The Ministry of Strategy and Finance (“MOSF”) announced its proposed tax law amendments for 2017 (the “2017 Tax Amendments”) on August 2, 2017. According to the MOSF, the purposes of the 2017 Tax Amendments are to promote creation of jobs and improve redistribution of income. Unless otherwise noted below, upon approval by the National Assembly, the 2017 Tax Amendments will be effective as of January 1, 2018.
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 KRW200 billion will be increased to 25% from 22% under the proposed 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 KRW200 billion.
With respect to interest paid by a Korean company in a hybrid financial arrangement with a foreign related party, the proposed 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.
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 proposed 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. Relaxing the standard for tax residency in Korea (Article 16-3 of the Presidential Decree of the Personal Income Tax Law (the “PITL”))
Under the current Presidential Decree of the PITL, a foreign individual is considered as a tax resident of Korea if he or she has resided in Korea for 183 days or more over two taxable years.
With the 2017 Tax Amendments, a foreign individual will be considered as a tax resident of Korea if he or she has had a residence in Korea for 183 days or more over one taxable year.
The government expects that by easing the standard for tax residency in Korea, the number of visits to Korea by foreigners and Korean residents in other countries will increase.
Currently, Korean tax residents (with some exceptions) are required to report their foreign financial accounts if the aggregate balance of those accounts exceed KRW1 billion at the end of any month during a given year.
According to the 2017 Tax Amendments, Korean tax residents will now be required to report their foreign financial accounts if the aggregate balance exceed KRW500 million at the end of any month during a given year.
The number of Korean tax residents (individuals and companies) covered by obligation to report foreign financial accounts is expected to increase, and these individuals and companies should carefully consider whether they will newly be subject to the reporting requirement.
Under the current rules, if a taxpayer failed to submit (or made false statements on) part or all of the CRIT (local file, master file, and country-by-country report), a fine of KRW10 million is imposed on each failure to file (e.g., if the local file and master file are not submitted, a fine of KRW20 million would be imposed).
The proposed 2017 Tax Amendments will increase the fine to KRW30 million for each failure to file. This will increase the taxpayer burden that arises when a taxpayer fails to submit (or makes a mistake in) the CRIT.
The higher fines will be applicable to non-submission or false CRIT submitted after January 1, 2018.
Under the current PITL and CITL, a non-resident/foreign corporation is subject to personal income tax/corporate income tax, respectively, on on-exchange transfer of listed shares in Korea, if the non-resident/foreign corporation holds 25% or more of the listed Korean company.
The 2017 Tax Amendments will expand taxation of capital gains derived by a non-resident/foreign corporation from on-exchange transfer of listed shares such that the non-resident/foreign corporation holding 5% or more of the listed Korean company will be subject to capital gains tax.
With the decrease in the threshold ownership ratio of a non-resident/foreign corporation giving rise to capital gains taxation, if a tax treaty allows source country’s taxing rights on the transfer of shares with a threshold ownership ratio of less than 25% (e.g., 10% threshold ownership ratio) or if there is no tax treaty, the scope of capital gains taxation will increase in Korea.
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. Such withholding obligation applies if the total service fees paid to a foreign corporation exceeds KRW3 billion in a year. In addition, only Korean companies in the air transport, construction, and professional/scientific/technical service industries are obligated to withhold on the service fees paid to a foreign corporation.
The proposed 2017 Tax Amendments will increase the withholding tax rate to 19%, and cut the threshold of the total service fees to be paid to a foreign corporation from KRW 3 billion to KRW2 billion per year. 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.
6. Improvement of the harmonization regime for transfer pricing and customs valuation (Article 6-3 of the LCITA, Article 14-7 of the Presidential Decree of the LCITA, Article 37-2 of the Customs Act, and Article 31-4 of the Presidential Decree 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 proposed amendment, 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 an 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.
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 proposed 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.
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 proposed 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.
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 proposed 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-yuear tax incentive, respectively.
This new rule will be effective for application of tax incentives made on or after January 1, 2018.
10. Change in the standard for imposition of fines related to non-submission/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 new 2017 Tax Amendments, the fines are imposed for each failure to submit/false submission of the reportable documentation. This amendment will increase the fines for taxpayers that have failed to submit (or falsely submitted) the statement on foreign local company, etc.
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 proposed 2017 Tax Amendments will gradually reduce the limit for claiming NOL carryforwards for non-SME, with the limit of 60% of income for 2018 and 50% 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 60% limit will apply to the fiscal year beginning on or after January 1, 2018, while the 50% limit will apply to fiscal years beginning on or after January 1, 2019.