I. Background

The Korean government began  providing  tax  incentives in order to attract foreign investment with  its introduction of Foreign Capital Inducement Act in 1960. Through the Special Tax Treatment  Control Law (the “STTCL”), the incentives were granted for investments in high technology and  industrial support services, large-scale foreign investments, and investments in specified regions  such as free economic zones.

With significant changes in the Korean economic conditions over the last 55 years, the Korean  government is now considering extensive revision of its tax incentive regime. This movement for large-scale  amendment arises from the following factors: (i) the current tax incentives are granted to only a  small number of foreign- invested companies, (ii) Korean companies competing with foreign-invested  companies have been placed at a competitive disadvantage and subject to reverse discrimination due  to the tax incentive regime, and (iii) the effectiveness of the tax incentive regime in attracting  foreign investment has been reduced, considering the current economic conditions in Korea.

II. Proposed Reform

According to materials from a public hearing recently held by the Korea Institute of Public Finance  (a government agency under the Prime Minister’s Office; the “KIPF”), the Ministry of Strategy and  Finance (the “MOSF”) is considering three major reforms to the tax incentive regime. First, the  7-year tax incentive, which was granted (a) for an investment in high technology business and  industrial support services business and (b) where a special committee of the free economic zone  had reviewed and approved an investment in the free economic zone, may be reduced to a 5-year tax  incentive. Second, the amount of tax incentives may increase for a foreign-invested company in the  service sector with a significant employment effect, with the upper limit of incentives linked to  the number of employees. Third, no tax incentives may be granted for part of the investment  effectively made by a Korean person, where the Korean person holds more than 10% of the ownership  interest in the foreign company investing in the Korean company. 

III. Assessment and Counter-Strategy

Although no clear announcements have been made on how the reforms proposed by the KIPF will be  reflected in the  STTCL  when  MOSF  and  the  National  Assembly  publish  their  proposed   amendments  to  tax  law (including the STTCL) this fall, it appears highly possible for the reduction of 7-year tax  incentive to a 5-year tax incentive to be adopted in the proposed amendments. If the National Assembly passes the  proposed amendments including the reduction mentioned above by the end of this year, the amendments  will likely become effective on January 1, 2016.

On a related note, a decision for grant of incentives is effective for 3 years from the date of  notice of such decision (Article 121-2(13) of the STTCL). Thus, it is recommended for a foreign-invested company  planning an investment in Korea within the next three years to quickly make an application for  exemption and receive a decision for grant of incentives regarding its investment from the MOSF  prior to effective date (i.e., January 1st, 2016) of the new law in order to enjoy the 7-year tax  incentive. Moreover, considering that the Ministry of Trade, Industry, and Energy must review and  approve the application for exemption in order for MOSF to issue the decision for grant of  incentives, a foreign-invested company would be well advised to file the application for exemption  as soon as possible.