IBA National Report Tax Republic of Korea

Transcription

1 IBA National Report Tax Republic of Korea National Reporter: Soo-Jeong Ahn Yulchon LLC Seoul, Korea Date: May 17, 2013 A. LEGISLATIVE DEVELOPMENTS 1. Foreign Entity Classification Rules a. Foreign entity classification rule in the amendment Korean tax law provides for separate sets of income tax regulation: corporations are subject to the Corporate Income Tax Law ( CITL ), whereas individuals are subject to the Personal Income Tax Law ( PITL ). However, under the previous regulation, it was not clear whether an unincorporated foreign entity should be treated as a corporation or as a pass-through entity for Korean tax purposes. The amendment to the CITL and the Presidential Decrees thereunder, which came into effect this year, provides a definitive set of criteria for classifying foreign entities in order to enhance the predictability and legal stability for foreign investors. If the foreign entity falls under one (or more) of the following criteria (indicia of a corporate entity), it will be treated as a foreign corporation for Korean tax purposes: Has a juridical personality granted by laws of the establishment jurisdiction Solely consists of members (partners) with limited liability Has an independent existence enabling it to act as a principal with rights and obligations separate from that of its partners Possesses similar legal characteristics as a domestic (Korean) entity that is a corporate entity under Korean corporate law Under the amendment, the NTS is to publish a list of frequently used foreign entity types and their classification for Korean tax purposes based on the above criteria. The NTS has yet to publish such a list and is in the process of surveying foreign entity types. The amendment is effective with respect to taxable years commencing on or after

2 Page 2/7 January 1, b. Clarification of taxation of foreign entities that are not corporations Along the same vein, Korean tax law is also amended to clarify the tax treatment of those foreign entities that do not fall under a corporation under the foregoing rules as follows: Foreign entity with a permanent establishment in Korea If information on partners and profit allocation ratio is submitted and business registration is made Tax the partners If no information submitted or no business registration made Tax the entity as one non-resident Foreign entity without a permanent establishment in Korea If information on If no information partners and profit submitted allocation ratio is submitted Tax the partners Tax the entity as one non-resident The amendment is effective with respect to taxable years commencing on or after January 1, c. Special election afforded to foreign eligible non-corporate entities Korean tax law provides certain domestic non-corporate entities with an election to be treated as partnership (to be more exact, it is taxed similarly to a partnership (i.e., passthrough) in the sense that there is no entity-level taxation, but the detailed rules are different in many respects; accordingly, it is frequently referred to as a quasi passthrough treatment). However, such a partnership election is afforded only to domestic entities, and not to any foreign entities. In an effort to eliminate this tax inequity and also to attract foreign investments, an amendment to Korean tax law expands the special partnership election regime to include foreign eligible entities carrying on a business in Korea through a permanent establishment. Under the amendment, there is no entity (partnership)-level tax if the eligible foreign entity elects to be treated as the partnership. Instead, partners would be taxed with respect to their share of income. In the case of limited partners, as passive investors in such foreign entity, they would not be treated as deriving business income from the permanent establishment; instead, they would be subject to Korean withholding tax in respect of their share of Korean income as dividend at the rate of 22%. If the limited partner is entitled to the benefits of a tax treaty between its residence jurisdiction and Korea, a reduced treaty rate (ranging from 5 to 16.5%, depending on the treaty) should be available. The requirements for foreign entities eligible to elect the special partnership election are as follows:

3 Page 3/7 The foreign entity possesses similar legal characteristics as those with a Korean non-corporate entity eligible for the special partnership election; conducts a business through a permanent establishment in Korea; and qualifies for a similar tax treatment in the country of organisation. After one year grace period, the proposed change will be applicable to taxable years commencing on or after January 1, Application of Transfer Pricing Rules to Intra-Company (Head Office- Branch) Transactions Korea s existing transfer pricing regulations have been amended, in order to conform to the some of the changes adopted by the OECD Model Tax Convention. To be more specific, the previous transfer pricing rules failed to provide clear guidelines as to the application of the transfer pricing principles to intra-company transactions between a Korean branch and the head office of a foreign corporation. The amendments address these issues by reflecting more refined standards based on the principles defined in Article 7 of the OECD Model Tax Convention, as amended in July Thus, it is made clear that transactions between the head office and its branch be also subject to the arm s length principle. In particular, the amendment allows a charge of mark-up on intra-company dealings such as management services provided by the head office; for expenses incurred in an intra-company transaction, a tax deduction is allowed as well, but only to the extent actually paid per the agreed-upon intra-company contract. The detailed rules including the provisions relating to the recognition of gains and losses and the calculation of arm s length price are set out in the Presidential Decree amended on February 15, It is notable that the amendment does not fully adopt the provisions under the OECD Model Tax Convention. Though the transactions between the head office and its branch are generally subject to arm s length principle, the new rules disallow interest and fees arising from intra-company loans and guarantee transactions, respectively, even if such interest and fees are at arm s length. Such disallowance, which deviates from the OECD standards, can be interpreted as efforts by the tax authorities to prevent possible abuse of the new rules. The rule will be applicable to taxable years commencing after January 1, MOSF s Guideline on Arm s Length Guaranty Fees The NTS has recently made aggressive challenges concerning payment guaranty fees and made a substantial amount of tax assessments against Korean multi-national enterprises, on the ground that the level of such fees charged by the Korea parent

