Korean Tax newsletter (January, 2010)
Revisions to Tax Laws
Revisions to the Corporate Income Tax Law (CITL), Individual Income Tax Law (IITL), Tax Incentive Limitation Law (TILL), Value Added Tax Law (VATL) and Local Tax Law (LTL), etc. generally became effective on 1 January 2010. Some of the changes to these laws were addressed in our previous newsletters, but there are also other items which were amended or added during the legislative process. This newsletter looks at some of the major revisions to the tax laws in 2010.
Corporate Income Tax Law
Deferral of reduced Corporate Income Tax (CIT) rate
According to the 2008 revisions to the CITL, the CIT rate (exclusive of resident surtax) for FY 2010 and onwards was planned to be reduced from 11% to 10% for a tax base up to KRW 200 million and from 22% to 20% for a tax base over KRW 200 million. The recent changes to the CITL, however, postpone the application of the reduced CIT rate for a tax base exceeding KRW 200 million until FY 2011. The applicable CIT rates are as follows:
|* The rates in parenthesis include the 10% resident surtax.
Extension of due date for CIT filing and payment
The revised CITL provides that a company subject to a mandatory extemal audit under the Act on External Audits of Stock Companies can request to file and pay CIT within four months after the fiscal year end (i.e. a one-month extension for filing and payment). However, interest at 0.03% per day will be imposed during the extended period. A stock company will be subject to the mandatory external audit requirement if:
- The company is listed on the Korean stock exchange;
- Its total assets are KRW 10 billion or more;
- Its total assets are KRW 7 billion or more and its total liabilities are KRW 7 billion or more; or
- Its total assets are KRW 7 billion or more and its employee headcount is 300 or more as of the most recent year-end.
Requirements for indirect foreign tax credit eased
A Korean parent company can claim an indirect foreign tax credit on underlying taxes of a qualified foreign subsidiary in proportion to the dividend amount received from the foreign subsidiary, provided the Korean parent holds at least a certain percentage of the voting shares of the foreign subsidiary for six months or more as of the dividend resolution date. The revised CITL reduces the ownership threshold to claim the indirect foreign tax credit from 20% to 10%.
Withholding tax on interest on bonds received by financial companies
The revised CITL provides that, as from 1 January 2010, interest income received by a financial institution on bonds/securities issued by the government or a domestic company, certificates of deposit, beneficiary certificates of investment trusts, notes, etc. are subject to withholding tax. Previously, this income was exempt from withholding tax.
New M&A tax rules
A number of changes have been made to the M&A tax rules, which will be effective as from 1 July 2010. Additional details and information on the new rules will be provided by the Presidential Decree (PD) of the CITL, which has not yet been promulgated.
Requirements for qualified tax-free merger
Under the new rules, the minimum ratio of the total value of stock issued by the surviving company in a merger over the total merger consideration received by shareholders of the merged company to qualify as a tax-free merger is reduced from 95% to 80%. However, the allocation of newly issued stock among the shareholders of the merged company must be made in a prescribed manner and certain shareholders of the merged company must hold the stock received until the end of the fiscal year in which the merger registration date falls. Details of these additional requirements have not yet been announced.
The other two requirements for a qualified tax-free merger have not been revised. Those requirements are:
- The merger is between domestic companies that have operated their businesses for one year or more as of the merger registration date; and
- The surviving company continues to operate the business of the merged company until the last day of the fiscal year in which the merger registration date falls.
Tax implications for merged company
Under the revised tax laws, a merger is basically regarded as a sales transaction triggering capital gain (loss) to be included in the taxable income of the merged company for the fiscal year to which the merger registration date belongs, rather than liquidation income for the merged company. The capital gain (loss) will be calculated by deducting the net book value of the merged company as of the merger registration date from the total merger consideration received from the surviving company.
If a transaction qualifies as a tax-free merger or if the merger is with a wholly-owned subsidiary, the merger consideration will be deemed to be the same as the net book value of the merged company as of the merger registration date. As a result, there would be no capital gain (loss) to the merged company.
Tax implications for surviving company
Under the revised tax laws, a surviving company will be deemed to purchase the assets of the merged company at fair value as of the merger registration date. In such a case, if the merger consideration is different from the total fair value of the merged company’s assets as of the merger registration date, the difference will be treated as goodwill or negative goodwill. Goodwill and negative goodwill will be amortized over five years from the merger registration date for tax purposes.
