APAC Tax Matters: November 2012
At a glance
- Taxation regime for offshore joint business to be introduced
- Taxation guidelines regarding internal transactions within one legal entity to be established
- Tax rate applicable to payment for use of equipment to be clarified
- Control on tax exemption/reduction for foreign-invested enterprises to be tightened
- Securities transaction tax on derivatives to be imposed from 2016
Proposed revisions to Korean tax laws for 2013
On 8 August 2012, the Ministry of Strategy and Finance (MOSF) announced the 2013 tax reform proposals.
The proposals focus on supporting job creation, boosting domestic demand, improving fiscal soundness and laying the foundation for an advanced tax system. The proposals contain revisions to various Korean tax laws including the Corporate Income Tax Law, the Tax Incentives Limitation Law, and the Value-Added Tax Law.
Clarification of criteria for taxation of OJB
According to the current tax law, an OJB classified as a foreign corporation is subject to taxation under the Corporate Income Tax Law (CITL), while that classified as a foreign organization is subject to taxation under the Individual Income Tax Law (IITL).
Despite there being different taxation treatments under the two regimes, no clear-cut criteria are provided under Korean tax law regarding how to determine if an OJB is a foreign corporation. For this reason, the CITL will be revised to include the following criteria for classifying an OJB as a foreign corporation:
- The OJB shall have a corporate (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 shall be classified as a corporation under Korean private law
If an OJB does not meet the foregoing criteria, it will be classified as a foreign organization which is subject to taxation under the IITL.
Clarification of taxation of foreign organizations which are not corporations (IITL)
Under the current IITL, where a foreign organization which is not a corporation does not distribute profits, it shall be treated as a single non-resident taxpayer, and where such a foreign organization distributes profits, it shall also be treated as a single non-resident taxpayer but be taxed at the level of each partner regarding its distributed share of the organization’s profits.
However, the tax law will be revised as described below to clarify the taxation of such a foreign organization in instances where there is distribution of profits.
|Foreign organization with a permanent establishment ("PE") in Korea||Foreign organization without a PE in Korea|
|If information on partners and the profit allocation ratio are submitted through business registration||If no information is submitted on partners or no business registration is made||If information, etc. on partners is submitted||If no information, etc. on partners is submitted|
|To be taxed at the level of each partner (as each member of the business)||To be taxed as a single non-resident taxpayer||To be taxed at the level of each partner (as each member of the business)||To be taxed as a single non-resident taxpayer|
Application of special tax treatment for partnership entities to OJB (Tax Incentives Limitation Law)
Under the current Tax Incentives Limitation Law (TILL), only domestic entities including associations (Johap) under the Civil or Commercial Law are eligible for special partnership taxation. According to the proposed amendments, however, an OJB satisfying the following requirements will also be able to elect special partnership taxation:
- The OJB shall be similar to the domestic entities eligible for special partnership taxation.
- The OJB shall conduct business through a PE in Korea.
- The OJB shall be eligible for a similar special taxation regime in the country of incorporation.
After a one-year grace period, the revised provision will be applicable to fiscal years commencing on or after 1 January 2014.
The current tax law does not provide clear-cut guidelines for the recognition of gains/losses under transfer pricing principles and the application of the arm’s length price as regards internal transactions between the permanent establishment (PE) of a non-resident/foreign corporation and its overseas head office or branch.
In order to address this issue, MOSF has proposed the adoption of the approach in Article 7 of the OECD Model Tax Convention as amended in July 2010, i.e., to make a PE of such non-resident/foreign corporations recognize gains/losses as if the PE is entirely independent from its overseas head office or branch.
Detailed rules on the recognition of gains/losses and the calculation of the arm’s length price for such internal transactions will be set forth in the relevant Enforcement Decree (ED).
According to the current IITL and the CITL, payments for the use of industrial, commercial or scientific equipment are treated as rental income and assessed to tax at 2%. On the other hand, most tax treaties classify such payments as royalties subject to treaty rates of withholding which could be between 0 and 15%. According to the proposed tax law amendments which specify withholding tax rates applicable to such payments, payments for the use of equipment classified as royalties under a tax treaty will be subject to the reduced treaty rate as applicable.
Exclusion of loans from foreign investment eligible for tax exemption/reduction
Under the proposed tax law changes, in order to prevent tax avoidance through loans extended to foreign investors, etc., the following cases of loans will be excluded from foreign investment eligible for tax exemption/reduction:
- Where the domestic shareholder of a 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.
Strengthened recapture rule in case of a share transfer
Under the current TILL, if a foreign investor which benefitted from corporate income tax exemption/reduction transfers shares in its FIE within 3 years from the commencement of the tax exemption/reduction period, the foreign investor and the FIE shall pay the amount calculated by applying the relevant share transfer ratio computed by reflecting the number of elapsed months to the amount of tax exemption/reduction as corporate income tax.
According to the proposed revisions, in order to strengthen the recapture of tax benefits taken by foreign investors in case of share transfers, if the reason for recapture, that is, the transfer of shares in the relevant FIE held by a foreign investor within the tax exemption/reduction period (5~7 years) arises, the amount calculated by applying the relevant share transfer ratio to the tax exemption/reduction amount for the 5 retroactive years will be fully recaptured.
Clarification of reasons for recapture
The TILL will be revised to specify concrete reasons for recapture of tax benefits (i.e., tax exemption/reduction) taken by FIEs. According to the revised provision, tax benefits received by FIEs will be recaptured, if the criteria of investment amount, industry, facilities installed, number of employees, etc. are no longer satisfied by FIEs.
In addition, if 2 or more reasons for recapture arise, such reasons will be applied in sequential order to the extent of the tax exemption/reduction amount.
Under current tax law, income tax and securities transaction tax are not levied on the trading of derivatives in order to foster the derivatives market. According to the tax reform proposal, taking into account the substantial growth of the market after its opening in 1996, and with a view to tax fairness as regards other incomes and financial products, trading of KOSPI 1200 futures/options (which account for 96% of the total trading of derivatives in the Korea Exchange), will be subject to securities transaction tax (futures: 0.01% of pre-arranged prices, options: 0.01% of transaction prices).
This proposed change will be applicable to derivatives traded on or after 1 January 2016, a three-year grace period will be given considering market conditions.