On July 26, 2021, the Ministry of Economy and Finance (MOEF) released its proposed amendments to the Korean tax laws for 2021. The three key policy initiatives announced in the proposals are aimed at: (i) promoting investment in national strategy technologies, such as semiconductors, batteries and vaccines, and supporting post-pandemic economic recovery by promoting employment, investment and consumption; (ii) pursuing inclusive growth, such as through expanded tax support for low-income earners and small enterprises, and fairness in taxation; and (iii) improving tax revenue and taxpayer convenience. The MOEF projects that the tax revenue generated from the proposed amendments will decrease by approximately KRW 1.5 trillion for the next five years, primarily as a result of the increased tax support for national strategy technologies and generous earned income subsidies. The MOEF is expected to submit the proposals to the National Assembly on September 3, 2021. Once the proposals are passed at the National Assembly, the amendments will become effective as of January 1, 2022.
Provided below is a summary of the major reforms proposed which may have an impact on foreign businesses with presence in Korea.
(1) Reporting requirements of liaison offices Under the current tax laws, foreign corporations having established liaison offices in Korea do not bear any reporting obligations with the tax office. The proposal introduces a new requirement for foreign corporations to submit detailed information on the status of the liaison office, including, among others, personal details of its representative, current status of the foreign corporation and any other branch offices within Korea, as well as a list of Korean counterparties. The submission will need to be file by February 10 of the following year.
This reporting obligation is intended to prevent the avoidance of tax by foreign corporations that establish liaison offices and effectively operate business activities via liaison offices. It is expected that the reports filed under this new scheme will allow the tax authorities to identify liaison offices that are conducting business activities sufficient to trigger permanent establishment, in which case such liaison offices would be required to register their business activities in Korea and pay relevant corporate income tax and value added tax.
The above reporting requirements will come into effect from the fiscal year beginning on or after January 1, 2022.
(2) Document retention requirements of simplified VAT registered businesses Under the current extraterritorial VAT regime, a foreign business supplying certain electronic services, such as games, apps, music, videos, software, and cloud services, to a Korean consumer is required to register as a simplified VAT registered business and meet VAT reporting and payment requirements. This regime applies not only to foreign businesses directly supplying services to Korean consumers, but also to foreign businesses supplying such services via open markets, such as Google and Amazon. Each simplified VAT registered business is required to report and pay VAT with the Korean tax authorities. Foreign suppliers subject to this regime are not required to issue tax invoices.
In an effort to increase taxpayer compliance and to verify the accuracy of VAT reporting, the proposal introduces a requirement for simplified VAT registered businesses to retain documents relevant to the supply of electronic services for five years and to submit such documents within 60 days of a submission request by the tax authorities. The information supplied to the tax authorities should contain details on the types of services provided, the service recipients, number of transactions and amounts, as well as timing of the supply.
The obligation to retain relevant documents will apply with respect to electronic services supplied from July 1, 2022 onwards.
(3) Beneficial ownership requirements for overseas investment vehicles Currently, overseas investment vehicles (OIV) are deemed as beneficial owners to Korean sourced income if:
(i) the OIV is liable to tax in its country of residence and such OIV was not established for purposes of unfairly reducing Korean tax; (ii) the OIV is recognized as the beneficial owner to the income under the relevant tax treaty; or (iii) the OIV is unable to identify its investors.
Under the propose amendments, requirements (i) and (ii) are revised so as to allow an OIV to be deemed as beneficial owner to Korean sourced income if:
(i) the OIV is a resident and liable to tax in the country of establishment under the relevant treaty and is entitled to treaty benefits with respect to the Korean source income under the relevant treaty; or (ii) the OIV, although it does not meet the requirements under (i), is deemed as the beneficial owner of Korean sourced income under a separate provision of the relevant tax treaty and is entitled to treaty benefits with respect to the Korean source income under the relevant treaty.
The proposed change applies to Korean sourced income paid on or after January 1, 2022.
(4) Issuance of tax residency certificates Under the current tax law, a tax residency certificate may be issued only if the taxpayer seeks to apply the reduced rates applicable under a relevant tax treaty. In order to accommodate other instances in which tax residency certificates may be required, the proposal includes the following reasons as grounds for issuance of tax residency certificates: (i) where a country which has entered into a tax treaty with Korea requests the application of a treaty for purposes other than to benefit from reduced rates; or (ii) the taxpayer is required to prove residency status for other tax reasons.
(5) Increase in threshold effective tax rate subject to CFC regime Under the current CFC regime, the undistributed earnings of a controlled foreign corporation (CFC) may be deemed as dividend income if the foreign jurisdiction in which the CFC is established levies a tax rate below the threshold effective rate of 15%. In an effort to prevent offshore tax evasion, the proposed change to the CFC regime is to amend the benchmark to impose deemed dividend tax if the local tax amount is less than 70% of the highest marginal Korean corporate income tax rate of 25%. In effect, under the proposed amendments, a low-tax regime would be considered to exist if the CFC pays effective income tax rate of 17.5% or less. Further, the amendments propose to broaden the scope of entities subject to the CFC rules by including trusts subject to corporate income tax, specifically special purpose trusts, trusts with beneficiary certificates and limited liability trusts, within the scope of CFCs.
This change is expected to come into effect from tax years beginning on or after January 1, 2022.
(6)Transfer pricing implications of the COVID-19 pandemic In an effort to incorporate some of the recommendations by the OECD in its ‘Guidance on the transfer pricing implications of the COVID-19 pandemic’, the proposal accommodates companies that suffered losses in periods affected by economic situations, such as economic depression, to be included in the comparability analysis.
In addition, the current transfer pricing mechanism grants tax authorities with the right to make an adjustment to the cost allocation between related parties involved in joint IP development to achieve an arm’s length allocation of costs. Under the proposal, force majeure may be invoked as an exception to the requirement for arm’s length allocation of such costs.