Global Tax Alert | 5 January 2018

Korea enacts 2018 tax reform bill

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Executive summary

On 19 December 2017, Korea enacted the 2018 tax reform bill (the 2018 Tax Reform) after it was passed by Korea’s National Assembly on 5 December 2017.1 The 2018 Tax Reform also includes provisions in line with the Organisation for Economic Co-operation and Development’s Base Erosion and Profit Shifting (BEPS) Action 2 (Neutralising the effects of Hybrid Mismatch Arrangements) and Action 4 (Limiting Base Erosion Involving Interest Deductions and Other Financial Payments), among others. Unless otherwise specified, the 2018 Tax Reform will generally become effective for fiscal years beginning on or after 1 January 2018. The Enforcement Decrees, which provide more specific guidance on the laws, are expected to be enacted in February 2018. This Alert summarizes the key features of the new and amended tax laws.

Detailed discussion

Additional corporate income tax bracket

The 2018 Tax Reform adds a new 25% corporate income tax bracket for taxable income in excess of KRW300 billion (US$270 million):

Taxable income
Current corporate income tax rate*
Amended corporate income tax rate

Over KRW20 billion (US$17.7 million) and up to KRW 300 billion

22%

22%

Over KRW300 billion

22%

25%

* A 10% local income tax surcharge is also imposed on the current and amended corporate income tax rates.

Limitation on utilization of net operating losses (NOLs) for domestic corporations

Effective for fiscal years beginning on or after 1 January 2016, domestic corporations other than small and medium-sized enterprises and certain other companies (e.g., companies under court receivership) have been subject to a limitation on utilization of NOLs to 80% of taxable income.2 The 2018 Tax Reform further reduces the limitation to 70% and 60% for fiscal years beginning on or after 1 January 2018 and 2019, respectively.

Revision of corporate accumulated earnings tax (AET)

Effective for fiscal years beginning on or after 1 January 2015, certain corporations have been subject to AET that is due to expire as of 31 December 2017.3 Under the 2018 Tax Reform, certain corporations will be subject to a revised AET regime effective for fiscal years beginning on or after 1 January 2018 with a sunset clause due to expire as of 31 December 2020. Major changes in the revised AET include: (i) the tax rate applied on accumulated earnings is increased from 11% to 22% (inclusive of local income tax); and (ii) dividends, unlike in the previous provision, would no longer be used to decrease accumulated earnings. The following chart summarizes the changes.

Previous provision
New provision

Method A

[Adjusted taxable income for the current year x
80% – (investment + payroll increase + dividends, etc.)] x 11%

[Adjusted taxable income for the current year** x
(60% ~ 80%)*** – (investment**** + payroll increase, etc.)] x 22%

Method B

[Adjusted taxable income for the current year x
30% – (payroll increase + dividends, etc.)] x 11%

[Adjusted taxable income for the current year x
(10% ~ 20%) – (payroll increase, etc.)] x 22%

** The maximum taxable amount will be specified in the Enforcement Decree.

*** Will be specified in the Enforcement Decree.

**** Excludes investment in land.

Employment succession requirement to satisfy tax-free merger and demerger conditions

Under the current law, a merger or demerger would be treated as tax-free if certain requirements, such as business purpose, continuity of interest and continuity of business, are met. The 2018 Tax Reform imposes the continuity of employment requirement as an additional condition for the tax-free treatment of merger or demerger. Under the new requirement, 80% or more employees of the transferred business4 must continue to be employed by the surviving entity/spun-off entity until the end of the fiscal year during which the merger or demerger is registered.

However, a tax-free merger or demerger may become taxable if certain events are triggered within two years from the end of the fiscal year during which the merger or demerger registration occurs. The triggering events include discontinuity of interest and discontinuity of business. The 2018 Tax Reform adds discontinuity of employment as a new triggering event. To maintain a tax-free merger, the total number of employees of the surviving entity must be 80% or more of the combined total number of employees of both entities.5 Similarly, to maintain a tax-free demerger, the total number of spun-off entity’ employees must be 80% or more of the total number of those of pre-demerger spun-off business.6

Revision to capital gains tax exemption qualification on foreign corporation’s transfer of shares listed on the Korean stock exchanges

