Korean Tax Newsletter (November, 2006)
Revisions to Tax Laws
Proposed Revision to the Local Tax Law (“LTL”) and the Enforcement Decree of LTL
The Ministry of Government Administration and Home Affairs announced proposed revisions to the LTL and the Enforcement Decree of LTL on October 24, 2006 and November 6, 2006, respectively, including the following:
- Introduction of electronic delivery of local tax documents
With the revision, a taxpayer would be able to obtain certain tax documents electronically. Taxpayers can check tax payment or refund notice in the designated network for local tax information run by the local tax authorities while other documents such as guidance for local tax filing can be sent to taxpayers by e-mail. Currently, local tax documents are delivered to taxpayers by personal delivery or registered mail only. Meanwhile, the national tax authorities have utilized electronic mode of communication since 2003.
- Extension of payment due date for local taxes
The proposed revision extends a payment due date for local taxes to 14 days from 7 days after receiving documents (such as a local tax payment notice, a reminder for local tax payment) if such documents are delivered via registered mail after the due date or 7 days or less before the due date.
- Allocation of resident surtax
A company which has its business places in many different cities or districts, a resident surtax, which is 10% of the corporate income tax, is to be allocated to each city or district in proportion to a number of employees and space of buildings including facilities. The revision clarifies that facilities include water or oil tank, silo, storage, water or oil pipelines and electric tower only.
Notice on Interest Rate for Transfer Pricing Adjusted Income
Where transfer pricing (“TP”) adjustment is made to transactions between a foreign related party and a domestic company, interest is to be accrued (for the period from the next day of FYE in which transaction occurred until the date a document confirming the return of TP adjusted income is submitted), at an interest rate to be published by the Commissioner of the National Tax Service (“NTS”), on the TP adjustment that a foreign related party should pay to a domestic company under the International Tax Coordination Law. The interest rate was finally announced to be a 12-month LIBOR (London Inter-bank Offered Rate) of each currency as of the end of each fiscal year immediately preceding the year in which the interest amount should be calculated.
Tax Treaty with Canada to be Revised
The governments of Korea and Canada have been renegotiating the tax treaty for last 2 years and finally signed the revised tax treaty on September 5, 2006. The revised tax treaty is expected to come into on January 1, 2007 after being ratified by a legislative body of each country. The revised tax treaty softens the taxing right of a sourcing country by lowering the marginal withholding tax rates while it has a new provision of limitation of benefits to prevent treaty shopping by third country investors. Details of major changes will be discussed again in the near future when the government ratifies the revised treaty.
Development at Tax Authorities
Income Classification of the Retirement Bonus
The NTS announced on November 2, 2006 that retirement bonus, to be paid to all employees in the specific job category according to a mutual agreement between labor and management shall be treated as retirement income, not earned income. Such classification of retirement bonus income can reduce tax burden of retired employees due to the different method of calculating tax for retirement income.
Recent Tax Rulings and Cases
Income classification of payment for a right to distribute certain software (Seomyun2team-2052, October 13, 2006)
When a domestic company acquires a right to distribute softwares from a foreign company, payment made by the domestic company to the foreign company for such right is not treated as royalty, therefore, not subject to a withholding tax, if i)the softwares are not custom made but standardized, iii) a final consumer downloads and installs the software by obtaining an identification account from the foreign company through the domestic company, and iii) the domestic company pays the foreign company a fixed fee which is not based on the usage of the softwares.
Zero rate VAT (Seomyun3team-2423, October 13, 2006)
Where a domestic business entity renders services eligible for zero rate VAT to a foreign company without a PE in Korea and offset service fee against payables to the foreign company, such provision of service would qualify for a zero rate VAT even though the service fee is not directly paid in Korean Won through a foreign exchange bank.
Foreign tax credit (Seomyun2team-1964, September 29, 2006)
Where a local company provides rental services to a liaison office of a Japanese company and receives rent payment from the Japanese company after deducting certain withholding tax in Japan, such withheld tax can not be claimed as tax credit since the rent is not considered as foreign source income eligible for a foreign tax credit.
Development in other countries
Issuance of FASB Interpretation No. 48 in the U.S.
In June 2006, the Financial Accounting Standards Board of the Financial Accounting Foundation (“FASB”) issued ‘FASB Interpretation No.48: Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109’. This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position in a tax return.
The evaluation of a tax position is a two-step process. The first step is recognition: The enterprise determines whether it is more likely than not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes. The second step is measurement: A tax position that meets the recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement.
Difference between tax positions in a tax return and amounts recognized in the financial statements will generally result in one of the following:
- (a). An increase in a liability for income taxes payable or a reduction of an income tax refund receivable
- (b). A reduction in a deferred tax asset or an increase in a deferred tax liability
- (c). Both (a) and (b)