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2006 tax revision: making Korea more business friendly.

The government announced a proposed bill on a revised taxation on August 21, 2006. The revision is aimed to support sustainable and broad-based economic growth and to enhance competitiveness in taxation through tax system advancement. The following is the gist of the revision particularly related to fostering a better business environment.

I. Facilitating foreign investment

1. Lower income tax on the earned interest from bonds held by non-resident individuals and foreign incorporation (Art. 156-1, Income Tax Law & Art. 98-1, Corporate Tax Law)

The government aims to facilitate local bond market by lowering the withholding tax rate on the earned interest from bond held by non-residents and foreign incorporation. The revised rate of 14 percent, down from current 25 percent, shall be applicable to interest income generated on or after January 1, 2007.

2. Reduce income tax for foreign engineers and researchers (Art. 18-1, Special Tax Treatment Control Law)

The sunset on income tax exemption for foreign engineers and researchers in Korea shall be extended with a view to supporting introduction of advanced foreign technologies.

As of now, a full tax exemption on earnings generated in Korea is granted to qualified foreign engineers and researchers for 5 years. The qualified engineers and researchers are as follows:

* technology provider in accordance with Engineering and Technology Promotions Act;

* researchers at KAIST; and

* researchers at non-profit research institutes.

The 2006 tax revision has extended the sunset on full tax exemption to December 31, 2009. The revised regulation shall be applicable to income derived from services rendered on or after January 1, 2007.

3. Maintain current tax incentives for foreign direct investment
(Table 1)

                                 Requirements

Hi-tech or Industry-   * to have critical influence in
support service        strengthening the international
businesses             competitiveness of domestic
                       industry; and

                       * to be decided (1) after
                       consultation with Foreign
                       Investment Committee

                       Business type   Minimum investment

                       Manufacturing     US$30 million
Foreign invested          Tourism        US$20 million
companies (2)           Logistics &      US$10 million
located in foreign          SOC
investment zone         R&D centers       US$5 million
                        Two or more      US$30 million
                          foreign
                        businesses

                                      Tax incentives

                        Corporate     Property,       Customs duties
                       and Income    Acquisition        and etc on
                           tax           and         imported capital
                                     Registration         goods
                                         tax

Hi-tech or Industry-                                Full exemption of
support service           Full exemption for 5       customs duties,
businesses              years & 50% reduction for   special excise tax
                            the next 2 years         and value-added
Foreign invested                                    tax for 3 years on
companies (2)                                        imported capital
located in foreign                                        goods
investment zone

(Table 2)

Tax incentives        Business types              Requirements

                                           * Manufacturing and tourism
                                           business with investment of
                  Foreign invested         US$10 million or more; or
                  companies located in
                  free economic zones      * Logistics and medical
                                           institutes with investment
                                           of US$5 million or more

                                           * Minimum investment of
(1) Full                                   US$30 million; or
exemption for 3   Business developers in
years & 50%       free economic zones      * Ratio of foreign
reduction for                              investment in the foreign
the next 2                                 invested company being 50%
years (3)                                  or more for projects worth
                                           US$500 million or more

                                           * Minimum investment of
                                           US$10 million; or
                  Business developers in
                  Jeju trade zone          * Ratio of foreign
                                           investment in the foreign
                                           invested company being 50%
                                           or more for projects worth
                                           US$100 million or more

                                           * Manufacturing business
                  Foreign invested         with investment of US$10
                  companies located in     million or more; and
                  the exclusive zones
                  for foreign investment   * Logistics business with
                                           investment of US$5 million
                                           or more

                                           * Manufacturing and tourism
                                           businesses with investment
(2) Full          Foreign invested         of US$10 million or more;
exemption of      companies located in     and
customs duties    the company town zone
for 3 years on                             * Logistics business and
imported                                   R&D centers with investment
capital goods                              of US$5 million or more

                                           * Minimum investment of
                                           US$30 million or more; or
                  Business developer in
                  company town             * Ratio of foreign
                                           investment in the foreign
                                           invested company being 50%
                                           or more for projects worth
                                           US$500 million or more

                                           * Manufacturing business
                                           with investment of US$10
                  Foreign invested         million or more; and
                  companies in the free
                  trade zone               * Logistics business with
                                           investment of US$5 million
                                           or more

(1) Total 637 services are eligible for the FDI tax incentives,
in which 149 businesses are the industry support services while 488
businesses being concomitant with the high tech industry.

(2) Foreign-invested companies are domestic companies and their
accounting and settlement are independent of those of their parent
companies and are subject to Foreign Investment Promotion Act.

(3) The exemption and reduction are with respect to corporate,
income, property, acquisition and registration tax.

NOTE: All FDI tax incentives are subject to Special Tax Treatment
Control Law.