The current law exempts tax on capital gains derived by foreign corporations without a permanent establishment in Korea from a transfer of shares listed on the Korean stock exchanges, provided: (i) the foreign corporation and its related party own less than 25% of the total outstanding shares issued by the listed Korean company during the year of the share transfer and the preceding five years; and (ii) the share transfer takes place on the stock exchange. Under the 2018 Tax Reform, the maximum ownership threshold for the capital gains tax exemption qualification would be reduced from less than 25% to less than 5%. The current law will continue to apply until 31 December 2018 for the transfer of listed Korean company shares acquired before 1 January 2018.7

Increased non-compliance penalties on transfer pricing documentation requirement

Under the current tax law, taxpayers failing to file a Combined Report of International Transactions (CRIT)8 or found to file false information are subject to penalties of KRW10 million (US$9,000) per documentation. Pursuant to the 2018 Tax Reform, the penalties would be increased to KRW30 million (US$27,000) per documentation. The amended law will be effective for non-compliance of transfer pricing documentation requirement from the date on which amended law is enacted.9

Limitation on expense deductions relating to hybrid financial instruments10

As a commitment to implement the hybrid mismatch rules recommended by the BEPS Action 2, the 2018 Tax Reform introduces a limitation on deductible expenses relating to hybrid mismatch arrangements.

The proposed rule will apply to cross-border hybrid financial instrument transactions between a domestic corporation (including the Korean branch of a foreign corporation) and its foreign related party. If a payment associated with a hybrid financial instrument remains wholly or partially nontaxable in the counterparty jurisdiction until the close of the recipient’s fiscal year beginning within 12 months following the close of the payor’s fiscal year in which the deduction is claimed, the nontaxable portion of the payment would not be deductible for the fiscal year in which the payment is made. A claw-back provision applies when the payor deducts the nontaxable portion of the payment for the fiscal year in which the payment is made. The amended law will be effective for fiscal years beginning on or after 1 January 2018.11

Limitation on deductibility of interest payments made to foreign related parties

Committing to implement the interest expense deduction limitation rules recommended by BEPS Action 4, the deductibility of interest payments made to foreign related parties will be limited.

The new rule will apply to a domestic corporation (including the branch of a foreign corporation), other than financial institutions and insurance agencies, with foreign related party transactions. A domestic corporation would be able to deduct net interest expense12 up to 30% of the domestic corporation’s adjusted taxable income.13

The domestic corporation must use the method that results in a larger disallowance of interest expense deduction computed either under the new interest expense limitation rule or the existing 2:1 debt-to-equity safe harbor rules. The new rule will be effective for fiscal years beginning on or after 1 January 2019.

Endnotes

1. See EY Global Tax Alert, Korea announces 2017 tax reform proposals, dated 18 August 2017.

2. See Global Tax Alerts, Korea enacts 2016 tax reform bill, dated 15 December 2015 and Korean Government releases 2015 tax reform proposals, dated 25 August 2015.

3. See Global Tax Alerts, Korea enacts 2015 tax reform proposals, dated 29 December 2014 and Korea announces 2015 tax reform proposals, dated 27 August 2014.

4. Measured at one month prior to the date of merger/demerger registration.

5. Same as endnote 4.

6. Same as endnote 4.

7. This is an amendment of the Enforcement Decree, which is expected to be enacted in February 2018.

8. Comprised of Master File, Local File and Country-by-Country reports.

9. This is an amendment of the Enforcement Decree, which is expected to be enacted in February 2018.

10. A financial instrument with both debt and equity characteristics where it is treated as a debt in one jurisdiction, while treated as equity in the other jurisdiction (e.g., participating bonds).

11. Additional guidance will be specified in the Enforcement Decree, which is expected to be enacted in February 2018.

12. Interest paid to foreign related parties less interest received from foreign related parties.

13. Taxable income before net operating loss deduction + depreciation expense deduction amount + net interest expense deduction amount.

For additional information with respect to this Alert, please contact the following:

Ernst & Young Han Young, Seoul
  • Min Yong Kwon
    min-yong.kwon@kr.ey.com
  • Jin Hyun Seok
    jin-hyun.seok@kr.ey.com
Ernst & Young LLP, Korean Tax Desk, New York
  • Shuck Il Cho
    shuckil.cho@ey.com
Ernst & Young LLP, Asia Pacific Business Group, New York
  • Chris Finnerty
    chris.finnerty@ey.com
  • Kaz Parsch
    kazuyo.parsch@ey.com
  • Bee-Khun Yap
    bee-khun.yap@ey.com
Ernst & Young LLP, International Tax, New York
  • Hae-Young Kim
    haeyoung.kim@ey.com

EYG no. 00063-181Gbl