APAC Tax Matters: 12th edition

Korea

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At a glance

  • Introduction of taxation regime for offshore joint businesses
  • Tax rate applicable to payment for use of equipment
  • Foreign investments funded from local borrowings are not eligible for tax exemption/reduction
  • Passive foreign partners’ income from Korean private equity funds (PEFs) to be  taxed by income source
  • Interests from foreign-currency denominated long-term fixed deposits held by non- residents are tax-exempt
  • Special income tax rate for expatriate workers is increased to flat 17%
  • Amendment of taxation of Korean source pension income of non-residents

Amendments to Korean Tax Laws for 2013

The 2012 Tax Reform Package announced by the government in August last year was passed at the National Assembly and took effect on 1 January 2013. Additionally, amendments to relevant enforcement decrees and enforcement rules will follow as delegated by the amended laws.

1. Improvements regarding the taxation of an offshore joint business ("OJB")

Clarification of criteria for taxation of an OJB

Previously, an OJB classified as a “foreign corporation” was subject to taxation under the CITL, whilst one that was classified as a “foreign organization” was subject to taxation under the Individual Income Tax Law (“IITL”). Despite such different tax treatments, there were no clear-cut criteria provided under Korean tax law regarding the determination of an OJB as a “foreign corporation”.

In order to provide a clear definition of the term “foreign corporation”, the CITL has been amended and the Enforcement Decree (“ED”) of the CITL as delegated by the amended law will also be amended to include the following criteria for classifying an OJB as a foreign corporation:

  • The OJB shall have a juridical personality.
  • The OJB shall be composed of partners with limited liability only.
  • A domestic entity which is the same as, or most similar to the OJB, would be classified as a corporate entity under Korean tax law.

According to these amendments, an OJB with a juridical personality which is composed solely of partners with limited liability and has the nature of a stock corporation (“Chusik Hoesa”) or a limited corporation (“Yuhan Hoesa”), shall be treated as a foreign corporation subject to corporate income tax on its Korean source income.


Application of special tax treatment for partnership entities to an OJB (Tax Incentives Limitation Law)

Under the previous Tax Incentives Limitation Law (“TILL”), only domestic entities including associations (“Johap”) under the Civil or Commercial Law were eligible for special partnership taxation. However, the tax law has been amended to include OJBs in the list of entities eligible for this special taxation and the ED of the TILL will also be amended to specify certain concrete requirements as described below:

  • The OJB shall be similar to the domestic entities eligible for special partnership taxation.
  • The OJB shall carry on a business through a PE (Permanent Establishment) in Korea.
  • The OJB shall be eligible for a similar special taxation regime in the country of incorporation.

After a one-year grace period, these amended provisions will be applicable to any such application filed on or after 1 January 2014 to elect the special partnership taxation regime.

2. Clarification of the tax rate for use of equipment

Under previous tax laws, uncertainties existed as to how to tax payments for the use of industrial, commercial or scientific equipment which were classified as royalties under tax treaties (reduced treaty tax rate: 0 ~15%), but treated as  rental income under Korean tax laws (applicable tax rate: 2%).

Despite such uncertainties,  based on relevant tax rulings, etc., such payments were, in practice, subject to the lower of the withholding tax rate on rental income under Korean tax laws (2%) or a reduced withholding tax rate under the relevant tax treaty (0~15%).Therefore, the 2% withholding tax rate was applied in most cases.

In order to clarify the tax treatment of such payments, the ITCL has been amended such that payments for the use of such equipment, classified as royalties under tax treaties, shall be subject to the lower of a reduced withholding tax rate under the relevant tax treaty (reduced treaty tax rate: 0~15%) or the withholding tax rate on royalties under Korean tax laws (20%). Consequently, after this amendment, the reduced treaty tax rates and not the 2% withholding tax rate will be applicable in most cases.  This will lead to an increased withholding burden.

3. Foreign investments ineligible for exemption/reduction if funded by local loans

According to the amended law, in order to prevent tax avoidance using loans extended to foreign investors, etc., the following cases of loans shall cause foreign investments to be ineligible for tax exemption/reduction:

  • Where the domestic shareholder of a foreign-invested enterprise (“FIE”) offers a loan to a foreign investor and then the foreign investor invests the loan in the FIE
  • Where a FIE receives investment from a foreign investor which is its shareholder, and then provides the investment again to the foreign investor in the form of a loan

4. Taxation of passive foreign partners of Korean private equity funds (PEFs) by income sources

Before the amendment of the TILL, any income allocated by a domestic PEF to its passive partner who was a non-resident or a foreign corporation was classified as dividend income regardless of the income source.  Accordingly, such income was subject to individual income tax or corporate income tax at a rate of 5 – 15% (where there was a relevant tax treaty) or 20% (where there was no such tax treaty).

After the amendment, however, in order to boost investment by foreign pension funds, etc., in domestic PEFs, any income allocated by a domestic PEF to a pension fund, etc., incorporated in a country that has a tax treaty with Korea, shall be taxed based on its income source, as long as such income is exempt from taxation in that country. Under this newly inserted provision, any such income classified as interest or dividend income, etc., shall be subject to income tax at a rate of 5 – 15%, and income classified as capital gains from share transfer shall be exempt from taxation in Korea, if it is taxed in the country of residence under a relevant tax treaty.

5. Tax benefits for foreign-currency denominated long-term fixed deposits held by nonresidents

Under the previous TILL, interest payments made to non-residents/foreign corporations on foreign-currency denominated bonds issued overseas, or in respect of foreign-currency denominated notes issued by financial institutions overseas, were exempt from individual income tax and corporate income tax.

According to the tax law amendment, interest payments on foreign-currency denominated long-term fixed deposits shall also be exempt from individual income tax and corporate income tax, provided that the maturity of the deposits is one year or longer. This amendment is intended to stabilize the structure of procuring foreign currency funds by inducing long-term foreign-currency denominated deposits and to reduce relevant procurement costs.

6. Amendment regarding special income tax rate for expatriate workers

In order to attract competent foreign workers and boost foreign investment, the sunset date of the special flat income tax rate for foreign expatriate workers has been extended for another two years. However, under the amended law, the previous rate of 15% has been increased to 17%.  This is to ensure equality in the rates of tax levied on foreign workers and those Koreans who are also eligible for the special income tax rate.

7. Improvement regarding the taxation of non-residents on Korean source pension income

Under the previous IITL,  pension income received by non-residents for their services performed within Korea during their employment was classified as retirement income, whereas that received after subscribing to a private pension scheme was classified as other income.

According to the amended law, however, as is the case with residents, pension income received by non-residents shall be treated as pension income.  However, any lump-sum refund received upon the closing of a pension plan account before the expiry of the contracted term of premium payments (or income received in any form other than a pension after such expiry), shall be treated as other income for Korean tax purposes.