Samil Commentary. Korean Tax Update. Proposed Changes to Dividend Received Deduction Rules for Nonfinancial. May 31, 2018

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1 Samil Commentary May 31, 2018 Proposed Changes to DRD Rules for Nonfinancial Holding Company Tax Law Amended to Increase Youth Employment NTS Tax Audit to Tackle Offshore Tax Avoidance Revised Regulations to Implement Matters for Financial Information Exchange Agreements Rulings Update Proposed Changes to Dividend Received Deduction Rules for Nonfinancial Holding Company The Ministry of Strategy and Finance (MOSF) announced a bill to amend the Presidential Decree of the Corporate Income Tax Law (CITL) on April 30, 2018 and invite public comments on the bill from April 30 to June 11, The proposed changes contained in the bill will be implemented after being finalized in a cabinet meeting. The bill contains a change that would supplement the subsidiary requirements for non-financial holding companies in connection with the application of the dividend received deduction (DRD) rules so as to reflect the recent industry classification change for non-financial holding companies under the revised Korea Standard Industry Classification (KSIC). Previously, a non-financial holding company was classified as professional, scientific and technical service under the old KSIC and it has been reclassified to financial service and insurance businesses under the revised KSIC, effective on or after July 1, Currently, higher DRD rates apply to holding companies compared with other general companies (as seen in the table below). However, non-financial holding companies are not eligible for the higher DRD rates if the related subsidiary engages in financial service or insurance business. According to the MOSF, the purpose of the proposed amendment is to expressly stipulate in the Presidential Decree of the CITL that where a subsidiary of a nonfinancial holding company is an intermediary non-financial holding company, the intermediary non-financial holding company should not be regarded as a corporation engaged in financial service and insurance business for tax purposes. This ensures that despite the industry classification change under the revised KSIC, the DRD rules for non-financial holding companies should apply in the same manner as before.

2 Listed subsidiary Unlisted subsidiary General Company (other than Holding Company) Holding Company Ownership DRD Ownership DRD 100% 100% More than 40% to 100% 100% More than 30% to less than 100% 50% 20% to 40% or less 80% 30% or less 30% Less than 20% 30% 100% More than 50% to less than 100% 50% or less 100% 50% 30% More than 80% to 100% 40% to 80% or less Less than 40% 100% 80% 30% Tax Law Amended to Increase Youth Employment The Strategy and Finance Committee of the National Assembly approved on May 17, 2018 a bill to amend the Special Tax Treatment Control Law (STTCL) that includes several changes to initially proposed tax benefits to boost youth employment in small- and medium-sized companies or startup businesses. The following proposed changes included in the bill will be implemented after being approved by the Legislation and Judiciary Committee and in the plenary session of the National Assembly at the end of May. Tax exemption for earned income tax for the youth employed in SMEs Currently, when persons that are 29 years old or younger are hired by small- and mediumsized enterprises (SMEs), they are entitled to a 70% reduction in earned income tax for three years. The income tax exemption rate will increase from 70% to 90%. The age limit will increase from 29 years to 34 years. The exemption period will increase from three years to five years. The temporary earned income tax exemption will be extended to the employment achieved until the end of December 2021, three years later than the scheduled termination at the end of December Tax exemption for youth startup SMEs and micro business startups A 50% tax exemption will be provided for five years even though youth startup SMEs or micro business startups are incorporated in metropolitan areas. For those startups incorporated in areas other than metropolitan areas, a 100% tax exemption will be granted for five years, compared with the current 75% tax exemption for the first three years and a 50% exemption for the two subsequent years. Three types of business including retail sale via mail order houses or the Internet will be added to the list of businesses eligible for the tax exemption. The age limit will increase from 29 years to 34 years. The temporary tax exemption will be available until the end of December 2021, three years later than the scheduled termination at the end of December However, the proposed rules to expand tax incentives to encourage employment growth and businesses returning to Korea by means of relocation or downsizing of their PricewaterhouseCoopers Page 2