4 Page 4/7 company was not sufficient to meet the arm s length principle. When a substantial number of cases were appealed, it came to the attention of both the MOSF and the taxpayers that there is no clear statutory guideline for determining the arm s length guaranty fees, creating vast uncertainties. In an effort to reduce further confusions between the NTS and taxpayers, the MOSF has enacted a new provision setting forth the standards of determining arm s length guaranty fees in the Presidential Decree under the Law for Coordination of International Tax Affairs ( PD-LCITA ). The newly amended Article 6-2(3) of the PD-LCITA stipulates a set of methods for determining arm s length price, specifically applicable to guaranty fees. The specific methods stipulated are (i) benefit approach (i.e., benefits derived in the form of the reduced cost of raising capital), (ii) cost approach (i.e., an expected loss to the guarantor), and (iii) cost-benefit approach (i.e., a reasonable compromise between (i) and (ii)). The amendment delegates many detailed points and refinements to the Ministerial Decree, which was promulgated on February 23, The Ministerial Decree specifies detailed factors that include not only traditional financial factors (such as interest differentials and credit rating) but also non-financial factors (such as geographical region, industry, level of technology, and market position). Article 6-2(3) also provides for a safe harbor, whereby fees determined by methods meeting certain requirements would be deemed arm s length. Although the amendment was motivated by the need to address the ambiguity concerning guaranty fees for Korean multinationals, the same principle should apply equally to foreign multination corporations with affiliates in Korea. This may provide a planning opportunity for foreign multinationals with Korean operations. The charge of payment guaranty fees to the Korean affiliates usually subject them to stringent documentation requirements, which, in the absence of a specific statutory guideline on what constitutes arm s length guaranty fees, could be overbearing. The amendment could substantially ameliorate the burden by its clear stipulation of arm s length price and adoption of a safe harbor. As part of the planning consideration, potential additional costs emanating from the charge of guaranty fees (such as withholding tax and proxy VAT) should be carefully weighed against the benefits to be gained. Also, consideration should be given to an impact on the effective tax rate of the affiliated group as a whole (i.e. by taking into account of any difference in the tax rates between jurisdictions of the parent and subsidiaries as well as the availability of foreign tax credit). The amendment will take effect with respect to payment guarantees provided after February 15, 2013, the effective date of the PD-LCITA. 4. New Deemed Gift Tax with respect to Giving Excessive Work Korea has adopted a new and rather creative way of penalizing a concentration of

5 Page 5/7 outsourced work to a related vendor, by imposing the gift tax on the vendor s controlling shareholder. This rule was adopted as amendment to the existing Gift Tax Act as part of the government s efforts to achieve economic democracy. The new gift tax rule attempts to eliminate large conglomerates practice of dealing excessively with a related vendor, without due regard to qualification of competing unrelated vendors. Under the rule, any corporation ( C ) delegating more than what is deemed to be the fair share of work to a vendor ( V ), whose controlling shareholder is related to C (i.e., the controlling shareholder and his family members (such as children, cousins, and spouse) effectively control C), is deemed to increase the value of such vendor (through the excessive increase in V s revenues). This effectively amounts to transfer of wealth to the related controlling shareholder; therefore, the new rule treats such increase in value (after-tax profits) as a gift and imposes the gift tax in the hands of V s controlling shareholder (as donee). The new gift tax regime was initially applicable to foreign-invested corporations as well as Korean corporations. However, in March 2013, the Ministry of Strategy and Finance (the MOSF ) announced that it would exclude foreign-invested corporations in which foreign investors held more than 50% of their shares. The MOSF s decision was explained as emanating from the concern that there is no similar regime abroad and there is a possibility of a trade dispute if Korea assesses such gift tax. Korean corporations will be subject to the new gift tax rule, and thus, are expected to consider changing the business structuring (including supply chain) to minimize the exposure. For instance, these corporations may merge the beneficiary corporation so that the transaction will be intra-company rather than inter-company, thereby avoiding the application of the deemed gift tax rule. The new tax rules went into effect from January 1, However, under the new rule, the taxpayer is considered to receive the deemed gifted as of the end of the fiscal year of the beneficiary corporation and is required to file and pay the deemed gift tax within 3 months after the due date for the corporate tax return of the beneficiary corporation (which is the end of March 2013 for calendar year corporations). Thus, most taxpayers are facing the obligation to file and pay the deemed gift tax by June 30, The new tax rules are currently a subject of heated debate, as to the constitutionality (it taxes unrealized gain on the part of the taxpayer), fairness (the taxpayer may be subject to double taxation, once via deemed gift tax and again when receiving dividends from the beneficiary corporation) and practicability (it is difficult for the taxpayer to calculate the amount of deemed gift without knowing the detailed operations figures of the outsourcing corporation). B. JUDICIAL DECISIONS IN TREATY AREA

