Tax Reform in 2004
One of the remarkable changes in the 2004 tax reform is the introduction of comprehensive real estate holding tax as a national tax to stabilize real estate markets. Along with these changes, various tax incentives to support creating of jobs are some of the main characteristic of the 2004 tax reform. On top of that, the corporation tax and income tax areas, various amendments are made in order to lend a helping hand to companies in boosting their competitiveness.
Meanwhile, to enhance the country’s competitiveness through inducement of foreign investment, a wide range of foreign investment incentives is provided via the 2004 tax reform. Criteria for industries to qualify for such investment incentives are eased and the scope of industry entitled to foreign investment incentives are expanded.
Finally, with regard to the taxation of foreign corporations and international transactions, the criteria for comparables used to determine the arm’s length prices have been eased. Along with these changes, various changes including modified criteria to evaluate a tax haven have been made to complement previous tax laws.
The following are main contents of the 2004 tax reforms on comprehensive real estate holding tax, job-creating tax incentives and corporation tax code;
1. Establishment of Comprehensive Real Estate Holding Tax (CREHT)
In order to enhance equity in tax burden and stabilize real estate market, comprehensive real estate holding tax (CREHT) is newly established. With this new tax regime, excessive holding of real estate will be discouraged.
i) Previously, land and residential houses were taxed separately only as a local tax. Under the new tax law, property tax (previous aggregate land tax is absorbed into property tax), which is a local tax, is imposed on lands and residential houses. Then high-priced lands and residential houses that exceed a certain amount held by one taxpayer across the nation are combined to be imposed with CREHT as a national tax.
ii) Tax bases for land and residential houses are revised to be in more in line with market prices. As holding tax is more strengthened with the introduction of CREHT, registration tax regarding registering transfer of real estate ownership is lowered to 2% from 3% in order to promote real estate transaction.
iii) To facilitate the balanced development of local economy and development of national economy, the amount of tax collected is transferred to local government. Especially, local autonomous governments, which are in more financial need, are allocated first with these tax revenues.
To facilitate the balanced development of local economy and development of national economy, the amount of tax collected is transferred to local governments. Especially, these tax revenues are allocated first to the local governments, which are in more financial need.
2. Korean government grant tax reduction and tax credit
Since the financial crisis, the job market was resilient, producing 400 thousand to 500 thousand jobs per year. However, despite about 3% of economic growth in 2003, we experienced 30 thousand jobs disappear. As a result, the Korean government decided to grant tax reduction and tax credit to a company that creates jobs or retains jobs. The purpose for this was to create jobs, which is a fundamental method to address youth unemployment, delinquent credit holders and aggravating income distribution. The main contents of such tax regime are as follows;
i) A company, which starts its operation and creates jobs, is provided with 50% to 100% of income tax or corporation tax reduction. Also, such a company is allowed to carry forward net operating loss (NOL) incurred within 2 years after starting operation for 7 years.
ii) Where the number of a regular employee exceeds that of previous year, one million won per employee in excess of the number of worker from the previous year is deducted from corporation tax or income tax.
iii) Where a company introduces a system to retain employment such as implementing a shift system and shortening working hours, 500,000 won per retained employee is deducted from corporation tax and income tax.
3. Withholding tax
As income tax rates are lowered by one percent, withholding tax rates are lowered by one percent to relieve withholding tax burden. 15% withholding tax rates on interest and distribution from securities investment are lowered to 14% respectively. However, 25% withholding tax rate on non-business loan remained the same as before.
4. Other related changes in corporation and income taxes;
i) Previously, dividend received from a wholly owned subsidiary was 50% excluded from taxable income of the parent company. However, under the revised tax law, such dividends received are 100% excluded from the taxable income.
ii) Company profits are taxed first in the corporation and then again in the shareholders’ hands. So, dividend gross-up mechanism is designed to preclude double taxation. As corporation tax rate is reduced by 2% starting from 2005, dividend gross-up rate is reduced to 15% from the previous 19%.
iii) A listed company or a large corporation having 100 billion won in net worth was not allowed to deduct interest expense on borrowings in excess of 400% of net worth of such a company. This provision is abolished as the financial structures of companies improved.
iv) Tonnage taxation system is introduced in the shipping industry. Shipping companies, which meet certain qualification can opt for this new tax scheme. Under the new regime, shipping companies’ income is divided into shipping income and non-shipping income.
v) Where a bond is sold before maturity, the seller of the bond is required to withhold and remit withholding tax imposed on interest accrued up to the point of sale.
5. Foreign investment incentives in 2004 tax reforms are as follows;
1. Foreign engineers and technicians are presently provided a tax incentive to boost Korean economy’s competitiveness by introducing advanced technology. Expatriate technicians or engineers employed by Korean companies are exempt from earned individual income tax for five years from the date of employment in Korea. Qualified industries for such incentives are expanded, including logistics industry and market research and public opinion polling.
2. Tax benefits that are presently granted to foreign investment companies in Free Economic Zones will be provided to foreign investment in foreign-exclusive industrial complexes. To qualify for the tax exemption or reduction, a foreign investment company should be engaged in the manufacturing or the logistics industry and satisfy a certain minimum investment requirements.
3. Foreign investment in high technology or industry supporting business should meet certain requirements to be provided with tax incentives. Under the amended rules, an exception to these requirements are provided to foreign investment in the R&D industry.
The following are with regard to the taxation of foreign corporations and international transactions;
1. Previously, the scope of comparability to determine the arm’s length price for cross-border transaction with related parties was limited to cross-border transaction between the independent companies. Under the revised tax law, a taxpayer is allowed to use domestic transactions with related parties in choosing comparable transaction to determine arm’s length prices.
2. The criteria for evaluating the nature of a low tax country under the anti-tax haven rule have been eased. Under the amended rule, a tax haven is defined as a low tax country where 50% or more of income is tax exempt or where effective tax rates on taxable income for the past three years (previously it was one year) is an average 15% or less.
3. A foreign corporation in Korea may deduct foreign taxes paid or to be paid or may use it as a credit against the Korean corporate income tax. However, there was not any specific provision about the carry forward of excess foreign credit. The revised rules make it clear that foreign corporations in Korea, like domestic companies, will be entitled to carry forward such excess foreign tax credits for five subsequent years.
4. Korean residents with 20 % or more of interest in a foreign company situated in tax haven are required to report information on investment in the foreign company whose head office or principal office is located in tax haven. Under the revised tax law, the reporting requirements also apply when the effective management of a foreign company is located in a tax haven.