Exercising Stock Options
Deducting Expenses by Korean Subsidiaries
This update summarizes two recent rulings of the National Tax Tribunal and the Ministry of Finance and Economy regarding (i) the taxation of stock options granted by a foreign parent company to the employees of its Korean subsidiary, and (ii) the deductibility of expenses incurred by the foreign-invested company in connection with the stock options.
Korean tax law stipulates the categories of income that are subject to individual income tax. Prior to December 29 2000, an employee's income which was earned through exercising stock options (ie, the difference between the exercise price and market value of the stock options) was untaxed. The revised Individual Income Tax Law, which took effect on January 1 2001, classifies such income as 'other income' if it is earned (i) through exercising stock options after retirement, or (ii) exercising stock options which were granted outside the employment relationship (Article 21(1)(22)).
In recent cases, a group of employees asserted that their taxed income should not be classified as 'earned' because they worked for a Korean subsidiary rather than a foreign parent company and, therefore, the stock options were not connected directly to their employment relationships.
The National Tax Tribunal held that such monies should be classified as 'earned' Class B income (Kook Shim 2002 Suh 25, February 9 2002).(1) The tribunal reasoned that (i) the foreign parent company had granted the stock options in exchange for services rendered by the employees to the Korean subsidiary, and (ii) the employees were utilized by the foreign parent company through the Korean subsidiary within the context of an employment relationship.
The tribunal's landmark decision is the first to examine the taxation of income earned by an employee through exercising stock options granted by a foreign parent company. The employees have appealed to the Administrative Court and a decision is pending.
Deducting Expenses by Korean Subsidiaries
In a separate ruling, the Ministry of Finance and Economy considered whether a Korean subsidiary can deduct as an expense that part of an employee's income earned through exercising stock options, granted by the foreign parent company, where the Korean subsidiary bears the expense (Jae Bup In 46012-82, April 23 2002).
The ministry held that the subsidiary is deemed to have purchased the stock at market value and sold it to the employees at the exercise price (which is usually lower than the market value). Applying domestic transfer pricing rules, the ministry refused to allow the Korean subsidiary to deduct such expense from its taxable income. Thus, a Korean subsidiary which reimburses its foreign parent company for costs it incurs in granting stock options to the subsidiary's employees may not deduct such costs from its taxable income.
For further information on this topic please contact Dong-soo Kim or Catherine E Shin at Woo Yun Kang Jeong & Han by telephone (+82 2528 5200) or by fax (+82 2528 5228) or by email ([email protected] or [email protected]).
Endnotes
(1) A Korean taxpayer's earned income is classified as either 'Class A' or 'Class B' income. Class A income includes wages, bonuses, severance pay or other allowances that an individual taxpayer receives from his or her employer. Class B income includes that paid by a non-Korean employer in foreign currency (for services rendered in Korea) which is not deducted as an expense in calculating the taxable income of the non-Korean employer's fixed place of business in Korea. Class B taxpayers are obliged to file a tax return or join a taxpayers' association through which monthly tax payments are made. A Class B taxpayer receives a 10% credit on his or her income tax liability in exchange for timely tax payments.