Korean Tax Newsletter (January, 2012)
Revisions to Korean Tax Laws for 2012
“Revisions to Korean Tax Laws for 2012” were promulgated on 31 December 2011 (1 January 2012 in the case of the revisions to the Individual Income Tax Law) and generally are effective as from 1 January 2012. The major changes are summarized below.
Corporate Income Tax Law
Introduction of additional corporate income tax bracket
Under the revised Corporate Income Tax Law (“CITL”), three corporate income tax brackets apply for fiscal years starting from 1 January 2012:
|* The corporate income tax rates in parentheses include the 10% local income surtax.|
New requirement for application of reduced treaty tax rate
The revised CITL introduces a new rule that requires a foreign company that is a beneficial owner of Korean-source income and that wishes to obtain a reduced tax rate under a relevant tax treaty to submit an application form (to be prescribed in the Presidential Decree of the CITL) to the withholding agent (i.e. the payer of the income) before the income is paid. If the Korean-source income is paid to the beneficial owners through an offshore investment vehicle, the offshore investment vehicle must receive the application form from the beneficial owners and submit a report on the offshore investment vehicle, including a detailed schedule of the beneficial owners.
If the withholding agent is not provided with the application form (or the report of the offshore investment vehicle) from the beneficial owner (or the offshore investment vehicle), or is unable to verify the beneficial owner of the Korean-source income based on the information provided, the withholding agent should withhold tax at the Korean domestic withholding tax rate. The beneficial owner has three years from the end of the month in which tax was withheld to claim a tax refund based on the reduced treaty tax rate if it did not claim the reduced rate at the time of withholding. The new application requirement applies with respect to tax to be withheld on or after 1 July 2012.
Repeal of 50% limitation on indirect foreign tax credit
Previously, a Korean parent company receiving dividend income from a qualifying foreign subsidiary was able to claim an indirect foreign tax credit for foreign tax paid by the subsidiary. If a tax treaty between Korea and the country in which the foreign subsidiary was resident allowed for an indirect foreign tax credit, 100% of the foreign tax could be claimed as an indirect foreign tax credit; otherwise, only 50% of the foreign tax was available for purposes of the indirect foreign tax credit. The amended rules abolish the 50% limitation, so that a full indirect foreign tax credit will be granted regardless of whether a tax treaty provides for it. (The 50% limitation continues to apply, however, to foreign tax paid by second-tier subsidiaries). The change is effective from the fiscal year in which the change was promulgated, i.e. fiscal year 2011.
Exclusion from taxable income of distribution out of excess legal reserves
Under the amended Commercial Code, when a company’s accumulated legal reserves (the sum of capital reserves and earned profit reserves) are greater than 1.5 times the paid-in-capital amount, the excess legal reserves may be distributed in accordance with a resolution of the shareholders’ meeting. The revised CITL prescribes that such distributions of excess legal reserves are to be excluded from taxable income.
Tax-free treatment for downstream merger
To qualify for a tax-free merger, the following conditions must be satisfied: i) the merger is between domestic companies that have operated their businesses for one year or more as of the merger registration date; ii) at least 80% of the merger consideration is distributed as shares in the surviving company and controlling shareholders hold such shares until the end of the fiscal year in which the merger registration takes place; and iii) the merging/surviving company continues to operate the business of the merged/liquidated company until the end of the fiscal year in which the merger registration takes place.
Where a subsidiary company merges with or into its 100% parent company, the upstream merger can qualify for tax-free merger treatment, regardless of whether the above conditions are satisfied. The revised rules extend this exceptional tax-free merger treatment to a downstream merger where a parent company merges with or into its 100%-owned subsidiary.
Introduction of triangular merger
Under the revised CITL, the second condition for qualifying for tax-free merger treatment will be deemed to be satisfied when the shares of a parent company that is a 100% owner of the surviving company on a merger are distributed to the shareholders of the merged company as consideration for the merger. This change accommodates the amended Commercial Code, which now allows for a triangular merger (i.e. where the shares of the parent of the surviving company are distributed as merger consideration to the shareholders of the merged company). This triangular merger rule takes effect for mergers taking place on or after 15 April 2012.
Limitation on use of built-in losses of surviving company in tax-free merger
When a merger is treated as a qualified tax-free merger, any losses on the disposal of assets held by the surviving company or the merged company before the merger (limited to losses incurred in fiscal years ending within five years after the merger registration date) may be offset only against taxable income generated by the relevant business before the merger (in other words, a disposal loss on assets held by the surviving company cannot be used to offset taxable income generated by the business of the merged company, or vice versa). Previously, the CITL stipulated such limitation only with respect to losses on the disposal of assets transferred from the merged company.
Deferral of gains on valuation of inventory
To alleviate any significant increase in the tax burden due to the adoption of K-IFRS, a company that changes its inventory valuation method from the last-in first-out (LIFO) method (which is not available under K-IFRS) to another valuation method (e.g. the weighted average method or the first-in first-out (FIFO) method) will be allowed to defer any inventory valuation gains for tax purposes. Under the revised CITL, the inventory valuation gains resulting from the change of valuation method due to the adoption of K-IFRS will be deferred and recognized equally over five years from the fiscal year following the year in which the K-IFRS is newly adopted. This deferral provision is effective from the fiscal year in which the revised CITL was promulgated (i.e. 2011).
