The government’s proposed tax law amendments for 2017, announced last August by the Ministry of Strategy and Finance, were approved by the National Assembly on December 5, 2017 with some minor changes. Most of the 2017 Tax Amendments will be effective as of January 1, 2018. We provide below the major points of the 2017 Tax Amendments.
1. Increase in top marginal rate for corporate income tax (Article 55(1) of the Corporate Income Tax Law (the “CITL”))
The top marginal rate for taxable income in excess of KRW300 billion will be increased to 25% from 22% under the 2017 Tax Amendments (see below for the current and new tax rates). Since the local income tax on the corporate income tax is 10% of the applicable corporate income tax rate, this means that Korean corporations may be subject to a top tax rate of 27.5% (= 25% + 10% * 25%) on taxable income in excess of KRW300 billion.
Under the government’s proposed amendments, the tax bracket for the top marginal rate was taxable income in excess of KRW200 billion. However, in order to relieve tax burden of companies, KRW200 billion has been eased to KRW300 billion by the National Assembly.
2. Strengthening of taxation against multinational enterprises
A. Denial of deduction for hybrid mismatch arrangement (Article 16-3 of the Law for the Coordination of International Tax Affairs (the “LCITA”))
With respect to interest paid by a Korean company in a hybrid financial arrangement with a foreign related party, the 2017 Tax Amendments will deny a deduction for such interest if the interest is viewed as dividends and not taxed in the recipient’s country.
As a result of this amendment, some of the interest which had been deducted may not be deductible depending on the tax treatment of the interest in the recipient’s country; thus, it is expected that uncertainty for tax purposes will increase in financial transactions between related parties.
B. Limiting deduction for interest expense of multinational enterprises (Article 16-2 of the LCITA)
If the ratio of net interest (= interest paid - interest received) to adjusted net income (i.e., EBITDA (earnings before interest, taxes, depreciation, and amortization)) paid to a foreign related party by a Korean company (including permanent establishment of a foreign corporation and excluding financial and insurance businesses) exceeds a certain ratio (30%), the excess interest will not be deductible under the 2017 Tax Amendments. Where the thin capitalization rules also apply to a taxpayer, the non-deductible interest is the greater of the amount resulting under the above new rule or the thin capitalization rules.
Since this new rule applies to interest paid to a foreign related party, interest on loans paid to foreign subsidiary or affiliate is also covered by this rule (whereas the current thin capitalization rule does not apply to such interest); consequently, some of the interest paid abroad may be denied as a deduction for not only foreign companies but also Korean companies with subsidiaries, etc., abroad. In addition, since the thin capitalization rules as well as this new rule will apply to a foreign company, it is anticipated that non-deductible interest will increase compared to the past.
This rule will be effective for taxable years beginning after January 1, 2019.
3. Increase in withholding tax rate applicable to income derived by dispatched foreign employees and expansion of withholding agent (Article 156-7 of the Personal Income Tax Law (the “PITL”))
Under the current PITL, a Korean company is required to withhold 17% of the service fees, as income tax, paid to a foreign corporation for services provided by the foreign corporation’s dispatched employees into Korea.
The 2017 Tax Amendments will increase the withholding tax rate to 19%. According to the government’s proposed tax law amendments for 2017, the threshold of the total service fees to be paid to a foreign corporation will be cut from current KRW 3 billion to KRW2 billion per year by revising the relevant Presidential Decree of the PITL. Furthermore, the scope of companies subject to this withholding obligation is to be expanded to cover Korean companies in the ship building and financial industries.
The new withholding rule will be applicable to payments of service fees on or after July 1, 2018.
4. Improvement of the harmonization regime for transfer pricing and customs valuation (Article 6-3 of the LCITA, Article 37-2 of the Customs Act)
In accordance with the current Korean tax law, if the transfer pricing (TP) method and the customs valuation method are similar, a taxpayer may utilize the harmonization regime for TP and customs valuation and simultaneously apply for advance pricing agreement (APA) and advance customs valuation arrangement (ACVA).
Under the 2017 Tax Amendments, even if the TP and customs valuation methods are different, taxpayer can claim a harmonized approach between domestic tax authorities and customs authorities and, in this line, simultaneously apply for APA and ACVA. Thus, tax authorities and customs authorities may be required to closely coordinate with each other in order to reach an agreement on the TP/customs value for imported goods.