If the transaction qualifies as a tax-free merger or if the merger is with a wholly-owned subsidiary, the merger consideration will be deemed to be the same as the net book value of the merged company as of the merger registration date, resulting in no goodwill or negative goodwill and no step-up in the tax basis of the assets transferred for tax purposes.
If one of the following events takes place within a maximum period of three years, the surviving company may need to recognize the difference between the fair value and the book value, if positive, of the assets transferred from the merged company, as taxable income of the surviving company. In addition, the surviving company may need to recapture any utilized tax losses that were carried over from the merged entity. The events are as follows:
- The surviving company ceases to operate the historic business of the merged company; or
- Certain shareholders of the merged company dispose of the surviving company’s shares received as consideration for the merger.
Furthermore, any loss incurred on the disposal of assets of the business transferred from the merged company in fiscal years ending within five years from the merger registration date will only be deductible from taxable income derived from the business transferred from the merged company.
Individual Income Tax Law
Deferral of reduced Individual Income Tax (IIT) rates
According to the 2008 revisions to the IITL, the IIT rates for FY2010 and onwards were planned to be reduced, but the recent revisions postpone the application of the reduced rate for a tax base over KRW 88 million until FY2011. The applicable IIT rates for each tax bracket are as follows:
|* The IIT rates in parenthesis include the 10% resident surtax.
Earned income deduction and earned income tax credit
The earned income deduction rate for annual salary income exceeding KRW 80 million was planned to be lowered to 3% (and 1% for income exceeding KRW 100 million) and the earned income tax credit for annual salary income over KRW 100 million was planned to be abolished, with effect from FY 2010. However, under the promulgated IITL, both the earned income deduction rate and earned income tax credit will remain unchanged until 31 December 2011.
IIT on housing rental deposits
If a Korean resident owns three or more houses and the total amount of key money deposits received from lessees exceeds KRW 300 million, a certain amount, i.e. the amount equivalent to interest for the key money deposits (calculated in accordance with the PD of the IITL but not yet issued), will be added to the resident’s taxable income for each taxable year. This rule is effective as from 1 January 2011.
Tax Incentives Limitation Law
Alternative Minimum Tax (AMT) rates
The AMT rate for companies other than small and medium-sized companies (SMCs) was proposed to be partially increased as from FY 2010. Under the promulgated TILL, however, the AMT rate applicable for a tax base exceeding KRW 10 billion will remain unchanged. The AMT rates are as follows:
|* The rates in parenthesis include the 10% resident surtax.
The reduced AMT rates for SMCs aiso remain unchanged.
(i.e. 8% in RY 2009 and 7% as from FY2010).
Temporary Investment Tax Credit (TITC)
The TITC was initially proposed to be terminated as from FY 2010. However, under the revised TILL, the termination of the TITC for investments made in areas other than the Seoul Metropolitan Area (SMA) is postponed until 31 December 2010. Further, the TITC rate applicable for areas other than SMA is reduced from 10% to 7% of the amount invested in the fiscal year. An additional 10% TITC for the amount of new investment exceeding the average investment amounts over previous three years is no longer available.
Tax incentives for comprehensive asset transfers
According to the changes to the TILL, where a domestic company (AA) transfers nearly all of its assets to another domestic company (BB) in exchange for shares in BB and then is liquidated, both domestic companies can now enjoy various tax incentives, such as a deferral of tax on capital gains from the asset transfer, liquidation income and deemed dividend income of shareholders, and an exemption from Securities Transaction Tax, Registration Tax and Acquisition Tax, etc., if they meet the following requirments:
- AA and BB have been operating business continuously for one year or more as at the comprehensive asset transfer date;
- The value of voting shares issued by BB represents 95% or more of the total transfer consideration and is owned by AA or AA’s shareholders until the end of the fiscal year to which the comprehensive asset transfer date belongs; and
- BB continues to conduct the business taken over from AA until the end of the fiscal year to which the comprehensive asset transfer date belongs.
Details of the tax incentives are to be provided by the new PD of the TILL. These changes will apply to comprehensive asset transfers taking place on or after 1 July 2010.
