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Korean Tax Newsletter (October, 2006)


Revisions to Tax Laws

Comprehensive Plans For Improvement of Business Environment

On September 28, 2006, the Ministry of Finance and Economy ("MOFE") announced its plans would include revisions or changes of many existing laws including the tax laws with an aim to have such changes/revisions take place before 2008 after the necessary legislative procedure.

  • Determination of the Range of Market Price
    Under the current anti-avoidance regime in the Corporate Income Tax Law ("CITL"), transactions between the related parties are to be at an arm's length price or interest rate (or market price) and the market price is defined to be the price that a third party would transact or prices/rates published by the government. With the changes, the MOFE would allow a range of market price (rather than a single market price) and the use of a weighted average borrowing interest rate of a taxpayer.
  • Harmonization of Tax and Financial Accounting
    The MOFE is also to change certain tax laws to reflect the changes made to the Korea Generally Accepted Accounting Principles ("KGA AP") so that there is less discrepancy between tax accounting and financial accounting. for example, the tax law would change to reflect the newly changed classification of lease assets in the KGAAP. Another example would be to treat document against acceptance ("D/A interest") and shipper's usance interest expense as deductible expense rather than as a part of acquisition cost.
  • Entertainment expense with Advertising Purposes
    Currently, expense incurred for sales promotion or provision of samples to a specific group of people is regarded as entertainment expense subject to a statutory deduction limit. Excess entertainment expense is disallowed. The contemplated changes would allow such entertainment expense with element of advertising or sales promotion to be deductible expense. For example, advertising expense within the limit of 30,000 won per person or cost of sample production would become deductible expense.
  • Exclusion of Sales Discount from VAT Tax Base
    The contemplated changes to the VAT Law would exclude sales discount from VAT base in order to alleviate taxpayers' VAT burden.

Development at Tax Authorities

Extension of tax audit release

The National Tax Services ("NTS") has announced that where a company is granted a faithful taxpayer status after a tax audit, the taxpayer would be exempted from a tax audit for a period of five years from the year in which the tax audit was conducted. This represents two additional years from a previous maximum three year exemption.

  • Establishment of an Advisory Committee for Selection of Tax Audit Targets
    The NTS has set up an Advisory Committee for Selection of Tax Audit Target Companies ("the Committee") in order to promote more rational selection of tax audit target companies. The Committee consists of 4 NTS officials and 5 independent individuals (such as CPAs, licensed tax accountants, professors, lawyers or tax researchers). The Committee recently had its first meeting in which the below issues were discussed:
    • Corporate taxpayers : The Committee discussed that different criteria should apply to different industries under certain economic conditions in selecting audit targets. For example, enhance audits on those businesses that have higher possibility of tax evasion.
    • Individual taxpayers : Individual targets should be selected randomly based on electronic sampling in order to encourage voluntary reporting and filing.

Recent Tax Rulings and Cases

Preferential Capital Gains Tax Rate upon Transfer of Small & Medium Sized Enterprise (Seomyun5team-145, September 15, 2006)

When a resident individual shareholder transfers stocks of a Small & Medium Sized Enterprise ("SME"), preferential capital gains tax rate is available. The Enforcement Decree of Tax Incentive Limitation Law ("TILL") treats a company that becomes a non-SME due to the reason that the size of the SME exceeds the criteria of SME while still meeting other criteria (industry and independence) as a SME for additional 3 years after the company becomes a non-SME. It was not clear whether a preferential capital gains tax rate is afforded when a transfer occurs within this 3 year grace period.
The ruling clarifies that determination of SME should be made as of the end of the business year preceding the year in which the transfer occurs. Therefore, if a company qualifies as a SME, including the 3 year grace period, as of the end of the year preceding the year of transfer, then an individual transferor can benefit from a preferential capitals gains tax rate.

Tax Reduction or Exemption for Foreign Investments (Seomyun2team-1912, September 26, 2006)

Where a foreign invested company, carrying on a business which qualifies for reduction or exemption of corporate income tax, individual income tax, acquisition tax, requisition tax or property tax ("corporate income tax, etc."), receives subsidy or grants from the government with regard to technology development, reduction or exemption of corporate income tax, etc. is not available to such subsidy or grants.

Deduction of Lump Sum Sign-on Bonus Payments (Seomyun2team-1738, September 19, 2006)

Where a company pays a lump sum sign-on bonus at the time of entering into an employment agreement, the lump sum payment should be equally allocated over the period specified in the employment agreement. Such allocated amount is deductible for corporate income tax purposes while the same amount is taxable income in the hands of the employee subject to an individual income tax each year.


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