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8 Jan 2018

2017 Presidential Decree Amendments Proposal (International Tax)

YULCHON

2017 Presidential Decree Amendments Proposal (International Tax)

The Ministry of Strategy and Finance (“MOSF”) announced its proposed Presidential Decree amendments for 2017 tax reform (the “2017 Presidential Decree Amendments”) on January 8, 2018. The purpose of the 2017 Presidential Decree Amendments is to prescribe matters delegated to the Presidential Decree by the 2017 Tax Amendments.
We provide below a summary of the key proposed Presidential Decree amendments relating to international tax.

1.

Strengthening of taxation against multinational enterprises

A.

Denial of deduction for hybrid mismatch arrangement (Article 28-4 of the Presidential Decree 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 deny a deduction for such interest if the interest is viewed as dividends but not taxed in the recipient’s country.
Under the 2017 Presidential Decree Amendments, the definition of hybrid financial products and the requirement and the method for denial of deduction are prescribed. Hybrid financial products refer to financial products which have both debt and equity characteristics and the tax treatment of which is different per country. Deduction will be denied for interest if such interest is not included in taxable income of the recipient or less than 10% of the interest is included in taxable income of the recipient (on the ground that the interest is viewed as “dividends” under tax law of the other country) until the fiscal-year end of the recipient that starts within 12 months after the fiscal-year end of the Korean company paying the interest. 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.
This rule will be effective for taxable years beginning after January 1, 2018.

B.

Limiting deduction for interest expense of multinational enterprises (Article 28-3 of the Presidential Decree 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 30%, the excess interest will not be deductible under the 2017 Tax Amendments.
According to the 2017 Presidential Decree Amendments, Korean financial and insurance companies prescribed under the Korean Standard Industrial Classification will be excluded from the scope of companies subject to this new rule. In addition, adjusted net income for tax purposes will be calculated by starting with income for the relevant taxable year and adding back depreciation and amortization expense for tax purposes and net interest expense relating to a foreign related party. Net interest expense will be calculated by deducting interest received from a foreign related party from interest paid to such foreign related party.
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.

2.

Relaxing the requirements for tax residency in Korea (Article 4-3 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 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 Presidential Decree Amendments, a foreign individual will be considered 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 requirements for tax residency in Korea, the number of visits to Korea by foreigners and Korean residents in other countries will increase.
This rule will be effective for taxable years beginning after January 1, 2018.

3.

Reinforcement of management of foreign sources of tax revenues (Article 49 of the Presidential Decree of the LCITA)

A.

Decrease in value of reportable foreign financial accounts (Article 49 of the Presidential Decree of the LCITA)

Currently, Korean tax residents (with some exceptions) are required to report their foreign financial accounts if the aggregate balance of those accounts exceeds KRW1 billion at the end of any month during a given year.
According to the 2017 Presidential Decree Amendments, Korean tax residents will now be required to report their foreign financial accounts if the aggregate balance exceeds 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.
This amendment will be applicable to foreign financial accounts held by Korean tax residents in 2018 and thereafter.

B.

Increase in fines for non-compliance with Combined Report of International Transactions (CRIT) requirement (Article 51(1) of the Presidential Decree of the LCITA)

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 Presidential Decree Amendments will increase the fine to KRW30 million for each failure to file. This will increase the taxpayer’s 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.

4.

Strengthening of taxation of non-resident/foreign corporation’s Korean source income

A.

Expansion of taxation of non-resident/foreign corporation’s capital gains from transfer of listed shares (Article 179 of the Presidential Decree of the PITL and Article 132(8) of the Presidential Decree of the Corporate Income Tax Law (the “CITL”))

Under the current Presidential Decree of the 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 Presidential Decree 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.
This amendment will apply to on-exchange transfer of listed shares made after July 1, 2018.

B.

Expansion of withholding agent with respect to income derived by dispatched foreign employees (Article 207-10 of the Presidential Decree of the PITL)

Under the current Presidential Decree of the PITL, a Korean company is required to withhold the service fees, as income tax, paid to a foreign corporation for services provided by the foreign corporation’s dispatched employees into Korea, and 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 Presidential Decree Amendments will cut the threshold of the total service fees to be paid to a foreign corporation from KRW3 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. As a result, the withholding obligation of a Korean company which pays service fees to a foreign corporation for services provided by the foreign corporation’s dispatched employees into Korea has been expanded.
The new withholding rule will be applicable to payments of service fees on or after July 1, 2018.

5.

Improvement of the effectiveness of the harmonization regime for transfer pricing and customs valuation (Article 14-7, 8 of the Presidential Decree of the LCITA, Article 31-2, 3 of the Presidential Decree of the Customs Act)

In accordance with the prior 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 Presidential Decree 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.
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.
This amendment will apply to application for APAs covering taxable years beginning on or after January 1, 2018.

6.

Imposition of fines related to non-submission/false submission of statement on foreign subsidiaries of a Korean resident company, etc. (Table 5 of the Presidential Decree of the PITL and Table 2 of the Presidential Decree of the CITL)

According to the 2017 Tax Amendments, if a statement on foreign subsidiaries of a Korean resident company, etc., is not submitted or falsely submitted, a fine of KRW50 million or less is imposed on each individual or corporation with the submission obligation.
Under the current Presidential Decree of the PITL and CITL, if a statement on foreign subsidiaries of a Korean resident company, etc., is not submitted or falsely submitted, a fine of KRW3 million or KRW5 million is imposed on each individual or corporation with the submission obligation. With the 2017 Presidential Decree Amendments, the fines are imposed for each failure to submit or false submission of the reportable documentation (a fine of KRW3 million is imposed for individual, and a fine of KRW5 million is imposed for corporation). This amendment will increase the fines for taxpayers that have failed to submit (or falsely submitted) the statement on foreign local company, etc.
This amendment will apply to non-submission or false submission made on or after January 1, 2018.

7.

Expansion of the scope of use of documents submitted for application for APA (Article 9 of the Presidential Decree of the LCITA)

Under the current Presidential Decree of the LCITA, the National Tax Service cannot use documents submitted for application for APA for any purpose other than for examining application for APA and ex post facto management.
The 2017 Presidential Decree Amendments will expand the scope of use of documents submitted for application for APA so that the National Tax Service may use such documents for purposes of exchanging information with the competent authority of the other Contracting State. As a result, taxpayers should consider that documents submitted to the National Tax Service for application for APA may be provided to the tax authority of the country where its foreign related party is located and thus take heed when submitting such documents to the National Tax Service.
This amendment will be applicable to exchange of information made between the National Tax Service and the competent authority of the other Contracting State on or after January 1, 2018.

CONTACT

Kim, Dong Soo +82-2-528-5219 dskim@yulchon.com
Lee, Kyung Geun +82-2-528-5238 kygelee@yulchon.com
Jo, Joon Yung +82-2-528-5594 jyjo@yulchon.com
Lee, Sun Young +82-2-528-5555 sunyoung@yulchon.com
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