On July 26, 2021, the Ministry of Economy and Finance (MOEF) published its proposed changes to Korean tax laws for 2021. The three main policy initiatives announced in the proposals aim to: (i) encourage investment in national strategy technologies, e.g. semiconductors, batteries and vaccines, and support post-pandemic economic recovery by stimulating employment, investment and consumption; (ii) pursue inclusive growth, such as through expanded tax support for low-income earners and small businesses, and fairness in taxation; and (iii) improving tax revenues and taxpayer convenience. The MOEF expects tax revenue from the proposed changes to decrease by around KRW 1.5 trillion over the next five years, mainly due to increased tax support for national strategy technologies and generous income subsidies. The MOEF is expected to submit the proposals to the National Assembly on September 3, 2021. Once the proposals have been approved by the National Assembly, the changes will take effect on January 1, 2022.
Below is a summary of the main proposed reforms that may affect foreign companies with a presence in Korea.
(1) Reporting obligations of the liaison offices Under the applicable tax laws, foreign companies that have set up liaison offices in Korea do not have to report to the tax authorities. The proposal introduces a new requirement for overseas companies to provide detailed information on the status of the liaison office, including but not limited to the personal information of its representative, the current status of the overseas company and all other branches in Korea, and a list of Korean counterparties. The submission must be made by February 10 of the following year.
This reporting requirement is intended to prevent tax avoidance by foreign corporations, who set up liaison offices and conduct their business effectively through liaison offices. The reports filed under this new regime are expected to enable tax authorities to identify liaison offices that are engaged in sufficient business to set up a permanent establishment. In this case, these liaison offices would have to register their business in Korea and pay corporation tax and sales tax accordingly.
The above reporting obligations come into force from the financial year beginning on or after January 1, 2022.
(2) Retention obligations of simplified VAT-registered companies Under the current extraterritorial VAT regime, a foreign company providing certain electronic services such as games, apps, music, videos, software and cloud services to a Korean consumer must register as a simplified VAT company and meet VAT returns and payment requirements. This regulation applies not only to foreign companies that offer services directly to Korean consumers, but also to foreign companies that offer such services through open markets such as Google and Amazon. Every simplified sales tax registered company must register and pay sales tax to the Korean tax authorities. Foreign suppliers who are subject to this regulation do not have to issue tax invoices.
In order to improve compliance by taxpayers and to check the accuracy of VAT reports, the proposal provides that simplified VAT companies keep the documents relevant to the provision of electronic services for five years and post these documents within 60 days Their submission must submit a request by the tax office. The information submitted to the tax authorities should include details of the nature of the service provided, the recipients of the service, the number of transactions and amounts, and the timing of the service.
For electronic services that are provided from July 1, 2022, the obligation to keep relevant documents applies.
(3) Requirements for beneficial ownership of foreign investment vehicles Currently, Foreign Investment Vehicles (OIV) are considered beneficial owners of Korean income if:
(i) the OIV is taxable in its country of residence and was not established to unfairly lower the Korean tax; (ii) the OIV is recognized as the beneficial owner of the income under the relevant double taxation agreement; or (iii) the OIV is unable to identify its investors.
According to the proposed changes, requirements (i) and (ii) will be revised so that an OIV is considered the beneficial owner of Korean income if:
(i) the OIV is resident and taxable in the country of establishment under the relevant agreement and is entitled to contractual benefits in relation to the income from Korean sources under the relevant agreement; or (ii) the OIV, although not meeting the requirements of (i), is deemed to be the beneficial owner of the Korean income under a separate provision of the relevant double taxation treaty and is entitled to treaty benefits in relation to the Korean source of income under the relevant treaty.
The proposed change applies to Korean source income paid on or after January 1, 2022.
(4) Issuing certificates of residence According to current tax law, a certificate of residence may only be issued if the taxpayer wishes to apply the reduced rates applicable under a relevant double taxation agreement. To accommodate other cases where a Certificate of Tax Residence may be required, the proposal includes the following grounds for issuing certificates of tax residence: (i) if a country that has a tax treaty with Korea, the use of a contract for purposes other than the use of reduced rates; or (ii) the taxpayer has to provide proof of residence for other tax reasons.
(5) Increase in the effective threshold tax rate that is subject to the CFC regulation Under the current CFC regime, the undistributed profits of a controlled foreign corporation (CFC) can be considered dividend income if the foreign country in which the CFC is established levies a tax rate below the effective threshold of 15%. To prevent offshore tax evasion, the proposed change to the CFC rule is to change the benchmark to include an applicable dividend tax when the local tax amount is less than 70% of the highest Korean marginal tax rate of 25%. In fact, under the proposed changes, a low tax regime would apply if the CFC pays an effective income tax rate of 17.5% or less. In addition, the amendments propose to expand the scope of the companies subject to the CFC rules by adding trusts subject to corporate income tax, in particular trusts with purpose limitation, trusts with beneficiary certificates and trusts with limited liability, to the scope of the CFCs be included.
This change is expected to take effect from tax years beginning on or after January 1, 2022.
(6) The effects of the COVID-19 pandemic on transfer pricing In order to incorporate some of the recommendations made by the OECD in its “Guide to the Impact of the COVID-19 Pandemic on Transfer Pricing”, the proposal stipulates that companies that have suffered losses in times of economic crisis such as an economic crisis , included in the comparability analysis.
In addition, the current transfer pricing mechanism gives tax authorities the right to adjust the cost allocation between related parties involved in the co-development of intellectual property in order to achieve a market cost allocation. According to the proposal, force majeure can be referred to as an exception to the requirement for a market distribution of these costs.