Tax incentives for comprehensive stock transfers/exchanges
Where a domestic company (AA) becomes a wholly-owned subsidiary of another domestic company (BB) through a qualified comprehensive stock transfer/exchange under article 360-2/ 360-15 of the Commercial Code and meets the following requirements, various tax incentives will be granted, such as a deferral of tax on capital gains from the stock transfer/exchange and an exemption from Securities Transaction Tax, Acquisition Tax, etc.:
- AA and BB have been operating business continuously for one year or more as at the comprehensive stock transfer/exchange date;
- The value of BB's shares received by AA's shareholders are at least 80% of the total stock transfer/exchange consideration where the transfer/exchange consideration is received by AA's shareholders, and BB and certain AA's shareholders hold the shares acquired through the comprehensive stock transfer/exchange until the end of the fiscal year to which the comprehensive stock transfer/exchange date belongs; and
- AA continues to operate its business until the end of the fiscal year to which the comprehensive stock transfer/exchange date belongs.
Details of the tax incentives are to be provided by the new PD of the TILL. This change will apply to comprehensive stock transfers or exchanges made on or after 1 July 2010.
Investment tax credit for energy saving facilities
The promulgated TILL extends the sunset clause for an investment tax credit for energy saving facilities to 31 December 2011. Hence,a company that makes an investment in certain specified energy saving facilities can continue to claim a tax credit of 20% of the investment amount, with a maximum credit cap of 30% of the income tax payable for the fiscal year.
R&D tax credit
The tax credit rates for R&D expenses incurred with respect to the New Growth Engine Industry or Original Source Technology are increased to 20% (and 30% for SMCs). The R&D tax credit rates under the revised TILL are as follows:
|* R&D expenses of the current year exceeding the average R&D expenses for the prior four years.
Tax incentives for foreign engineers
Fifty percent of the salary income received by certain foreign engineers in Korea is exempt from IIT for two years and the sunset clause for this incentive is extended to 31 December 2011.
Tax incentives for foreign empolyees
One of the benefits for foreign employees working in Korea (i.e. an income exclusion equal to 30% of total salary) is no longer available as from 1 January 2010. However, foreign employees can opt to continue to apply a flat tax rate of 15% (16.5%, including the 10% resident surtax) to their salay income until 31 December 2012.
Tax exemption on royalty payments received by nonresidents
Previously, royalties received by nonresidents that had introduced certain high-technologies in Korea were exempt from CIT or IIT for five years from the date of the first royalty payment. The tax exemption is abolished as from 1 January 2010.
Value Added Tax Law
Postponement of mandatory issuance of Electronic Tax Invoice (ETI) for corporate taxpayers
According to the 2008 revisions to the VATL, as from 1 January 2010, corporate taxpayers will be subject to a penalty for failure to issue the mandatory ETI and transmit details of the ETI to the National Tax Service (NTS). The penalty is 2%/1% of the invoice amount that is not in compliance with the ETI issuance and transmission requirements. However, the revised VATL provides that the mandatory ETI issuance requirement is postponed, and for 2010, corporate taxpayers can choose to issue paper tax invoices or ETIs. Thus, under the revised VATL, the penalty tax will not be imposed on corporate taxpayers for no-issuance/no-transmission or late transmission of ETIs until 31 December 2010, and reduced penalty tax rates for no-transmission and delayed transmission will be applied from 1 January 2011 to 31 December 2012 as follows:
|* Delayed transmission is where a taxpayer does not transmit the ETI issuance details to the NTS within the statutory due date (i.e. the 15th day of the month following the ETI issuance date) but transmits them before the 15th day of the month following the half calendar year (i.e. taxable period for VAT) in which the ETI issuance date falls.
Aggregated VAT payment by principal place of business
Prior to the revision, where a taxpayer that has two or more places of business submits a request to the tax office to make an aggregated VAT payment to the district tax office in which the principal business place is located and obtains approval from the tax office, the taxpayer can make a consolidated payment of the VAT to be paid by each place of business to the tax office where the principal business is located. The revisions to the VATL remove the requirement to obtain approval from the tax office to make a consolidated payment.
Local Tax Law and Presidential Decree of Local Tax Law
Triple Registration Tax on acquisition of dormant company
Under the LTL, a company incorporated in the SMA is subject to a registration tax on an increase in capital or acquisition of real estate made within five years of its incorporation at a rate of 1.44% or 7.2%, which is three times the normal tax rate (i.e. 0.48% or 2.4%).
