Korean Tax Newsletter (July, 2015)
Korean Tax Newsletter is a monthly publication of Deloitte Anjin LLC. We hope you will find useful information in this newsletter.
Revisions to the Presidential Decree of Personal Income Tax Law (“PITL-PD”)
Selection of monthly withholding tax (“WHT”) amount on earned income
From July 1, 2015, taxpayers are entitled to select monthly WHT amount on their earned income. Under the previous PITL-PD, the monthly WHT amount on the earned income, which varies depending on monthly salary amount and number of dependents as specified in the simplified WHT table for earned income, was equally applied to all earned income taxpayers. With the revision, the taxpayers can choose 80% or 120% of the monthly WHT amount in the simplified WHT table for earned income by submitting an application for adjustment of WHT amount to a withholding agent before the payment date of earned income for the month in which the adjusted WHT applies.
Once the taxpayers select the ratio (i.e., 80% or 120%), the selected ratio should continue to be applied to the earned income paid from the application date until the end of the concerned tax year.
If the application for the selection is not made, the WHT amount in the simplified WHT table applies.
Revisions to the Tax Law
Foreign sourced income in calculating a foreign tax credit (“FTC”) limitation
(Seomyun Bupryung Kuk-jo – 22495, 2015.06.25)
The National Tax Service (“NTS”) has issued a tax ruling on whether payment guarantee fees added in taxable income through transfer pricing (“TP”) adjustments can be included in a foreign sourced income in calculating FTC limitation (i.e., computed corporate income tax (“CIT”) × foreign sourced income / CIT base).
In this ruling case, a domestic company has provided payment guarantee services to an overseas subsidiary for borrowing from a foreign bank, while the domestic company has received no fees from the overseas subsidiary and paid no taxes overseas in relation to the payment guarantee services. The NTS has interpreted that the payment guarantee fees added in the taxable income through the TP adjustments should be included in the foreign sourced income in calculating the FTC limitation.
Deductible expenses for calculation of personal service income
(Seomyun Bupryung Kuk-jo-0079, 2015.06.26)
Concerning the case where a foreign airline company, who seconded a flight attendant to a domestic airline company for over 1 year and received service fees subject to a Korean WHT at 22%, files a personal service income tax return based on tax base calculated after deducting relevant expenses from the service fees and the progressive CIT rates (i.e., 11% for income up to KRW 200 million, 22% for income above KRW 200 million up to KRW 20 billion, and 24.2% thereafter) under the special taxation system for personal service income of a foreign company in the Corporate Income Tax Law (“CITL”), the NTS has interpreted that deductible expenses are limited to expenses incurred in relation to the stay of the flight attendant in Korea such as airfare, lodging charge and meal expenses paid by the service recipient (i.e. the domestic airline company) directly to an airline, lodging and restaurant business operators only, and salary costs paid to the flight attendant would not be allowed as the deductible expenses for personal service income tax purposes.
The NTS also ruled that a taxation period for the personal service income tax return should be determined based on general rules for a fiscal year of a foreign company under the CITL (i.e., the reported fiscal year, but it cannot exceed one year. In case of no reporting, it is deemed to be a calendar year). In addition, an amended tax return filing is not allowed if the original personal service income tax return was not duly filed within the due date (i.e., three months after completion of the personal services in Korea) under the CITL.
WHT rate on dividends paid to German SPCs (Supreme Court 2013 du 7704, 2015.05.28)
The Supreme Court has rendered a decision on the beneficial owner of dividends and application of reduced WHT rates under the Korea-Germany tax treaty (“Treaty”).
In this case, a German partnership fund has established two limited liability companies in Germany (“German SPCs”) to acquire 100% interest in a Korean company owning a building in Korea (50% interest for each German SPC, respectively). The Korean company applies 5% WHT to dividends paid to the German SPCs. The 5% WHT applies when the beneficial owner of the dividends is a company holding directly at least 25% of the capital of the Korean company paying the dividends under the Treaty (in all other cases, 15% WHT rate is applied on dividends under the Treaty).
The Korean tax authority asserted that the beneficial owner of the dividend income is the German partnership fund and the dividend income should be subject to the Korean WHT at 27.5%, which was applicable at the time of the dividend payment under the previous CITL, since the German SPCs were established for treaty shopping purposes in which case the reduced WHT rate shall not apply under the anti-avoidance provision in the Treaty.
The Supreme Court upheld the Korean tax authority’s decision that the beneficial owner of the dividends is the German partnership fund rather than the German SPCs considering the facts, among others, that i) the German SPCs were established to avoid deemed acquisition tax on the building acquisition in Korea; and ii) the German SPCs did not have their own ability (e.g., manpower, investment funds, etc.) to control or manage the investment in the Korean company and the dividend income.
With regard to the applicable WHT rate, the Supreme Court ruled that the German partnership fund, which is a ‘Fiscally Transparent Entity’, is not comprehensively liable to tax under the German tax laws and thus, cannot be treated as a German tax resident eligible for the Treaty benefits on the basis that the determination of the German partnership fund as a company under the Korean tax laws does not necessarily mean that it can be a tax resident eligible for treaty benefits, since the determination of a tax resident should be made separately based on the relevant tax treaty. The Treaty does not provide any special rule for the ‘Fiscally Transparent Entity’. The Supreme Court further provides that, once income is determined to be attributed to a fiscally transparent entity under the source country domestic tax laws, the tax treaties between income source country and tax resident countries of partners of the fiscally transparent entity cannot be simply applied by ignoring the determination of such income owner.
The Supreme Court concluded that i) the 5% WHT cannot be applied as the German partnership fund is not viewed as a company under the Treaty; and ii) the 15% WHT under the Treaty applies only to the proportion of partners of the German partnership fund who are comprehensively liable to tax in Germany. (the Supreme Court viewed that it is reasonable to regard the German partnership fund as a German tax resident only to such a proportion, because application of domestic tax laws without limitation due to treatment of a fiscally transparent entity is not in line with the purpose of double tax relief intended in the Treaty by both Contracting States.)
Under this Supreme Court judgment, benefits of the look through approach commonly used in practice may not be possible, when a fiscally transparent entity is regarded as an actual income owner under the Korean tax laws and partners of the fiscally transparent entity are a tax resident in other countries than the country of the fiscally transparent entity.
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.