SOUTH KOREA Law and Practice Contributed by: Young Joon Chun, Kyu Dong Kim, Yong Whan Choi and Hyeon Jeong, Yulchon LLC
Korean tax under an applicable tax treaty or subject to withholding tax at 11% (including local income tax) of the sale proceeds or 22% (including local income tax) of the capital gains, whichever is lower. The purchaser is obliged to withhold and pay the tax. Capital gains arising from the sale of listed shares are not subject to capital gains tax to the extent the non-resident shareholder did not hold 25% or more of the total outstanding shares at any time during the year when the sale took place or in the preceding five years. 5.4 Tax Implications of Change of Control Since Korea does not have an indirect capital gains tax, gains arising from the sale of shares of a foreign company that directly or indirectly owns shares of a Korean company are not subject to tax (indirect share transfer). However, the Korean tax authority may attempt to impose tax on gains arising from an indirect share transfer by applying the substance-over-form principle. 5.5 Formula-Based Income Attribution No special formulas are used to determine the income of foreign-owned local affiliates selling goods or pro - viding services; the OECD Guidelines would apply. 5.6 Deductibility of Intra-Group Management and Administrative Charges The Korean tax authority often challenges the deduct - ibility of management service fees. In order to deduct the fees, the following conditions must be satisfied (under the Law for the Co-ordination of International Tax Affairs): • an agreement should be entered into by the service provider prior to the provision of the service; • the domestic company should benefit from the ser - vice provided by its foreign related party through additional profit or reduced expenses; • the provision of the service should be verified through supporting documentation; and • no related party should be performing the same type of service as the one received by the domes - tic company, and no third party should be provid - ing the same type of service as the one received by the domestic company to a related party of the
domestic company; however, an exception applies to cases where the same type of service is tempo - rarily received due to a reasonable cause, such as business restructuring or streamlining management decision processes. 5.7 Restraints on Related-Party Borrowing Where a Korean company borrows from its foreign controlling shareholder and the debt-to-equity ratio exceeds 2:1, interest exceeding such threshold will not be deductible and will be treated as a dividend (thin capitalisation rule). Also, in line with the OECD’s recommendation on the limitation of interest expense deductions, Korea introduced a new rule that treats interest deductions as non-deductible to the extent net interest paid to foreign related parties exceeds 30% of adjusted net income (for this purpose, adjusted net income equals earnings before interest, taxes, depreciation and amortisation). Net interest expense refers to the total amount of interest paid on funds borrowed by a Korean company from all foreign related parties minus the total amount of interest income received by the Korean company from foreign related parties. If the resulting value is negative, the net interest expense will be deemed to be zero. In addition, loans from foreign affiliates should be at arm’s length. Currently, the default interest rate (deemed arm’s length interest rate) for loans from a foreign affiliate to a Korean company is the market interest rate for the relevant currency (such as the Secured Overnight Financing Rate for US dollars and the Euro Short-Term Rate for euros) plus a 1.5% spread, and the default interest rate for loans from a Korean company to its foreign affiliate is 4.6%. If a separate TP analysis is conducted, the arm’s length rate can be determined based on such analysis. 6. Taxation of Foreign Income of Local Corporations 6.1 Foreign Income Exemptions As Korean companies are taxed on their worldwide income, their foreign source income is also subject to tax in Korea. However, taxes imposed by foreign gov -
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