Korean Tax Newsletter (July, 2011)
New Tax Treaty with Peru
The Ministry of Finance and Strategy (“MOSF”) signed a tax treaty with Peru on 7 July 2011, the main features of which are as follows:
- The withholding tax rate on dividends will be 10% and that on interest and royalties, 15%.
- Capital gains will be exempt in the source country, except for gains derived from the transfer of the shares of real estate-rich companies (i.e. shares where at least 50% of the value of the underlying assets consists of real estate) and shares owned by majority shareholders.
- A most favored nation clause will apply with respect to the withholding tax rates on dividend and interest income and the capital gains tax exemption; under this provision, more favorable provisions in any tax treaties that Peru enters into with other countries will be applied to Korean residents.
- An exchange of information article to the level of the global standards.
The treaty will be effective once both countries complete their official signing and ratification.
Audit by Board of Audit and Inspection
In July 2011, the Board of Audit and Inspection released the results of its 2010 audit of the tax division of the MOSF, the National Tax Service (“NTS”) and the Tax Tribunal. The audit, which was conducted during the period of 15 September through 15 November 2010, focused on the taxation of domestic-source income earned by foreign entities and foreign-source income earned by domestic entities, as well as the monitoring system for the taxation of international transactions. As a result of the audit, the Board notified the MOSF and the NTS to assess additional taxes of approximately KRW 177 billion to taxpayers.
The main issues arising in the audit were as follows:
- Beneficial ownership issue in applying tax treaties (treaty shopping)
- Controlled foreign companies
- Transfer pricing
- Foreign-source income earned by expatriates
- Withholding tax rate on dividends paid to nonresidents
Korea-India Social Security Administrative Agreement ("KISSAA")
The Ministry of Health-Welfare signed a KISSAA with India on 25 July 2011, which is expected to be effective as from September 2011.
In general, foreigners staying in Korea are subject to the Korean national pension, but will be able to enjoy benefits under the relevant social security agreement.
The social security agreements are categorized into the totalization agreement and the contributions-only agreement, based on the type of benefits provided, and the social security agreement with India is the totalization agreement type.
The totalization agreement includes provisions on totaling the periods of coverage between the two countries, as well as the elimination of dual coverage. A person from one contracting country who is employed or self-employed in the other contracting country for a short period of time normally can be covered only under one contracting country's pension system during the working period. In addition, a person who has coverage in two countries may acquire benefit eligibility by totaling his/her periods of coverage in both countries.
With the KISSAA, a Korean individual staying in India will be exempt from the Indian national pension and the national pension coverage period in India will be totaled with the coverage period in Korea. The same benefits will apply to Indians staying in Korea.
Recent Tax Case
Scope of related parties (Supreme Court 2008 du 150, 2011. 7. 21)
The Korean Supreme Court issued a decision on 21 July 2011 on the scope of the definition of “related parties” that conflicts with previous case law.
The Corporate Income Tax Law (“CITL”) provides that the anti-avoidance rule applies to transactions between related parties, and the Presidential Decree of the CITL (“CITL-PD”) specifies the scope of the “related parties”.
The case involved a company (A Co) that transferred shares to another company (B Co) at a price lower than the fair market value of the shares. A Co and B Co had a common shareholder that held 49% of the shares of A Co and 20% of the shares of B Co. The tax authorities assessed additional taxes on A Co based on the anti-avoidance rule.
The Supreme Court concluded that B Co is not a related party of A Co from A Co’s perspective and, therefore, the anti-avoidance rule cannot be applied to A Co. Basing its decision on the provision in the CITL-PD that defines related parties as entities having the special relationship listed in the CITL-PD with the taxpayer, the court held that related party status must be determined from the perspective of the relevant taxpayer, not from the perspective of the other party to the transaction.
In previous cases, the Supreme Court has held that the determination of related parties should be made from the perspective of either the taxpayer or the other party to the transaction. However, this Supreme Court case stated that such determination of related parties, conflicting with this supreme court case, needs to be abrogated.