6 Page 6/7 In the first half of 2012, the Supreme Court rendered a series of much-awaited decisions concerning the substance-over-form principle (Korea s domestic general anti-abuse rule) in the context of the tax treaty application. Among others, in April 2012, the Supreme Court rendered a decision involving LaSalle 1, where it confirmed the domestic substance over form principle can be applied to deny the treaty benefit of the immediate holding company of the relevant Korean asset. Continuing the same trend, in October 2012, the Supreme Court rendered another decision involving WiniaMando 2 and firmly established the application of the substance over form principle in determining the substantive owner for the purpose of applying the treaty entitlement. It also re-affirmed a few other points relevant to the investment structuring. We discuss the relevant facts and key points of the decision below. 1. Relevant Facts A Cayman Limited Partnership ( Cayman LP ) established a Korean company ( WiniaMando ) underneath a series of holding companies, including Belgium NV. WiniaMando acquired and operated a business division from another Korean company. From this investment, Belgium NV received dividends income from WiniaMando and also obtained capital gains income from sale of shares in WiniaMando. The NTS argued that since Belgium NV was only established as a conduit company to avoid tax, corporate income tax should be determined in reference to Cayman LP as the substantive owner of the dividends and capital gains income. The taxpayer argued that Belgium NV should be respected as the substantive owner of the income and therefore the Korea-Belgium tax treaty should apply. The taxpayer appealed the assessment to the Administrative Court and the High Court in turn, but at each level, the courts found in favor of NTS. The taxpayer, then, appealed to the Supreme Court. 2. Supreme Court Decision Since Cayman LP has an independent existence enabling it to act as a principal with rights and obligations separate from that of its partners, it is a foreign corporation for the Korean tax purpose. Belgium NV was party to the transaction only in form; therefore, the substantive owner of the income was Cayman LP. 3. Implication of the Decision 1 LaSalle Asia Recovery International I L.P. v. Head of Jong-ro Tax Office, 2010Du11948 (Supreme Court of Korea, April 26, 2012). 2 WiniaMando Inc. v. Head of Cheonan Tax Office, 2010Du25466 (Supreme Court of Korea, October 25, 2012).

7 Page 7/7 The WiniaMando Decision continued the line of reasoning adopted in the previous decisions and firmly established the application of the substance over form principle in determining the substantive owner for the purpose of applying treaty benefits. It also re-affirmed the proposition that a foreign entity is to be characterized for Korean tax purposes in accordance with their legal characteristics, rather than the tax treatment in their residence jurisdiction. In this case, the Court viewed a Cayman LP as a foreign corporation, taxable under the CITL. In addition, while the decision on LaSalle did not specifically rule on whether a LP, rather than the investors in it, should be the substantive owner of income, the Court in WiniaMando held that, given the relevant circumstances, the lower court was not wrong in viewing the limited partnership, as opposed to investors in it, as substantive owner of income. In light of the WiniaMando and LaSalle decisions and recent developments in the Korean tax arena, it is advised that extreme care be exercised in any treaty-based structuring to ensure sufficient substance. C. OTHER DEVELOPMENTS OF INTEREST The election of President Park Guen-hye has heralded a time of strong efforts by both the Executive and the National Assembly to enact measures to achieve economic democracy. As part of such efforts: NTS has intensified its tax audits; all large corporations with assets of at least KRW 500 billion are subject to an audit every five years without exception. NTS has also stepped up its enforcement against offshore tax evasion by, for example, announcing that it plans to obtain a list of 100,000 taxpayers with foreign income from 45 countries that has entered into tax information exchange agreements with Korea. The National Assembly has enacted provisions on the deemed gift tax as seen above to combat large business conglomerates practice of giving excessive work to its related vendors. The National Assembly has also amended tax law so as to trigger gift tax in respect of a deposit made with a financial institution by parents in the name of their children, unless proven otherwise. Making a deposit in another family member s name had long been a customary practice in Korea and was treated for tax purposes merely as the parents own deposit in nominees (the children s) name and thus not considered to trigger the gift tax.