According to changes to the LTL, the acquisition of a dormant status company will be viewed as the establishment of a new company. Therefore, where a company that acquires another company that had existed within the SMA but was in a dormant status makes a capital increase or acquires real estate through the newly acquired dormant company within five years of the acquisition of that dormant company, the capital increase or acquisition of real estate will be subject to the triple registration tax. The following is a list of dormant companies under the revised PD of the LTL whose acquisition will be regarded as an incorporation of a new company for registration tax purposes:
- A dissolved company or a deemed dissolved company under the Commercial Code;
- A closed company under article 10 of the PD of the VATL;
- A company that revives through a court registration of a (deemed) dissolved company within one year before the acquisition date;
- A company that files a business registration as a closed company to the tax office within one year before the acquisition date; or
- A company that has not operated its business for two years or more before the acquisition date and has changed 50% or more of its directors within one year before or after the acquisition date.
The revision takes effect 1 January 2010.
Adoption of the General Company Accounting Standards
The Financial Service Commission approved the General Company Accounting Standards (General Standards) on 29 December 2009. The General Standards must be applied to unlisted companies that do not apply the Korea Adopted International Financial Reporting Standards (“K-IFRS”), from fiscal years beginning on or after 1 January 2011. The key aspects of the General Standards that differ from current Korean GAAP include the following:
- The statement of disposition of retained earnings is excluded from the financial statements and can be disclosed in the notes to the financial statements when required by relevant laws such as the Commercial Code.
- The cost model can be applied for companies that have applied the revaluation model for tangible fixed assets at the time of initial application of the General Standards.
- A change in depreciation method for tangible fixed assets will be regarded as a change of accounting estimation, such that the effect of the change will be accounted for prospectively.
- The standard costing method for inventory valuation will be permitted, provided the difference from results of actual costing methods is not material.
- Only the purchase accounting method for business combination will be allowed. The interest pooling method will no longer be applied.
The General Standards also differ from K-IFRS as follows:
- The LIFO method for inventory valuation will be permitted, whereas it is not permitted under K-IFRS.
- Hybrid instruments, such as redeemable preferred shares, will be classified based on legal classification (i.e. redeemable preferred shares are equities), whereas they are classified based on economic substance under K-IFRS (i.e. redeemable preferred shares are debts).
- Revaluation of intangible assets is not permitted, whereas it is permitted under K-IFRS.
- Goodwill can be amortized equally over a certain period, whereas equal amortization of goodwill is not permitted; instead, only impairment loss of goodwill based on the impairment test is permitted for goodwill under K-IFRS.
Developments at Tax Authorities
Horizontal Compliance System (HCS)
On 13 November 2009, the NTS announced that a trial of the HCS would operate from 1 November 2009 to 31 December 2010. The HCS is designed to assist taxpayers to improve transparency management and timely settlement of tax issues by meeting with the NTS on a regular or as-needed basis under a “Compliance Agreement” concluded between the NTS and a taxpayer that has implemented a proper internal tax control system.
Tax matters related to all national taxes (including corporate income tax, VAT and withholding tax) covered by the Agreement would fall within the scope of the administration of a dedicated team within the NTS which will be comprised of five officials from the Seoul Regional Tax Office and three officials from the Jungbu Regional Tax Office. In the event of conflicting opinions or complicated tax issues, the NTS will provide support to the taxpayer in resolving the issues through the Advance Ruling System or a Request for an Interpretation of the Tax Law.
Fifteen companies with gross revenue of more than KRW 100 billion, but less than KRW 500 billion, were selected out of 40 applicants to participate in the trial. According to the recent announcement of the NTS, it will review and analyze the trial results and reflect those results in the actual implementation scheduled from 2011, e.g. by increasing the number of companies concluding an Agreement with NTS, granting legal binding effect to responses of the NTS on tax issues in dispute, etc.
Advance Pricing Agreement with Chinese Tax Authorities
On 3 November 2009, the Commissioner of the NTS and its Chinese counterpart at the State Administration of Taxation (SAT) signed an advance pricing agreement (APA) relating to a Korean company that has business operations in the Chinese market. The APA provides that there will be no transfer pricing tax audits of the Korean company during the period stipulated by the agreement.
This APA represents the fifth such agreement between the NTS and the SAT since 2007; all of the APAs are expected to facilitate subsequent agreements with respect to future APA requests made by other Korean companies having business operations in China and, therefore, mitigate the burden associated with tax audits on transfer pricing issues.