II. Strengthening industry competitiveness through revising base tariff rates on 893 items

1. Ease customs duties burden on basic 310 raw materials
Basic raw materials

          Non-competitive                    Competitive

Basic tariff rates are to be zero-    Basic tariff rates shall be
based for items with high industry    lowered to boost industry
linkage (backward or forward), for    competitiveness.
such items as naphtha, zero tariff
concession items (i.e., pulps) and
items with tight supply and demand
(i.e., copper mine).


Energy

Basic customs duty on major energy items such as crude oil, LNG and LPG shall be lowered from current 5 percent to 3 percent. However, for the sake of price stability, flexible tariff rates shall be applied for the time being. Accordingly, for crude oil, LNG and LPG, current quota tariffs of 1 percent, 1 percent and 1.5 percent shall be maintained respectively. Petroleum goods

Petroleum goods

As for the petrochemical goods, applied tax rate (currently 5 percent quota tariff) shall replace the base duty of 8 percent on gasoline. Intermediaries or raw materials for petrochemical goods

Intermediaries or raw materials for petrochemical goods

Basic customs duty on intermediaries and raw materials for petrochemical goods (i.e., xylem) will be lowered to an appropriate level (from 5 to 3 percent) to foster a level playing ground with other competing economies.

III. Strengthening the service sector competitiveness

1. Facilitate restructuring of small and medium sized logistics companies

(1) Relaxing requirements for tax deferral

When self-run logistics business unit is spun off from the mother company and merged into a specialized logistics company, requirements for tax deferral on the valuation profit from the spin-off shall be softened (Art. 46-4, Special Tax Treatment Control Law).
             Current                             Revised

(Eligibility requirements)          (Relaxed eligibility requirements)

a. spin-off of a local company      a. spin-off of a local company
(mother company) going concerned    (mother company) going concerned
for 5 years or more                 for 1 year or more

b. the compensation for spin-off    * Relaxed requirements are not
payable to the shareholders of      applicable to the case where
mother company to be made via       special relations exist between
stocks of the new company after     the spin-off business unit and the
spin-off                            acquisition company.

c. the new company after the        * Sunset on the relaxed
spin-off to continue mother         requirements is set on Dec 31,
company's business till the end     2009.
fiscal year of the spin-off date
                                    Item b and c remain unchanged.

(Deferral method)                   (Deferral method)

Tax can be deferred till disposal   Remain unchanged
or amortization of tangible fixed
assets for business purpose.


The revision has been initiated to facilitate cost reduction in logistics by way of converting current system into 3rd party logistics. The relaxed requirements shall come into effect to mergers of spin-off logistics business unit on or after January 1, 2007.

(2) Relaxing requirements for succeeding carried-over deficit (Art. 46-5, Special Tax Treatment Control Law)

In case of merger between logistics companies, current requirements for the acquisition company to take over carried-over deficit of the merged company shall be relaxed.

The revision aims to support logistics companies to become bigger in terms of its operation scheme. Meantime, merger between local venture companies also recognizes a minimum 3 percent share holding, a substantial dip from the current 10 percent requirement, by the existing shareholders of the merged company in accordance with the Art. 47-3 of the Special Tax Treatment Control Law. The relaxed requirements shall be applied to companies with merger and acquisition on or after January 1, 2007.
             Current                             Revised

(Succession requirements)           (Relaxed succession requirements)

a. to be qualified for the          Item a, b and d remain unchanged.
requirements of tax deferral on
valuation profit from merger

* both the merging and merged
companies going concerned for 1
year or more;

* 95% or more of the merger price
being paid off at the par value
of stock price; and

* merging company to be engaged
in the business taken over till
the end of fiscal year when the
subjet merger has been completed.

b. assets of the merged company
to be taken over by the merging
company at the book value

c. the total stocks paid off to     c. the total stocks paid off to
the existing shareholders of the    the existing shareholders of the
merged company for the merger       merged company for the merger
price to be at least 10% of the     price to be at least 3% of the
value of total number of stocks     value of total number of stocks
issued by the merging company as    issued by the merging company as
of the registered merger date       of the registered merger date

d. existing business under the      Sunset on the relaxed requirements
merging company and the one         has been newly established as
succeeded from the merged company   December 31,2009.
to be separately managed after
merger


(3) Extending sunset on the deferred tax benefits to boost strategic alliance among logistics companies (Art. 46-3, Special Tax Treatment Control Law)

The government has extended sunset clauses on the tax benefits given to logistics companies with strategic alliances. This will support inter-logistics M&As and restructuring within the sector. The extended sunset will be applied to share-exchange or investment in kind by and between logistics companies on or after January 1, 2007.

Currently, in case where a logistics company exchanges stocks with the alliance partner or makes investment in kind in the alliance partner company in accordance to the strategic alliance plan, the capital gains tax from the alienation of shares shall be deferred till the selloff of the shares of alliance partner company .

The sunset shall be extended from December 31, 2006 to December 31, 2009.

