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Key International Tax Law Amendments in the Draft 2019 Tax Revision Bill

August 2019 - Tax. Legal Developments by Lee & Ko .

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On July 25, 2019, the Ministry of Economy and Finance publicly released the 2019 draft Tax Revision Bill (the “Draft Bill”). The Draft Bill is expected to be sent to the National Assembly on September 3, 2019 for deliberation and adoption.

A summary of some key international tax law proposals in the Draft Bill that can potentially impact multinational companies and other foreign investors doing business with Korea, or that have investments in Korea, is provided below.

1. Strengthened penalties for non-compliance with obligation to submit documents relating to international transactions (Law for the Coordination of International Tax Affairs (“LCITA”) §12)

The proposal would increase the maximum amount of penalty from KRW 100,000,000 to KRW 300,000,000 for failure to submit documents in relation to international transactions, such as the statement of international transactions or combined report of international transactions, as well as for submission of false documents. Under the proposal, the National Tax Service (the “NTS”) may assess penalties not only once as under the current law, but repeatedly every 30 days based on the deficient submission (KRW 5 million to KRW 70 million per penalty assessment but capped at KRW 300 million total) until the documents are duly submitted to the NTS. This proposal will be effective from the taxable years starting on or after January 1, 2020.

2. Newly introduced statutory basis for the NTS to determine arm’s length price for transfer pricing if taxpayer fails to comply with obligation to submit documents in relation to international transactions (LCITA §11⑦ newly enacted)

The proposal would newly introduce a statutory basis for the NTS to apply an arm’s length price with its own comparable data in international transactions if the taxpayer fails to comply with the obligation to submit required documents, such as the master file or the local file, as prescribed by the Presidential Decree. This proposal will be effective from the taxable years starting on or after January 1, 2020.

3. Rationalization of allocation of burden of proof concerning indirect transactions (LCITA §2-2 ④, ⑤)

Under the substance-over-form principle that applies to international transactions, if a taxpayer carries out an international transaction indirectly through a third party with the main or principal purpose to unfairly avoid or reduce its Korean tax burden, the tax treaties and the LCITA shall apply according to the economic substance of the transaction, i.e., as if such transaction has been conducted directly by the taxpayer. Under the proposal, where a taxpayer, by virtue of an indirect transaction through a third party, reduces its tax burden in Korea by more than the statutory threshold (e.g., 50%), the NTS may assume the taxpayer’s transaction was mainly or principally undertaken to obtain treaty benefits provided under the tax treaties or under the LCITA. In such case, the NTS may tax the taxpayer according to its economic substance, unless the taxpayer can sufficiently demonstrate that there was no tax avoidance purpose, and that the transaction was undertaken for a valid business reasons. This proposal will be effective from the taxable years starting on or after January 1, 2020.

4. Revision to taxation of Korean-source royalty income for patents not registered in Korea (Income Tax Law (“ITL”) §119, §156 ①, Corporate Income Tax Law (“CITL”) §93, §98 ①)

There have been several Supreme Court cases where a Korean company paid royalties to a foreign owner of a patent and the applicable tax treaty entered between Korea and the foreign company’s resident country provides that royalties should be sourced to the country where the intangible property was used (e.g., the Korea-US Tax Treaty). In such cases, the Court has consistently ruled that a patent not registered in Korea cannot be viewed as being used in Korea as defined in the tax treaty, and therefore payments for the use or the right to use such patents should not be treated as Korean-source income under the relevant tax treaty, notwithstanding a Korean tax law provision providing otherwise.

In order for the NTS to tax royalties for patents not registered in Korea in such circumstances, this proposal would: i) revise the definition of “Korean-source royalties” under ITL and CITL as including consideration for the use, or right to use, or gains derived from the disposition of “other like property or rights” (as included in the definition of royalties under the tax treaties containing the “place of use” provision), and ii) clarify that the term “other like property or rights” includes “methods of production, skills, information, etc. embedded in a patent not registered in Korea if such property or rights are used for manufacture, production, etc. in Korea.”

The proposal thereby announces that under Korean tax law, consideration for the use, or the right to use, or gains realized from disposition of a patent shall be deemed Korean-source royalties in applying a tax treaty containing the “place of use” provision if the patent has been used for manufacture, production, etc. within Korea, regardless of whether the patent is registered in Korea or not.

