beginning on or after January 1, 2015 unless otherwise noted. Major revisions to the PD of the tax laws are as follows:


Corporate Income Tax Law

Detailed criteria for earnings accumulation tax (“EAT”) regime

EAT regime was introduced to discourage the excessive accumulation of earnings by a company within a group restricted from cross-shareholdings or with net equity over KRW 50 billion and detailed criteria for imposition of EAT were stipulated in the CITL-PD as below:

  • Taxation methodology of the EAT = {Accumulated Earnings (“AE”) [(A) or (B)] – Reserve for future distribution} X 10%
    • (A) [(Company Earning (“CE”) X 80%) – (Investment + Payroll Increase + Dividends)]
    • (B) [(CE X 30%) – (Payroll Increase + Dividends)]
  • Calculation of CE = Taxable income + Additions – Deductions
    • Additions:
      • Interest on tax refund
      • Dividend received deduction
      • Prior years’ donation in excess of tax limit deducted in current year
      • Depreciation of assets included in qualified investment for EAT purpose
    • Deductions:
      • Corporate income tax (“CIT”), local income surtax, and agricultural and fishery tax
      • Legal reserve
      • Tax loss carry forwards utilized in current year
      • Non-deductible bonus and severance payments made through appropriation of retained earnings
      • Donation in excess of tax limit
      • R&D reserve recaptured in current year
    • Scope of the qualified investment, payroll increase and dividends
      • Investment in fixed assets such as a newly constructed building or building with new extension, lands for the newly constructed building or building with new extension, machinery, vehicles, intangible assets (exclusive of goodwill), etc.
      • Payroll increase from the previous year for employees (exclusive of directors, employees receiving annual salaries of KRW 120 million or more, etc.) including book value of treasury stocks or cash contributed to employee stockholders association
      • Cash dividends including interim dividends and acquisition cost for treasury stocks of listed companies cancelled within one month from the acquisition
    • Reserve for future distribution
      • The company can reserve an amount in whole or part of AE for future distribution and get a deduction of the reserve for future distribution from the AE when calculating the EAT. If the reserve for future distribution deducted in the prior year exceeds the current year’s negative AE, 10% of the exceeding reserve amount should be additionally paid as EAT along with the regular CIT of the current year.
    • Election of EAT method
      • The company is required to report the AE amount, calculated by electing a method “A” or “B” described in the above, within the due date for the CIT return to the district tax office. The elected method should continue to be used for three years.

Changes on foreign tax credit

Before the revision, a Korean parent company could claim 100% of indirect foreign tax credit (“IFTC”) on underlying taxes of its first-tier foreign subsidiary and 50% of IFTC on underlying taxes of its second-tier foreign subsidiary in proportion to the dividend amount received from the foreign subsidiaries. However, the revised CITL eliminated the IFTC provision on underlying taxes paid by the second-tier foreign subsidiary.
In addition, the company could compute the foreign tax credit limit with either country-by-country calculation basis or combined total calculation basis in a situation where foreign source income of the company is derived from two or more overseas business places. With the revision, the country-by-country calculation basis will only be available for the computation of the foreign tax credit limit.

Interim severance payments to directors

Under the previous CITL-PD, interim severance payments to directors were treated as deductible severance pay for tax purposes if such severance payments were made to change the compensation scheme for the directors to an annual salary system on the condition that severance payments would not be paid again after the change. However, the interim severance payments made to directors due to the above reason will not be allowed as deductible severance payments for tax purposes under the revised CITL-PD. This revision will be effective for a tax year beginning on or after January 1, 2016.


Personal Income Tax Law

Scope of real estate shares

Under the PITL-PD, shares issued by a company of which 50% or more of total assets is comprised of real estate (“real estate shares”) is viewed as the real estate; therefore, a favorable capital gains tax rate for shares would not be applied to the real estate shares. With the revision, when calculating the real estate ratio out of the total assets of the company, the real estate shares as well as real estate will be included in computing the real estate asset amount.


Tax Incentive Limitation Law

Classification of small & medium sized company (“SMC”) and middle sized company (“MC”)

To be classified as a SMC, a company should meet criteria on number of employees, capital amount, or sales revenue. The revised TILL-PD simplified the criteria for the SMC based on the sales revenue scale only. On the other hand, to be a qualified MC eligible for various tax benefits under the TILL, a company will need to satisfy additional new independence requirement (i.e., an entity with total assets of KRW 5 trillion or more should not directly or indirectly own 30% or more of voting shares of the company) under the revised TILL-PD.

Expansion of claw-back provision

Under the TILL-PD, a taxpayer is subject to claw-back of the investment tax credit if the relevant assets are disposed within 2 years from the completion date of the investment. With the revision, the period for the claw-back provision will be extended to 5 years for certain buildings and structures such as dormitory, workplace daycare center, warehouse, accommodation facilities, library, museum, etc.


