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24 February 2006
Following the revision of major Korean tax laws relating to domestic transactions at the end of 2005, the Ministry of Finance and Economy issued revised enforcement decrees to be incorporated into the Korean tax legislation for 2006. Enforcement decrees, which are a subset of the main body of the relevant law, provide a more detailed description and explanation of how the relevant provisions of the law are to be interpreted and enforced.
In 2005 the ministry also proposed revising the tax laws relating to international transactions (for further details please see "Proposed Revisions to International Aspects of the Tax Legislation"). The National Assembly is expected to vote on these proposed revisions in February 2006 and, if the measures are passed, the ministry is expected to announce revised enforcement decrees for the revisions.
This update summarizes the key revisions announced by the ministry, the majority of which became effective on January 1 2006.
Generally, a non-resident enjoys a reduced rate of withholding tax provided under an income tax treaty for interest income derived from Korean bonds. However, there have been cases where a non-resident holder has claimed the reduced withholding rate for interest income paid at times when the bonds were not held by the non-resident.
In order to prevent this, the ministry has proposed that if a non-resident holder cannot prove the holding period, the relevant interest income will be subject to the larger of (i) a reduced rate under an income tax treaty, or (ii) a tax of 15.4% of the interest derived by a resident bond holder.
In the case of a spin-offin which the original business disappears, the entity succeeding the business may not currently utilize any net operating losses from the disappearing entity.
The ministry has proposed that the succeeding entity should be entitled to utilize the net operating losses of the disappearing entity based on the book value of the business-related fixed assets of its predecessor. For example, if the book value of fixed assets relating to the spun-off business amounts to 50% of the disappearing entity's total fixed assets, the succeeding entity should be entitled to utilize 50% of the disappearing entity's net operating losses.
The ministry has also proposed that the use of net operating losses should be available in mergers as well as spin-offs.
Certain qualified domestic entities are currently entitled to a dividend declared deduction if they declare 90% or more of their distributable profits as dividends. Qualified entities include, among other things, asset-backed securities special purpose companies (SPCs), certain real estate investment trusts and project finance SPCs.
Under this rule there have been cases where individuals (both resident and non-resident) reduce and/or eliminate the tax applicable to their income. For example, if an individual transfers a building, the capital gains from such transfer would be subject to individual income tax rates up to 38.5%. However, if an SPC entitled to a dividend declared deduction is interposed, the capital gains may entirely escape any corporate income tax liability at the SPC level by distributing all of the SPC's profits to its individual shareholder and the character of the capital gains effectively becomes dividends paid to the individual, subject to 27.5% tax. In the case of a non-resident individual, the benefit is even greater as an income tax treaty generally provides a reduced rate for dividends, ranging from 10% to 15%.
In order to prevent such abuse, the ministry proposes that the dividend declared deductions rule be made unavailable to an SPC that is held by one or two individuals if the shareholding of such individual(s) (along with related parties) in the SPC amounts to 95% or more. The ministry has proposed an exception in cases where these individuals do not have the right to participate in a distribution of profits from the SPC.
Furthermore, the ministry has proposed that the dividend declared deductions rule should not apply to dividends received from entities entitled to an exemption from or a reduction in corporate income tax. Such entities would include asset-backed securities SPCs and foreign-invested companies which are entitled to certain exemptions from corporate income tax.
Currently, various types of investment funds enjoy tax benefits, including infrastructure investment funds. From January 1 2006 the tax benefits for investors in such funds include a special withholding tax regime for dividends. Instead of the usual withholding tax rate of 27.5%, the recipient of dividends from an infrastructure investment fund is entitled to a withholding rate of 5.5%, up to an investment amount of W300 million, and 15.4% for any investment over W300 million.
This special withholding regime is available to dividends paid on or before December 31 2008.
For further information on this topic please contact Jay Shim or Sangmoon Chang at Woo Yun Kang Jeong & Han by telephone (+82 2528 5200) or by fax (+82 2528 5228) or by email (email@example.com or firstname.lastname@example.org).
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