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Korean Tax Newsletter (June, 2006)


Revisions to Tax Laws

On May 24, 2006, the Ministry of Finance and Economy (“MOFE”) announced proposed revisions to the Presidential Decree of International Tax Coordination Law (“PD-ITCL”). The main proposed revisions, primarily focused on transfer pricing area, are summarized below:

Report of Transfer Pricing (“TP”) Method

With the revision, taxpayers who transact business with foreign related parties would not be required to report a TP method when filing a tax return if the amount of transaction with the related parties does not exceed 5 billion won (0.5 billion won in case of service transaction). Prior to the revision, taxpayers who had cross-border transactions with foreign related parties were required to report the TP method with a tax return regardless of the transaction amount.

TP method for intangible properties

The revision introduces guideline factors that taxpayers should consider in determining arm’s length price with regard to intangible properties (IP), such as royalty payments for use of technology:

i)Expected benefits of the IP calculated by net present value method;
ii)Whether IP rights are exercised in a restricted area;
iii)Whether products produced based the IP rights are exported;
iv)Whether the use of IP rights is exclusive;
v)Whether the IP rights are renewable;
vi)Terms and conditions of an IP agreement;
vii)Costs in developing the IP; and

Arm’s length price for intra-group services

The proposed revision also lays out specific conditions that taxpayers should satisfy so that fees for qualified intra-group services such as business management, financial consulting, or technical supporting services are considered to be at arm’s length price (including allocation of fees paid outsourced services):

i)Services are actually provided in accordance with an agreement;
ii)Service recipients expect to derive benefits (economically or business wise) from the services;
iii)Service fees are determined at an arm’s length price; and
iv)Documentation for i), ii) and iii) should be in place.

The following services are not qualified intra-group services, therefore are not deductible expense:

i)Shareholder activities such as shareholders’ meeting, issuance of shares, internal audit, reporting to shareholders, or preparation of financial statements in accordance with accounting principals in the country where the shareholders reside;
ii)Duplicate activities which are performed by a 3rd party or the service recipient already. (There is an exception for duplicate services provided temporarily due to reasonable cause such as restructuring.);
iii)Activities which do not give direct benefits to service recipients, but only incidental benefits.

Development at Tax Authorities

MOFE plans to promote Exchange of Information with tax haven countries.

The MOFE proposed certain tax haven countries, such as Bermuda, Cayman Islands or Virgin Island, for exchange of information system with a goal to enter into at least one agreement by the end of this year. Initially, Bermuda reacted positively to the proposal and will review such exchange of information.

List of tax haven countries applicable to new withholding regime

The MOFE announced a list of countries/jurisdictions that the new withholding regime is applicable so that the Korean tax authority withholds at 27.5% first and taxpayers request for a refund upon proving the beneficial ownership of the income. Initially, the MOFE designated Labuan as the only jurisdiction to be on the list.

Recent Tax Ruling and Cases

Scope of non-taxable earned income (Seomyun1team-456, 04.10.2006)

Relocation expenses (such as passport/visa fees, fees for storage household goods, language education cost, individual income tax return preparation fees) for a foreign employee and/or his/her family paid by a domestic company is regarded as taxable earned income of the foreign employee, not a reimbursement of cost of non-taxable income listed in the Presidential Decree of Individual Income Tax Law.

Exercise of stock option after retirement (Seomyun2team-639, 04.19.2006)

In case where a domestic company grants stock options to a German resident who is a member of board of directors of the company, income derived from exercise of such stock option is classified as director’s fee, not other income, even though he/she exercises stock option after retirement. Director’s fee is subject to Korean withholding tax while other income is exempt from the Korean withholding tax under the Korea-Germany tax treaty.

Recognition of income from exercise of a right to receive stocks conditional stock (Seomyun2team-928, 2006. 05. 24)

In case where a foreign employee who obtained rights to receive stocks while working for a foreign parent company actually exercises the rights in Korea, such exercise can result in Korean source income on the day the foreign employee received the stocks by exercising the rights.

Prohibition of duplicate tax audit (Daebub 2004du12070, 2006. 06. 02)

The Supreme Court of Korea ruled that duplicate tax audits performed by the tax authorities for the same fiscal year with same tax items without clear evidence of tax evasion by taxpayers is illegal, therefore, taxpayers are not obligated to pay the tax assessed by the second duplicate audit.


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