[Invest Korea] New Tax Rules Beneficial for Foreign Investors

Friday, June 14th, 2013 KOREA IT TIMES (INFO@KOREAITTIMES.COM) This month we present Part II of our two-part series on Korea’s amended Presidential Decree under the Law for Coordination of International Tax Affairs and other relevant tax laws. Below we look at important tax regulation changes providing foreign investors with advantageous effects. Background In order to provide better conditions for investing in Korea, the Korean government amended some provisions of the Enforcement Decree of Corporate Income Tax Act and the Enforcement Decree of Special Tax Treatment Control Law early this year. Related tax incentives encompass those relating to not only foreign direct investment but also investments through domestic funds or foreign funds, considering that the portion of foreign investment through an investment fund or a private equity fund is ever growing. 1. An Exception to the General Tax Treatment Toward a Limited Partner’s Income of a Domestic Private Equity Fund Prior to the amendment, if foreign investors invested in Korean shares through a Korean private equity fund (PEF), all income allocated to limited partners (including the foreign pension fund) by the Korean PEF was classified as dividends; therefore, regardless of the character of the underlying income, all distributed income by the Korean PEF was subject to withholding at 22 percent for dividends (or a reduced rate under an applicable tax treaty). Because foreign private equity investors, including foreign pension funds, usually realized investment profits in the form of capital gains, rather than dividends, such taxation had the effect of depriving investors investing through a Korean PEF of the opportunity to claim a capital gains tax exemption under an applicable treaty. Effective 2013, however, the amended tax law allows look-through treatment to determine the character of income of a Korean PEF allocated to certain foreign pension funds, thereby affording them the opportunity to claim tax treaty exemptions. As a result of the amended rule, such income allocated to eligible foreign pension funds will be classified as interest, dividends or capital gains from alienation of shares depending on the character of the underlying income recognized by the PEF. 2. Special Tax Treatment for Foreign Investment Entities Under the past tax regulation, certain domestic joint investment entities such as domestic private equity funds can elect to be treated as a partnership, which is a quasi pass-through entity subject to no entitylevel tax. On the other hand, the permanent establishment of foreign corporations is not entitled to this partnership election and was subject to corporate income tax of maximum 24.2 percent at the entity level. To eliminate this tax inequity and attract foreign investments, the lawmakers expanded the special partnership taxation election regime to include foreign eligible entities carrying on a business in Korea through a permanent establishment. According to the new rule, there is no partnership-level tax if the eligible foreign entity with a Korean permanent establishment elects to be treated as the partnership. Instead, limited partners, as passive investors in such foreign entity, are subject to Korean withholding tax with respect to their share of Korean income as dividend at the rate of 22 percent. However, a reduced treaty rate ranging from 5 percent to 16.5 percent should be available depending on the residency of the limited partner. After a one-year grace period, the proposed change will be applicable to taxable years commencing on or after January 1, 2014. 3. Amendments to Foreign Direct Investment Incentive Regime The foreign investment zone regime’s prescription of eligible businesses was expanded to include information technology services from February 15. Until the end of last year, the following businesses were eligible for the incentives: (i) manufacturing with a minimum investment amount of USD 30 million; (ii) tourism with USD 20 million; (iii) logistics services with USD 10 million; and (iv) research and development with USD 2 million. However, the amended rules include computer programming, system integration and management services, data processing/ hosting services and other related information services with a minimum investment amount of USD 30 million. Source : Invest Korea Taylor Scott International