Extension of carryover period for statutory donations
Donation expenses exceeding the statutory limit for deduction may be carried forward for one or five years, depending on the classification of the donations, i.e. one year for “statutory donations” and five years for “designated donations,” respectively. Under the revised CITL, the carryover period for statutory donations is extended to three years (for both companies and individuals).
International Tax Coordination Law
Relaxation of CFC rules on qualified foreign holding company
The International Tax Coordination Law (“ITCL”) provides an exception to the CFC (controlled foreign company) rules with regard to a foreign holding company. Under the exception, the CFC rules are not applied to a qualified foreign holding company that satisfies certain conditions prescribed by the ITCL. One of the conditions was that subsidiaries of the foreign holding company were located in the same region (e.g. the EU, China and Hong Kong) or country as the foreign holding company. If some of the subsidiaries were located in a different country or region and the effective tax rate of the foreign holding company was 15% or less, the CFC rules applied, since the conditions for the exception rule could not be satisfied. In that case, the entire CFC income was deemed to be distributed as dividend income by the foreign holding company to its domestic parent company.
Under the revised rules, even if a foreign holding company has a subsidiary located in a different country or region, the foreign holding company can still qualify for the same region holding company exception if the passive income (i.e. dividend and interest income) derived by the foreign holding company from subsidiaries located in the same country or region as the foreign holding company is 90% or more of the foreign holding company’s total income (excluding income derived from an active business).
Expansion of scope of CFC rules
The direct or indirect shareholding ratio required to constitute a CFC is reduced from 20% to 10%. Previously, where a domestic company held directly or indirectly 20% or more of shares in a foreign company located in a country or region that has an effective tax rate of 15% or less, income of the CFC would be subject to the CFC rules. The direct or indirect shareholding requirement is now reduced to 10%.
Reconciliation of taxable import price with transfer price
New provisions are introduced to alleviate the tax burden on taxpayers arising from a discrepancy between the taxable import price for customs duty purposes and the transfer price for income tax purposes. If the taxable import price for customs duty is different from the transfer price for income tax due to an adjustment made by the Korea Customs Service (KCS) after the relevant income tax return was filed, the taxpayer can file an amended return with the Korean tax authorities within two months of the date the taxpayer becomes aware of the adjustment or receives the notice of the adjustment. The tax authorities should then notify the taxpayer as to whether they will allow an adjustment of the relevant transfer price within two months from the date the amended tax return is filed.
A taxpayer can request a reconciliation between the taxable import price for customs duty purposes and the transfer price for income tax purposes from the MOSF (Ministry of Strategy and Finance) within 30 days of the date the taxpayer receives the notice from the tax authorities. In this case, the MOSF can recommend an adjustment of the price to the tax authorities or the KCS, and should notify the taxpayer of an implementation schedule received from the tax authorities or the KCS within 90 days of the date the request for adjustment was submitted.
Tax Incentive Limitation Law
Changes in tax exemption for foreign investment
Under the revised Tax Incentive Limitation Law (“TILL”), when a foreign-invested company that enjoys the foreign investment tax exemption increases its capital via a stock dividend (which transfers distributable earnings to the statutory capital account), it also may be eligible for the tax exemption for foreign investment, but only according to the same exemption schedule and scheme as the initial foreign investment.
Further, when fixed assets used in a business for which a previous tax exemption period had expired are used in a business newly eligible for the tax exemption based on a new capital increase (“new business of capital increase”), the tax exemption amount will be decreased to the amount multiplied by a specified fixed asset ratio [i.e. the decreased tax exemption amount = original tax exemption amount × (fixed asset amount newly acquired or installed after the registration date of the capital increase / total fixed asset amount in the new business of capital increase)] under the revised TILL.
Investment tax credit for creation of employment
The revised TILL replaces the temporary investment tax credit (TITC) with an employment creation investment tax credit (ECITC). The ECITC rates apply to new investment amounts as follows:
|* Applicable when the number of employees does not decrease from the previous year.
** Capped at (increase in number of employees from previous year × KRW 10, 15 or 20 million).
*** SMA refers to the Seoul Metropolitan Area and SME refers to small and medium-sized enterprises.
Changes in R&D tax credit
The scope of the R&D tax credit is extended to expenditure incurred on the development of new services and service delivery systems. However, the eligibility of such expenditure for the R&D tax credit is limited to that incurred for the self-development of new services and service delivery systems.
The R&D tax credit can be calculated and claimed either on a current year spending basis or on an incremental spending basis, whichever is higher. The revision makes it clear that the incremental spending basis method cannot be selected if no R&D expenditure was incurred in the previous four years.
Further, large companies are now subject to the minimum tax with respect to the qualifying salary costs of researchers that have master or doctorate degrees; previously, the minimum tax did not apply to such costs of large companies.