Offshore Tax Evasion Inspection Center
On 19 November 2009, the NTS announced that it launched the Center for the Inspection of Offshore Tax Evasion to prevent tax evasion through international transactions. Due to its extensive scope of operations (e.g. information collection, international cooperation, investigation assistance, etc.), the center was established as a separate division, and includes 15 members in three teams under the direct supervision of the Deputy Commissioner of the NTS. The center will integrate the existing task force team that has been responsible for the investigation of overseas concealed property and will recruit more professionals with specialized skills and experience. The major tasks of the center include the following:
- Recruiting and managing personnel for the collection of domestic and overseas information;
- Collecting and analyzing financial databases and released information relevant to domestic and overseas companies and real estate;
- Analyzing suspicious cases of overseas property concealment or income tax evasion and providing investigation assistance on such cases;
- Expanding the information exchange network with foreign tax authorities; and
- Performing case studies on aggressive tax planning and establishing an international cooperation system to effectively deal with such tax planning.
Agreenment between Korea and Colombia for new tax treaty
On 27 November 2009, the Ministry of Strategy and Finance (MOSF) announced that a tax treaty between Korea and Colombia has been agreed upon. The main provisions of the tax treaty are as follows:
- Permanent establishment (PE) status of a construction site, etc.: A construction site will constitute a PE if it lasts more than six months.
- Withholding tax rates for passive income
- Dividend: 5%, 10% or 15%
- Interest: 10%
- Royalties: 10%
- Capital gains on the transfer of shares: Taxed in the resident country only; however, if the shareholding ratio is 25% or more, the capital gains may be taxed in the source country.
The treaty contains the limitation on benefits provision and a provision on the exchange of information, etc.
The treaty will enter into force after both countries complete their ratification procedures.
Recent tax rulings and cases
Input VAT on rental of non-operating passenger vehicles (Jaebuga-704, 2009.10.22)
Under the revised VATL effective from 1 January 2008, input VAT on the “purchase, rent and maintenance” of non-operating passenger vehicles may not be credited against output VAT. Before this revision, the VATL provided that input VAT on the “purchase and maintenance” of non-operating passenger vehicles was non-recoverable, and the Basic Interpretation of the VAT Law stated that input VAT on the “rent” of non-operating passenger vehicles also was not recoverable.
The Supreme Court ruled that the category “purchase and maintenance” could not be interpreted broadly to include “rent” and, therefore, the recovery of input VAT on the rental of non-operating passenger vehicles should be permitted [Daebup2006Du10559, 2006.08.25]. Accordingly, the Ministry of Strategy and Finance has issued a new ruling confirming that input VAT credits can be claimed on the rental of non-operating passenger vehicles incurred before 31 December 2007.
Retirement allowance for directors (Beobin-1226, 2009.11.5.)
Under the CITL, retirement allowances paid to directors pursuant to a company’s articles of incorporation (AOI) or retirement allowance policy established according to the AOI are deductible expenses for tax purposes. However, where the AOI authorizes the board of directors to establish an internal policy governing retirement allowances for directors but the internal policy is adopted by the board of directors on a temporary basis, retirement allowances paid to directors according to the internal policy are deductible only up to the tax limit prescribed in the CITL (The deduction limit is calculated by multiplying the amount corresponding to 10% of the total salaries paid to the director in his/her final year of employment by the total number of years of services).
No penalties on issuance of VAT invoice for non-VAT able transaction (Buga-1585, 2009.11.3.)
Where a Korean company A provides goods to another Korean company B, but the physical purchase and delivery of the goods take place in a foreign country, the transaction for the sale of the goods made overseas would not be subject to Korean VAT. Even if A issued a VAT invoice to B on this non-VATable transaction and details of the VAT invoice were reported in the VAT return of A and B, no penalties would be imposed.
Indirect foreign tax credit for Private Equity Fund (PEF) that elects partnership taxation (Kookjesewon-2, 2010.01.05.)
If a domestic PEF under the Capital Market and Financial Investment Business Act, which elects partnership taxation under the TILL, owns a subsidiary (Special Purpose Company) incorporated in Canada, the indirect foreign tax credit amount the PEF can claim on underlying taxes of the subsidiary is to be calculated by regarding the PEF as one domestic company and subsequently allocated to its corporate partners in proportion to the pre-determined distribution ratio.
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:
|Seung Chan Park
+82 (2) 6676-2422
|Young Pil Kim
+82 (2) 6676-2432
|Seong Ran Hong
+82 (2) 6676-2442