2. Boost bond and stock markets

(1) Extending sunset on tax exemption for securities transaction by public funds (Art. 117-18, STTCL)

With a view to supporting investment in securities by public funds (1), the sunset on tax exemption for securities transaction is to be extended. The sunset extension shall be applied to alienation of shares on or after January 1, 2007.

In specific, securities transaction tax is exempted when the public fund transfers its purchased securities at the securities market. The sunset on the tax exemption is set on December 31, 2006, which is to be extended to December 31, 2009 under the revised STTCL.

(2) Offering tax assistance to high risk-high yield funds (Art. 91-6, STTCL)

Tax assistance to high risk-high yield funds is to be established. The purpose of the new provision is to address polarization in corporate bond market by facilitating bond issuance and to promote foreign investment. The revision shall be applied to the eligible bond issuance on or after January 1, 2007.

In specific, a separate low tax rate will be levied on interest or dividend income from the junk bond (2) held by bond investment funds with a certain percentage of portfolio investment being made to junk bonds. Both residents and non-residents including foreign corporate are eligible for the tax assistance provided that they have:

a. acquired 10 percent or more of junk bonds with BB+ or lower credit ratings; and

b. invested 60 percent or more of fund assets in local bonds in Korea.

With regard to the actual tax assistance, 5 percent separate taxation will be applied to investment principal of 100 million won or less for non-residents. The tax assistance shall be provided to non-residents regardless of the investment amount.

The new tax assistance shall be applied to funds making investments on the junk bonds on and after January 1, 2007 and shall be valid through December 31, 2009.

IV. Rationalizing and advancing the tax regime

1. Foster business-friendly environment

(1) Adjusting the dividend ratio eligible for alienation from gross income of a holding company (Art. 18-2 of the Corporate Tax Law)

The government decided to lift up the proportion of dividends eligible for alienation from the gross income and standardized to the level of those in advanced countries. This revision is to facilitate conversion into the holding company system, which is expected to enhance corporate transparency.

The revised rule is applied to dividends paid out on or after January 1, 2007.
                    Current

Where a holding company is paid dividends by its
subsidiary, a certain proportion * of the
dividend amount can be excluded from gross
income.

* to be calculated based on percentage of shares
held by the holding company

                       Holding company

Subsidiary        Share         Proportion of
   type       percentage (%)    dividends (2)

  Listed           100               100
 company          40-100             90
                  30-40              60
             Less than 30 (1)        30

 Unlisted          100               100
 company          80-100             90
                  50-80              60
              Less than 501          30

(1) Ordinary company

(2) Excludable from gross income (%)

                    Revised

The proportion of dividends eligible for
alienation from gross income shall be upwardly
adjusted by phases.

              Proportion of dividends excludable
                     from gross income (%)

Percentage
of shares      2007        2008       2009

40-100 (1)      90          90      90[right
                                    arrow]100
30-40 (2)    60[right    70[right      80
             arrow]70    arrow]80

(1) Over 80%-less than 100% in the case of
unlisted company

(2) Over 50%-80% or less in the case of
unlisted company


(2) Repealing preferential tax benefits granted to institutional investors with respect to legitimate alianation of dividends from gross income (Art. 18, Corprate Tax Law)

The existing preferential tax treatment, which allows institutional investors holding less than 10 percent of total shares to exclude 90 percent of dividends from their gross income, runs counter to the general taxation principle where the actual proportion of dividend to be excluded from the gross income is automatically determined on a pro rata basis with the actual share holding ratio.

In specific, currently, the law stipulates that where a qualified (3) institutional investor such as a financial institution is paid dividends from a listed company, the amount equivalent to 90 percent of the dividend amount is excluded from its gross income.

The 2006 tax reform mandates that such preferential treatment shall be repealed. Instead, institutional investors shall be subject to the same principle applied to ordinary companies. Therefore, under the revised rule, institutional investors and ordinary companies all together are subject to maximum 30 percent of dividend eligible for alienation from gross income.

In particular, in case where a parent company holds a larger number of subsidy shares, the rationale for preventing double-taxation (in this case the exclusion of parent company's dividend from gross income) gets more justified taking into account the higher sameness between the two. That is exclusion ratio on the pro rata basis with the holding share ratio makes much more sense for this case.

This revision shall be applied to dividends paid out on or after January 1, 2007.

(1.) Public fund refers to National Pension Fund, Civil Service Pension Fund and Pension Fund for Private School Teachers.

(2.) Junk bond means bond issued by companies with BB+ or lower credit ratings according to the local credit agency designated by the government.

(3.) All institutional investors are eligible for the tax benefit as long as they hold less than 10% of the total shares issued by the listed company.
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Title Annotation:Policy Issues
Publication:Economic Bulletin (Korea)
Geographic Code:9SOUT
Date:Sep 1, 2006
Words:2584
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