Korea, Republic of
The consolidated corporate tax filing system can be adopted for a domestic corporation in cases where two or more wholly owned subsidiaries exist. A taxpayer may elect the consolidated filing scheme upon approval from the tax authorities, but it cannot be revoked for at least five years after the election of the consolidated tax filing.
The LCITA authorises the tax authorities to adjust the transfer price based on an arm’s-length price and to determine or recalculate the taxable income of a domestic company (including PE of a foreign company) when the transfer price for the transaction between the domestic company and its foreign related party is either below or above an arm's-length price.
The LCITA lists the following methods for determining an arm's-length price: the comparable uncontrolled price (CUP) method, the resale price method, the cost-plus method, the profit-split method, the transactional net margin method, and other reasonable methods. Other reasonable methods can be used only if it is unfeasible to apply one of the aforementioned methods.
The method used and the reason for adopting that particular one for an arm's-length price determination, as well as the details of international transactions and condensed income statement of foreign related parties having the transaction with a taxpayer, must be submitted to the tax authorities by a taxpayer in the prescribed forms within six months from the end of the month that a fiscal year-end date belongs to. However, the disclosure requirement will be exempt if the transaction amount for each type of disclosures does not exceed an annual threshold (e.g. in case of the details of international transactions, KRW 5 billion for goods and KRW 1 billion for services as well as intangibles, respectively). The exemption from the requirement will apply to transactions made in fiscal years beginning on or after 1 January 2023. In addition, the disclosure requirements shall not apply to the taxpayer that is subject to file master file and local file.
To address consistency with international standards on transfer pricing rules, the tax reform for 2019 introduces a new rule to clarify and establish the principles for determining the arm’s-length prices of the transactions involving intangibles and addressing an appropriate remuneration for the functions performed, such as development, enhancement, maintenance, protection, and exploitation of intangibles. The principles of determining the arm’s-length price in a cross-border intangible transaction and addressing an appropriate remuneration in the transaction provide that the comparable uncontrolled price (CUP) method or profit split method would take precedence over other transfer pricing methods; and the companies performing the functions and assuming the relevant risks regarding the development, enhancement, maintenance, protection, and exploitation of intangibles should get appropriate remuneration for the contributions they made.
Transfer pricing documentation requirement
In line with the OECD Base Erosion and Profit Shifting (BEPS) Action 13, the LCITA includes a reporting requirement for multinational companies in Korea to submit a consolidated report (including local file and master file) on their cross-border, related-party transactions, affecting not only Korean corporations but also foreign corporations having a PE in Korea that meet all of the following conditions: (i) annual gross sales of a Korean company or a Korean branch exceeding KRW 100 billion and (ii) international related-party transactions exceeding KRW 50 billion per year. Required information to be submitted for reporting includes organisation, business, intangible assets, related-party transactions, etc. relating to the group and the local entity. Failure to comply with the reporting requirement will result in a penalty and eventually lead to the assessment of an estimated tax. A penalty of up to KRW 100 million is imposed for failing to submit the documentation or for submitting incorrect information. A penalty of up to KRW 200 million may be imposed every 30 days after the first penalty assessment was imposed until the documentation is submitted, depending on the lateness of the submission.
The LCITA introduces the requirement to submit country-by-country (CbC) reporting following the implementation of the transfer pricing rules requiring multinationals in Korea to submit local files and master files on their cross-border transactions. The CbC report must be filed within 12 months after the end of the ultimate parents’ income tax year.
In cases where a Korean company borrows from its overseas-controlling shareholder and the debt-to-equity ratio exceeds 2:1 (6:1 in case of financial institutions), a portion of interest expense on the excess borrowing is characterised as dividends to the shareholder subject to Korean WHT (reduced rate if a tax treaty applies) while being treated as non-deductible in computing taxable income of the company.
In line with the OECD’s recommendation on the limitation of interest deductions (BEPS Action 4), the new rule shall restrict interest deduction on top of the existing thin capitalisation rule. Deduction of net interest (i.e. the amount of interest expense paid to overseas related parties minus the interest income received from overseas related parties) claimed by a domestic company for the borrowing from foreign related parties shall be limited to 30% of the adjusted taxable income (i.e. taxable income before depreciation and net interest expenses) of the domestic company.