3 operations, which were contained in the original government bill, will be discussed in the regular session of the National Assembly. NTS Undertakes Tax Audit to Tackle Offshore Tax Evasion On May 2, the National Tax Service (NTS) announced that it has initiated a focused examination of 39 taxpayers suspected of hiding their income or assets overseas to evade taxes. During 2017, the NTS tax audit targeted 233 taxpayers suspected of hiding their income or property overseas to evade taxes and collected a total tax amount of KRW 1.3 trillion. The investigation of ten taxpayers was escalated to criminal cases and accusations were pursued against six out of those ten taxpayers. In addition, the NTS imposed a total of KRW12 billion in penalties in the same year against 53 taxpayers who had failed to meet the requirements for reporting their offshore financial accounts, while accusing 18 taxpayers of failing to meet the reporting requirements on a significant level. The NTS said that the tax audit targets were selected among corporations and wealthy individuals who were suspected of allegedly avoiding taxes by hiding their income and property overseas. The selection of targets was based on a comprehensive analysis of a range of information such as foreign exchange transactions, import and export transactions, overseas investments, filings of overseas income and property information with foreign government authorities and other information collected via fiscal information exchange arrangements with foreign governments, etc. Tax audit on inheritance and gift tax avoidance The NTS announced on May 16 that it initiated a tax audit targeting 50 large companies or high net worth individuals. The targets were identified via a precision analysis of a list of those suspected of certain categories of activities, for example engaging in certain related party transactions to circumvent limitations on ownership or business management succession, illegal transfer of corporate funds, property ownership or management in another person s name, and irregular financial transaction to avoid inheritance and gift tax. During 2017, the NTS undertook investigations of 1,307 cases and collected a total of KRW2.8 trillion in back taxes. The tax audits on 40 of them were escalated to criminal cases which ultimately resulted in 23 taxpayers who were accused of tax avoidance. MOSF Revises the Rules to Implement Matters for Agreements on Periodic Exchange of Financial Information The global trend is that countries are strengthening the taxation of offshore income earned overseas and there is increased commitment to the intergovernmental exchange of information in order to tackle tax avoidance through the concealment of assets overseas. Korea has periodically exchanged financial account information with the US since PricewaterhouseCoopers Page 3

4 Agreement to Improve International Tax Compliance between the two countries came into force in September Korea also has exchanged financial account information with other countries based on the Multilateral Competent Authority Agreement ( MCAA ) on Automatic Exchange of Financial Account Information. The MOSF published a circular (No ) to revise the rules to implement matters concerning the agreements on the periodic exchange of financial information. The purpose of the revision to be enforced from May 1, 2018 is to adjust the scope of jurisdictions where domestic financial institutions must report the required information to the tax authorities by the end of June according to such agreements. The revision also aims to make improvements to facilitate and ensure the enforcement of financial information exchange by enhancing the verification process of reported financial accounts. The agreements covered by the revised regulations include: 1. OECD Multilateral Convention on Mutual Administrative Assistance in Tax Matters 2. MCAA on Automatic Exchange of Financial Account Information 3. Intergovernmental agreement between Korea and the US to Comply with the US Foreign Account Tax Compliance Act 4. Agreement on the Automatic Exchange of Financial Account Information between Korea and Singapore 5. Agreement on the Automatic Exchange of Financial Account Information between Korea and Hong Kong Under these agreements on the periodic and automatic exchanges of financial account information, the Korean tax authorities must provide information on domestic financial accounts held by foreign residents under 60 tax jurisdictions by 30 September 2018 and reciprocally receive information on foreign financial accounts held by Korean residents from 78 tax jurisdictions. The information to be reported by financial institutions include: Personal identification information: Name, address, residential jurisdiction, tax identification number, date of birth. Financial account information: Account number, name and identification number of reporting financial institutions Other financial information: Year-end balance at financial accounts, total amount of income accrued from foreign accounts including PricewaterhouseCoopers Page 4

5 Rulings Update Whether goodwill recorded for accounting purposes could be treated as appraisal gains on merger subject to corporate income tax In this case, on May 1, 2007, a Korean company (the dissolving company ) was merged into another Korean company (the surviving company ) and for the merger transaction, the surviving company recorded goodwill for the difference between the merger consideration and the net asset value of the dissolving company for accounting purposes. For tax purposes, the surviving company made a tax adjustment to deny the goodwill per its tax return as it viewed that the goodwill recorded in its books would not be accepted as an amortizable asset for tax purposes. However, the tax authorities asserted that the goodwill would constitute appraisal gains on the merger subject to corporate income tax while the surviving company could amortize the goodwill for tax purpose. Under the former CITL (effective prior to the amendment on December 31, 2009), where a surviving company recorded assets transferred from a dissolving company at an appraised value exceeding the book value of the assets, the appraisal gains on the merger were generally treated as taxable income of the surviving company. Also, according to the former Presidential Decree of the CITL (effective prior to the amendment on June 8, 2010), goodwill arising from a merger could be treated as an amortisable asset for tax purposes to the extent that consideration was paid for the business value of the dissolving company such as trademarks, transactional relationship or trade secrets, etc. in case the surviving company acquired the assets of the dissolving company at an appraised value. The Supreme Court interpreted that in order to impose corporate income tax on the goodwill arising from a merger by treating it as appraisal gains on merger, the surviving company should have recognised the dissolving company s trademarks, etc., as the intangible assets that can generate excess earnings in the future and paid consideration for the intangible assets based on the valuation of the assets. Also, the Court interpreted that whether the surviving company would value the intangible assets should be determined objectively based on all surrounding facts and circumstances such as the background and motives behind the merger, the business status of both the surviving and dissolving companies around the merger, tax filings relating to the merger and it should not be inferred from the fact that the goodwill was recorded in the books under Korean GAAP. In this respect, the Supreme Court decided in favour of the taxpayer that the goodwill recorded in its books should not be treated as appraisal gains on merger as it was difficult to view that the surviving company would recognise the intangible assets for the dissolving company s trademarks, etc. that can generate excess earnings and pay consideration for the intangible assets based on the valuation of the dissolving company s business in light of the facts and circumstances in this case (e.g., the dissolving company had suffered from significant losses and was on the verge of bankruptcy) and so, the goodwill at issue would not be accepted as an asset for tax purposes. (Daebeop2015 du41463, PricewaterhouseCoopers Page 5