Interest income derived from foreign currency-denominated bonds
Previously, where a person or an entity other than an individual resident or a domestic company earned interest and associated fee income from i) foreign currency-denominated bonds issued by the government or a domestic corporation; or ii) certificates of foreign currency deposits and foreign currency notes issued by a domestic financial institution for issue or sale in foreign countries, the interest and associated fee income were tax-exempt. The revised TILL abolishes the tax exemption on such interest and fee income earned by a Korean business place or branch of a foreign company. Also, the revised TILL abolishes the tax exemption on interest and fee income on the foreign currency denominated bonds issued in Korea.
Expansion of entities eligible for partnership taxation
The partnership taxation rules apply to an unincorporated association (Johap under the Civil Law), an anonymous unincorporated association (Ikmyong Johap under the Commercial Code), an unlimited liability company (Hapmyong Hoesa or Hapja Hoesa under the Commercial Code) and certain Yuhan Hoesa rendering personal services. As new types of unincorporated entity have been introduced in the Commercial Code, the TILL was revised to include the Hapja Johap as an entity eligible for partnership taxation. In certain respects, Hapja Johap is similar to a Hapja Hoesa; in other respects, it is similar to a U.S. limited partnership. This revision will be effective for applications submitted on or after 15 April 2012.
Change in tax credit for third-party logistics expenditure
Previously, a manufacturing company could claim a tax credit for third-party logistics expenditure at a rate of 3% of the increase in such expenditure over third-party logistics expenditure of the previous year if the third party logistics expenditure ratio (i.e. third party logistics expense / total logistics expense incurred) in each fiscal year was 50% or higher and the third party logistics expenditure ratio of the fiscal year concerned was not less than that of the previous year. If the third party logistics expenditure ratio of the previous year was less than 50%, while the ratio of the current fiscal year exceeded 50%, 3% of the excess third party logistics expenditure amount (i.e., third party logistics expenditure in excess of 50% of total logistics expenditure of the fiscal year) also could be claimed. The revised TILL lowers the third party logistics expenditure threshold ratio from 50% to 30%.
Value Added Tax Law
Repeal of extended VAT filing due date for foreign company
Under the previous VATL, the VAT filing and payment due date for a foreign company (i.e. a Korean branch or permanent establishment of a foreign company) was the 50th day from the end of each calendar quarter. According to the revision, the extended VAT filing and payment due date available only to foreign companies was repealed. Thus, the VAT filing and payment due date will be the 25th day from the end of each calendar quarter for both domestic and foreign companies.
Extension of proxy VAT payment on intangible assets
Before the revision, if VAT-able services were provided by a nonresident or foreign company that did not have a place of business in Korea to a Korean VAT-exempt business, the Korean VAT-exempt business was required to make a “proxy payment” of VAT (or reverse VAT charge) on the services. The revised VAT law extends the proxy VAT payment requirement to the following situations: i) the supply of intangible assets by a nonresident or a foreign company to a Korean VAT-exempt business; and ii) the provision of services or the supply of intangible assets to a Korean VAT-able business that is not eligible for an input VAT credit with respect to such services or intangibles.
Amended VAT invoicing date
Before the revision, where a supply of goods or services was cancelled due to the cancellation of the contract, an amended VAT invoice had to be issued based on the original transaction date and an amended VAT return filed. To reduce the additional filing burden, a taxpayer will issue an amended VAT invoice based on the cancellation date of the contract under the revised VAT law; hence, it is no longer necessary to file an amended VAT return.
Imposition of VAT on free real estate rental services to related parties
Services provided free of charge are not subject to VAT, while services provided to related parties at a price lower than fair market value are subject to VAT at the fair market value price. Under the revised VAT law, the provision of real estate rental services to related parties free of charge is now subject to VAT.
Individual Income Tax Law
Introduction of new top marginal individual income tax (IIT) rate
A top marginal tax rate of 38% is introduced for a tax base exceeding KRW 300 million. The applicable tax brackets for the individual income tax are as follows:
|* The IIT rates in parenthesis include the 10% local income surtax.|
Limitation on retirement income of directors
To prevent tax avoidance through the payment of excessive retirement income, which is subject to lower taxes than salary income, retirement income paid to directors under the revised IITL is limited to the amount calculated as follows: (the three-year average salary income before retirement x 10% x years of employment). Any excess is treated as salary income. It should be noted, however, that directors’ retirement income accrued up to 31 December 2011 is not subject to the new limitation.
National Tax Basic Law
Definition of "related party"
The revised National Tax Basic Law (“NTBL”) introduced a definition of “related party” to standardize the meaning of related parties among the different tax laws. A related party is defined as a person who has one of the following relationships with a taxpayer: i) kinship; ii) an economic relationship, such as the relationship of directors and employees and iii) a controlling relationship, such as the relationship of shareholders. The detailed scope of the definition will be prescribed in the Presidential Decree of the NTBL. Each tax law may cite the definition in the NTBL and establish an additional regulation, if necessary.
If you have any questions concerning the items in this newsletter, please contact your tax advisor at Deloitte Anjin LLC or the following tax professionals.