In addition, the proposal would prescribe that if any payment is made by a Korean resident to a foreign owner of a patent registered overseas (and not registered in Korea), to whom the “place of use” tax treaties are applicable, as compensation for patent infringement (e.g., damages, settlement payment, etc.), such payment should be considered Korean-source “other income”, rather than royalties.

As discussed, this proposal is intended to enable the NTS to tax royalties for a patent not registered in Korea, which was not possible when applying the “place of use” provision is contained in a tax treaty. This proposed revision will be effective for payments made on or after January 1, 2020.

5. Enactment of principle on interpretation and application of tax treaties (LCITA §3-2 newly enacted)

This proposal is meant to clarify that in case a tax treaty does not provide definition of a term or a phrase referred to in the tax treaty, such term or phrase should be interpreted and applied in accordance with the definition and meanings given to the term or phrase under the Korean domestic tax law.

6. Revision to the submission of duplicate documents on international transactions (LCITA §11①, Enforcement Decree of LCITA §7①)

Under the current law, the taxpayers should submit a statement of international transaction, arm’s length price calculation method report, and local file and master file in relation to any international transaction undertaken. The proposal would exempt the submission of the statement of international transaction and arm’s length price calculation method report if the local file and master file have been submitted. The proposal will be effective from the taxable years starting on or after January 1, 2020.

7. Expansion of the effect of Mutual Agreement Procedure (“MAP”) decisions (LCITA §27④ deleted, Enforcement Decree of LCITA §41-3 newly enacted)

The current LCITA prescribes that MAP shall be null and void if a court’s final ruling contradicts the terms of the MAP. The proposal would delete the LCITA provision that provides that a MAP decision contrary to a Korean court decision is nullified. Accordingly, under the proposal, a MAP will not be null and void even if the court makes a final ruling to the contrary after the conclusion of the MAP. Separately, the proposal newly prescribes that the taxpayer may formally submit its views and positions to the Competent Authority while the MAP is on-going. This proposal will be effective for MAPs executed on or after January 1, 2020.

8. Introduction of legal basis for collection and exchange of beneficial owner information (LCITA §31)

As the competent authority can acquire and exchange tax information with another competent authority of a contracting state, the proposal would clarify that the NTS can request information on beneficial owner for purpose of the tax information exchange. The details of the request, such as the scope of the beneficial owner information will be regulated by the Presidential Decree. This proposal will be effective for information requests made on or after January 1, 2020.

9. Clarification of scope of taxation on Korean-source capital gains derived from disposition or alienation of real property under the Korea-US Tax Treaty (ITL §119, CITL §93)

This proposal would include “shares in a real property company” in the definition of real property under the Korea-US Tax Treaty with respect to Korean-source capital gains realized from disposition or alienation of real property. Under the Korean tax law, the “shares in a real property company” is defined as unlisted shares of the company that the value of the real property held by the company in Korea equals or exceeds 50 percent of the value of all the value of all the property held by the company. Korea and the US mutually agreed in 1999 that, in applying the Korea-US Tax Treaty, capital gains realized from disposition or alienation of shares in a real property company should be sourced to the country where such real estate is situated. The definition of “shares in a real property company” was prescribed in the Korea-US Mutual Agreement in 1999 differently by referencing the Korean old tax law provision before amendment which had prescribed three conditions (1) that the value of the real property held by the corporation in Korea equals or exceeds 50 percent of the value of all the property held by the corporation; (2) that the shareholder (and related parties) hold at least 50 percent of the shares of the corporation; and (3) that the shareholder transfers at least 50 percent of the corporation.

This proposal clarifies the interpretation and application of the Korea-US Tax Treaty with respect to definition of “shares in a real property” in the Korea-US MAP that the capital gains derived from disposition or alienation of the shares in a real property company are treated as Korean-source income based on the current Korean tax laws without meeting the three conditions described under the Korea-US Mutual Agreement.

If you have any questions regarding this article, please contact below:

Jay SHIM (jay.shim@leeko.com)

Ted KIM (ted.kim@leeko.com)

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