Controlled foreign corporations (CFCs)
Under the Korean CFC rule, when a Korean national or company directly or indirectly owns at least 10% in a foreign corporation and the foreign company’s average effective income tax rate for the three most recent consecutive years is 16.8% or less (the level of 70% of the top marginal CIT rate of 24% at present from the tax year beginning on or after 1 January 2023), the undistributed earnings of the CFC shall be deemed to be paid as a dividend to the Korean national thereby subject to CIT in Korea.
For more information on the CFC rule, see Foreign income in the Income determination section.
Special tax treatment on income attributed to an overseas transparent entity
Effective 1 January 2023, a new rule shall allow a special tax treatment on income attributed to an overseas transparent entity in the hands of a Korean resident or company to prevent the possibility that overseas investments of the resident or company might be subject to foreign income tax that would arise as a result of the reverse-hybrid entity rules in foreign countries. Under the new rule, the term ‘overseas transparent entity’ that is eligible for the special tax treatment refers to an entity that meets the following two requirements: (i) it should be a foreign corporation under item 3 of Article 2 of the CITL, an overseas investment vehicle under Article 93-2 of the CITL, or an unincorporated association established in a foreign country and treated like a corporation under Korean tax laws (the ’foreign corporation, etc.’), and (ii) a shareholder, an investor, or a beneficiary in the foreign corporation, etc. (the ’investor‘) rather than the foreign corporation should be directly liable for tax on income derived by the foreign corporation, etc. according to the tax laws of the country where the foreign corporation, etc. was established. To obtain the special tax treatment, a resident or a domestic corporation that is the investor in the overseas transparent entity must file an application with the concerned district tax office.
Deduction limit on hybrid financial instruments
In a commitment to implement the hybrid mismatch rules recommended by the OECD (BEPS Action 2), a new rule was introduced in 2018 to limit expense deductions for hybrid mismatch arrangements. Hybrid financial instruments include financial instruments that are treated as a debt in Korea but treated as an equity in a foreign country. In principle, expense deduction will be denied for the amount of payment that is not taxed in a counterpart jurisdiction. Domestic corporations that engage in transactions of prescribed hybrid financial instruments shall submit a statement of adjustments to interest expenses concerning hybrid financial instruments by the filing due date of the CIT return for the relevant fiscal year. Effective 1 January 2023, a new penalty of up to KRW 30 million per instrument shall be imposed against the failure to comply with the submission requirement.
Under the CITL, the tax authorities may recalculate the corporation’s taxable income when CIT is considered to be unreasonably reduced due to transactions with related parties not in accordance with fair market value. Generally, if the discrepancy between the transaction price and fair market value exceeds the lesser of 5% of the fair market value or KRW 300 million, the transaction will be subject to this provision.
New rules for global minimum tax
Korea has introduced new rules for global minimum tax (‘GloBE Rules‘ or ’Rules‘) at the end of December 2022. The Rules include an ‘Income Inclusion Rule’ (IIR) and ‘Supplementary Rule for Income Inclusion’ (referred to as the UTPR). Based on the current tax law, both rules will be effective for fiscal years beginning on or after 1 January 2024. The Rules apply to all constituent entities of a qualified multinational enterprise (MNE) group with annual consolidated revenues of EUR 750 million or more in at least two of the four fiscal years immediately preceding the tested fiscal year. The Rules shall not apply to entities that are excluded entities, which refer to a government entity, an international organisation, a non-profit organisation, a pension fund, an investment fund that is an ultimate parent entity, and a real estate investment vehicle that is an ultimate parent entity. In addition, the rules shall not apply to an entity that is directly or indirectly owned by an excluded entity.
The effective tax rate is calculated by dividing the adjusted covered taxes incurred by the net global anti-base erosion (GloBE) income for all of the MNEs’ constituent entities that are located in the same jurisdiction (i.e. jurisdictional blending). If the effective tax rate is lower than 15% in a given jurisdiction, an additional top-up tax for the jurisdiction for the fiscal year is calculated in accordance with the prescribed formula and paid by other CEs within the group under the relevant law. Filing a tax return and payment shall be due 15 months from the end date of the tested fiscal year. However, for the first year, the due date extends to 18 months from the end date of the tested fiscal year.