International Tax Coordination Law

Reporting obligation on transfer pricing (“TP”) method for service transactions

Under the ITCL-PD, when filing the CIT return, a taxpayer who has cross-border transactions with foreign related parties is required to submit the following TP documents for those related party transactions: (i) report on TP method; (ii) the detailed schedule of transactions with its foreign related parties; and (iii) the summarized income statements of the foreign related parties that the taxpayer had transactions with. This reporting obligation is waived if the transaction amounts do not exceed the stipulated amounts. Under the revised ITCL-PD, the stipulated amounts for the report on TP method on service transactions increase from KRW 500 million to KRW 1 billion for total service transaction amounts with all foreign related parties and from KRW 100 million to KRW 200 million for service transaction amounts with an individual foreign related party.

Penalty on failure to submit detailed schedule of transactions with foreign related party

Before the revision, a failure to submit the above required TP documents by the submission due date would not automatically give rise to penalties, while penalties of up to KRW 100 million could be imposed if the TP documents are not submitted after a specific request by the Korean tax authority without any reasonable causes. However, the ITCL-PD was revised to impose a penalty of KRW 10 million if the taxpayer fails to submit the detailed schedule of transactions with the foreign related parties by the original submission due date.

Details of advanced pricing adjustment (“APA”) system between national tax and customs

The ITCL introduced the unilateral APA between national tax and customs to alleviate tax burdens of taxpayers. The revised ITCL-PD provides detailed conditions and procedures of the unilateral APA and main features of the procedures include the followings:

  • If the TP method for the national tax and customs are similar, the taxpayers can request for the unilateral APA to the National Tax Service (“NTS”).
  • The NTS should notify eligibility of the unilateral APA procedures to the taxpayers within 90 days from the application date. If the taxpayers are informed that the unilateral APA is not available, they can report to the NTS within 30 days from the notification date from the NTS as to whether the Advanced Pricing Agreement for income tax purposes and Advance Customs Valuation Arrangement for customs purposes will be separately proceeded.

Scope of loans subject to thin capitalization rule

If a domestic company borrows a loan from its Foreign Controlling Shareholder (“FCS”) or a third party with a guarantee from the FCS, and such borrowing exceeds 200% (600% for financial company) of its equity (or contributed capital if greater than the equity) in the company, the interest expense on the borrowing exceeding the thin capitalization ratio of the FCS’s equity in the company is not deductible. Under the revised ITCL-PD, loans from related parties of the FCS would be subject to the thin capitalization rule in addition to the loan from the FCS and the third party with FCS’s guarantee. The scope of the related parties of the FCS is summarized as below:

  • Relative relationship such as blood relatives, relatives by marriage, etc.; and
  • Economic relationship such as directors, employees, and persons who maintain their livelihood based on money or other property of the FCS


Value Added Tax Law

Credit for Output VAT on bad debt

Under the VATL-PD, output VAT on bad debts, treated as deductible expenses for CIT purposes within the due date for the final VAT return of the VAT period within 5 years from the supply date, can be claimed as a credit in the relevant final VAT return. The revised VATL-PD clarifies that output VAT paid for VAT base increased as a result of tax audits by the tax authorities can also be claimed as the credit for output VAT on bad debt if the related receivables are allowed as deductible bad debt expenses for CIT purposes.


National Tax Basic Law

Calculation of interest on tax refund

The tax authority pays interest on tax refunds made due to amended tax returns and the concerned interest has been calculated for the period from the next day of the date (e.g., tax payment date, 30 days after original tax return filing date, etc.), provided in the tax law depending on a type of amended tax returns, to the tax refund date. However, with the revision, initial date for calculation of interest on tax refunds determined through the amended tax returns will be unified as the next day of the filing date of the amended tax returns.

Revisions to Presidential Decree of Tax Laws

Zero rate VAT on management service (Jaebuga-47, 2015.01.15)

The MOSF interprets that management services provided by a domestic company to its second-tier foreign subsidiary would be eligible for zero rate VAT for the VAT purposes if the domestic company receives payments in foreign currency.


VAT exemption on payment guarantee service (Josim2014Seo1156, 2015.01.29)

In relation to the case where the tax authority made a TP adjustment based on the arm’s length price on payment guarantee services provided by a company operating trade and overseas resource development business to an overseas subsidiary and imposed a penalty on underreported zero rate VAT base to the company, the Tax Tribunal ruled that the payment guarantee service is considered as financial services to be classified as VAT exempted services under the VAT law, in which case the penalty on underreported zero rate VAT base should not be levied.

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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