The Korean National Assembly approved an extraterritorial Value Added Tax (“VAT”) regime1 in December 2014 that imposes VAT on the supply of electronic services by foreign companies to Korean consumers. The Korean government finalized the implementing regulations for the regime through a Presidential Decree and Ministerial Decree2 in February and March of this year, respectively (hereinafter, the “Regime”). Accordingly, if foreign companies provide electronic services prescribed under the Regime to Korean residents, they must register for VAT purposes in a simplified manner and report and pay VAT, even if they do not have a permanent establishment (“PE”) in Korea.
I. Scope of Application
The Regime will be applicable where foreign companies without a PE in Korea provide services that satisfy all of the following requirements in Korea (including the case where a foreign company with a PE in Korea provides services with no connection to such PE).3
- The services are supplied by means of an information and communication network in accordance with Article 2-1(1) of Korea’s Act on Promotion of Information and Communications Network and Protection of Information;
- The services can be used in real time without being stored or operated by being stored on a mobile communication device or a computer, etc.; and
- The services include works such as, or improvements of works such as, game, sound, and video files, electronic documents, or software that is processed by optical or electronic means and produced or manufactured in the form of codes, letters, sounds, and videos, etc.4
Where electronic services are provided through a third party (i.e., intermediary platform companies) falling under any of the following, the third party would be deemed to have provided the electronic services in Korea and thus be subject to the Regime.
- A person who operates an open market or similar thing that enables transactions of electronic services by means of information and communication network, etc., and provides related services;
- As a person acting as an intermediary, etc., in transactions of electronic services, a person that receives payment from the purchaser and pays the same to the seller; or
- Other persons prescribed under the Presidential Decree participating in transactions of electronic services similar to those under subparagraphs i and ii above.
II. Effective Date
The Regime will be effective as of July 1, 2015.
III. Registration and Reporting under the Regime
Foreign service providers to whom the Regime applies are required to apply for a simplified VAT registration5 to Korea’s National Tax Service within 20 days from their business commencement date. They must file a provisional VAT return and pay VAT every quarter6, and file a final VAT return and pay VAT every six months7. Therefore, foreign service providers that have started their businesses before June 30, 2015 should note that they must complete VAT registration by July 20, 2015.
IV. Remaining Uncertainties and Concerns
- Scope of covered services
The definition of the services covered by the Regime is not clear. More specifically, the references to “software” and “electronic documents” are very broad and imprecise. In addition, that definition does not distinguish between B2C (services provided by business to end consumers) and B2B services (services provided by business to intermediate businesses in the value chain). Thus, both B2B and B2C services appear to be covered under the current languages of the Regime, which runs counter to international practices.
There is no VAT loss on sales to business customers by foreign suppliers, as a business customer will in turn make a taxable supply. Also, if the Regime applies to B2B services, such application may overlap partly with the operation of the current reverse charge mechanism8 under which Korean purchasers report and pay VAT on behalf of foreign service providers, resulting in double taxation. Accordingly, there is an argument that the Regime should apply solely to B2C transactions, as in other jurisdictions such as the EU and Japan.
- Input VAT credit/refund for B2B service purchasers in Korea
Input VAT credit allowed under the Korean VAT Act is “VAT on goods or services that a business used or received for purposes of use in its business”.9 However, even for services purchased by a Korean business in connection with its business, the Regime may not allow domestic companies to claim input VAT credit.
That is because under the Regime, foreign service providers are exempt from the obligation to issue statutory VAT invoices,10 and therefore there is a high likelihood Korean businesses (i.e. service purchasers) cannot claim input VAT credit even though they have purchased and used electronically supplied services in their VAT-able business in Korea.
- Customer identification: unclear meaning of term “supplied in Korea”
The Regime currently applies to services that are provided “in Korea”. It is unclear whether the term “in Korea” means services that are provided to customers located in Korea and the Regime contains no provisions that prescribe how to determine the customer’s geographical location. Therefore, clear guidance on the term “in Korea” is needed and the Regime should provide indicators to determine customers’ location consistently with the existing tax regimes to which the foreign taxpayers are subject to.
- Inflexible obligations of by platform companies
A platform company that acts as an intermediary between a foreign service provider and a Korean customer becomes the taxpayer for Korean VAT purposes. Under the Regime, it is required to charge, collect, and remit VAT in connection with transactions with the customer. Practical reasons may render the application of this new obligation to a platform company infeasible. Because the term “platform company” can apply to many different business models, under which companies may provide very different types of services or levels of service, some platform companies may not have the ability to comply with Korean VAT obligations because of the nature of their business (e.g., platform companies that provide a smaller scope of services or provide services to various countries).
- Impact on other tax issues (e.g., constituting a PE for direct tax purposes)
The Regime (or other relevant law and regulations) does not clearly stipulate that making a registration for VAT purposes will not create a Korean PE for direct tax purposes. In addition, the Regime does not state that registration under the Regime will not negatively affect the status of currently unregistered foreign service providers as recipients of zero-rated supplies. Accordingly, an argument can be made that the Regime should clearly state that registration for a VAT purpose under this Regime does not result in any direct or indirect tax compliance obligations other than reporting on consumer sales.
- Registration threshold
The Regime does not provide a reasonable registration threshold for foreign service providers. This deviates from practices in other tax jurisdictions, which usually provide a certain level of threshold. For example, under the Japanese Consumption Tax regime, an enterprise must earn JPY 10,000,000 (approximately USD 100,000) in annual gross revenues subject to consumption tax from Japanese customers before the enterprise is required to collect and remit consumption tax11.
We believe that the Regime will significantly impact foreign major IT businesses which provide electronic services to Korean customers. Given the critical nature of the Regime, we have organized a dedicated team of international tax experts, consisting of experienced lawyers and accountants, and also former officials from NTS and MOSF. Based on our knowledge and practical experiences, Yulchon’s Tax Group will provide comprehensive advice to clients facing issues from the Regime.