6 The Supreme Court decision may provide clear guidance for the requirements for taxing goodwill arising from a merger transaction under the former CITL (applicable to a merger before or on June 30, 2010). Also, under the current merger taxation regime, the decision may be referred in determining the deductibility of the merger consideration over the value of net assets transferred from a dissolving company in case of a non-qualified merger. Whether the sale of voluntary emission reductions would be subject to VAT In this case, a company participating in a voluntary greenhouse gas emission reduction project sold the emission reductions to the Korean government via a state-run organization as subcontracted by the government for the operation of the emission reduction project. The company received consideration in question from the state-run organization for the sale of the emission reductions from the 1 st quarter of 2010 to the 1 st quarter of This case concerns whether the emission reductions would fall under goods for VAT purposes and so whether the transfer of the reductions would be subject to VAT. Generally, the delivery or transfer of goods by contractual or legal causes should be subject to VAT. The term goods means any tangibles or intangibles such as rights having property value according to the VAT Law. For the scope of intangibles having property value, the Supreme Court ruled in the past that whether certain intangibles have property value should not be determined based on the subjective valuation between transaction parties, but determined objectively based on the economic exchange value of the intangibles. The Court further ruled that in order to fall under the meaning of supply of rights for VAT purposes, the transferred rights should be utilisable in practice and it should have an objective property value such as an economic exchange value. In April 2018, the Supreme Court decided against the taxpayer on the basis that the emission reductions sold by the company could be treated as the rights having property value since the certified emission reductions could be traded with other entities, government, etc. and it could be viewed that the property value of the reductions was recognised by the government given the consideration paid for the purchase of the reductions. The Court further decided that since the ownership to the emission reductions was attributed to the government while the emission reductions of the company was reduced, the attribution of the emission reductions should be viewed as the supply of goods. (Daebeop2017 du65524, ) This latest decision seems meaningful in that it is likely to set a case for how the sale of the rights having property value such as the emission reductions is treated for VAT PricewaterhouseCoopers Page 6

7 Whether the contributory charges for the failure to meet a mandatory employment rate for disabled persons would be deductible for tax purpose Most companies except certain small-sized companies as specified by relevant laws must employ disabled persons at a certain rate and shall be subject to contributory charges if they fail to meet the mandatory employment rate. For an inquiry of the deduction of such contributory charges, the MOSF responded that the charges should not be deducted as they are imposed as sanctions for the failure of duties or a violation of the requirements under relevant laws. (Corporate Tax Division-145, ) It disagrees with the previous rulings released by the NTS that treated such charges as deductible expenses. (Seoi , , etc.). As such, in order to protect taxpayers who relied on the earlier rulings of the NTS, the MOSF ruled that its latest ruling should apply to contributory charges filed and paid on or after February 21, 2018 when it issued the new PricewaterhouseCoopers Page 7

8 For more information, please contact: International Tax Services Alex Joong-Hyun Lee Sang-Do Lee Sang-Woon Kim Michael Kim Dong-bok Lee Chong-Man Chung Hyun-Chang Shin Chang-ho Jo Il-Kyu Cha Nam-Gyo Oh Young-Ok Kim Robert Browell Domestic Tax Services Jung-Il Joo Yeon-Gwan Oh Young-Sin Lee Chul-Jin Hwang Jin-Ho Kim Min-Soo Jung Chan-Woo Chung Bok-Suk Jung Hyungsuk Nam Dong-Jin Nam Seungdo Na Sung-Wook Cho Sun-Heung Jung Youngsuk Noh Hye-Won Choe Transfer Pricing & International Trade Heui-Tae Lee Henry An Won-Yeob Chon Junghwan Cho Global Mobility Services (GMS) Younsung Chung Corporate Administrative Services (CAS) Jina Park Inheritance & Gift Tax Services Hyun-Jong Lee Financial Tax Services In-Hee Yoon Taejin Park Hoon Jung Nonprofit Corporation Service Center YoungSun Pyun Small and Midsize Enterprise and Startups Service Center Bong-Kyoon Kim Knowledge & Innovation Han-Chul Cho Samil Infomine/ Samil Academy Sang-Keun Song Mirah Kang Samil Tax Corp. Nam-Bok Jo PwC Customs Service Sang-Tae Moon Stay current and connected. Our monthly newsletters and ad hoc alerts keep you updated on Korean tax laws as well as significant business regulatory developments. Please send an if you like to subscribe or want to add someone to the mailing list to: The information contained in this publication is for general guidance on matters of interest only and is not meant to be comprehensive. The application and impact of laws can vary widely based on the particular facts involved. For more information, please contact your usual Samil PwC client service team or professionals listed above. C 2018 Samil PricewaterhouseCoopers. All rights PricewaterhouseCoopers Page 8