With the amendment, taxpayers will now be able to use profit-based TP method (e.g., transactional net margin method), which is the most commonly used TP method, in harmonizing customs valuation and TP, despite the fact that such profit-based TP method is not adopted as a customs valuation method by Korean customs law. As a result, it is anticipated that the effectiveness of the harmonization regime for TP and customs valuation will be improved.
5. Tightening the deadline for application for APA (Articles 5 and 6 of the LCITA)
Under the current LCITA, the deadline for application for APA is the last day of the first taxable year to which the taxpayer has requested that the proposed APA be applied. The 2017 Tax Amendment tightens this deadline to the day prior to the first day of the first taxable year to which the proposed APA will apply. Taxpayers should be mindful of this new tighter deadline when they seek to apply for an APA.
This new deadline will apply to application for APAs covering taxable years beginning on or after January 1, 2019.
6. Expansion of the scope of exemption for under-reporting penalty (Article 13 of the LCITA)
Under the current LCITA, under-reporting penalty is exempted only if a TP study is prepared and stored by the deadline for filing of corporate income tax return (i.e., 3 months after the fiscal-year end), even though the deadline for submission of local file was extended last year to 12 months after the fiscal-year end (i.e., no exemption for under-reporting penalty can be provided even if the local file is submitted within 12 months of the fiscal-year end). The 2017 Tax Amendments also provide for such exemption if the local file is submitted on time (i.e., by the end of 12 months after the fiscal-year end). The new rule promotes convenience for taxpayers.
7. Increased tax incentives for foreign-invested company’s job creation (Article 121-2 of the Special Tax Treatment Control Act (the “STTCA”))
In accordance with the current STTCA, when personal income tax/corporate income tax incentives are provided in connection with income derived from a foreign-invested company’s eligible business, a certain amount for each hired employee is granted as additional tax incentive for purposes of supporting job creation by foreign-invested companies. The upper limit for the additional incentive is 40%/30% of the foreign investment amount for the 7-year/5-year tax incentive, respectively.
Under the 2017 Tax Amendments, the upper limit for additional tax incentive from additional employment is increased to 50%/40% of the foreign investment amount for the 7-year/5-year tax incentive, respectively.
This new rule will be effective for application of tax incentives made on or after January 1, 2018.
8. Change in the standard for imposition of fines related to nonsubmission/false submission of statement on foreign subsidiaries of a Korean resident company, etc. (Article 165-3 of the PITL and Article 121-3 of the CITL)
Under the current PITL and CITL, if a statement on foreign subsidiaries of a Korean resident company, etc., is not submitted or falsely submitted, a fine of KRW10 million or less is imposed on each individual or corporation with the submission obligation. With the 2017 Tax Amendments, the fines are imposed for each failure to submit or false submission of the reportable documentation. This amendment may increase the fines for taxpayers that have failed to submit (or falsely submitted) the statement on foreign local company, etc.
9. Reduction in the limit for claiming NOL carryforward by large corporations (Article 13 of the CITL)
In accordance with the current CITL, a corporation that is not a small-and-medium enterprise (SME) (i.e., a company with less than KRW100 billion in sales and less than KRW500 billion in assets) can claim NOL carryforward as a deduction up to 80% of the income for a taxable year (for a SME, NOL carryforward may be claimed as a deduction up to 100% of the income).
The 2017 Tax Amendments will gradually reduce the limit for claiming NOL carryforwards for non-SME, with the limit of 70% of income for 2018 and 60% of income from 2019. As a result of this amendment, it has become more likely that non-SMEs with NOL carryforwards that are close to expiration (NOLs can be carried forward for 10 years) may not be able to claim such carryforwards as deductions.
The 70% limit will apply to the fiscal year beginning on or after January 1, 2018, while the 60% limit will apply to fiscal years beginning on or after January 1, 2019.
Under the government’s proposed amendments, the limit for claiming NOL carryforwards for non-SME was 60% of income for 2018 and 50% of income from 2019. However, in order to relieve tax burden of companies, the limit has been eased to 70% of income for 2018 and 60% of income from 2019.