Korea, Republic of

Corporate - Income determination

Last reviewed - 30 June 2020

Gross income consists of gains, profits, income from trade and commerce, dealings in property, rents, royalties, and income derived from any transactions carried on for gain or profit.

Inventory valuation

Inventories generally are stated at either the lower of cost or market (LCM) or cost method. Any one of LCM and six cost methods, including specific identification, first in first out (FIFO), last in first out (LIFO), weighted-average, moving-average, and retail method, can be elected for tax purposes. The method elected should be applied consistently each year unless an application for change has been submitted before three months from the year-end. Different valuation methods may be used for different categories (i.e. manufactured goods and merchandised goods, semi-finished goods and goods in process, raw materials, supplies in stock) and different business places.

For inventory costing under Korean International Financial Reporting Standards (K-IFRS), LIFO is not an acceptable accounting method. Consequently, in a year when a taxpayer first adopts K-IFRS and duly reports the change of inventory valuation method from LIFO to one of the other costing methods (e.g. FIFO, weighted average), the taxpayer is allowed to exclude the inventory valuation gain arising from the change and include it in its taxable income over the next five-year period using a straight-line method.

Stock valuation

The valuation of securities or bonds shall be made using the cost method. For the cost method, the weighted-average cost method or moving-average cost method shall be applied for the purpose of valuation of securities, and the specific-identification method may be used for valuation of bonds.

Capital gains

Generally, capital gains are taxed at the same CIT rate as ordinary taxable income. For the purposes of taxation, gross income does not include income derived from gains from capital transactions, such as capital surplus, gains on reduction of paid-in capital, etc. However, gains from treasury stock transactions are taxed, and losses are deductible from taxable income.

Note that capital gains from the disposal of non-business purpose land or houses may be subject to additional capital gains tax at the rate of 10% (40% in the case of non-registered land or houses) in addition to the normal CIT.

Dividend income

All distributions to shareholders are taxed as dividend income, whether paid in cash or in stock.

However, a qualified domestic holding company that owns 80% (40% in case of listed subsidiary) or more share ownership in its domestic subsidiary will receive a 100% deduction for dividends, while a 90% deduction is allowed for share ownership of less than 80% (40% in case of listed subsidiary) and an 80% deduction is allowed for share ownership of less than 50% (30% in case of listed subsidiary). A domestic corporation other than a qualified holding company will also receive a 100% deduction for share ownership of 100%, 50% for 50% (30% in case of listed subsidiary) or more share ownership, and 30% for share ownership of less than 50% (30% in case of listed subsidiary).

Interest income

Except for certain cases, all interest income must be included in taxable income. Generally, interest income is included in taxable income as it is received.

Rental income

Income from the leasing of property shall be included in taxable income. In cases where a company is subject to an estimated tax by the tax authority due to the absence of books of accounts, the deemed rental income as calculated at a term deposit interest rate on the lease deposit received by the company will be included in taxable income.

Royalty income

Royalties are considered to be taxable income when earned. Korean companies paying domestic-source royalties to foreign corporations must withhold tax at an effective rate of 22% (including local income tax). The WHT rate may be reduced by a tax treaty. With effect from 1 January 2020, payments to foreign licensors for the use of patents registered outside Korea will be treated as Korean-source royalty income for the use of ‘other similar properties or rights’ as defined in territorial-based tax treaties if the manufacturing method, technology, information, etc. contained in the patents registered outside Korea is used in manufacturing and production activities within Korea and, accordingly, shall be subject to WHT in Korea.

Gains and losses on foreign currency translation

Companies are allowed to recognise unrealised gains and losses on foreign currency translation of their monetary assets and liabilities in a foreign currency. This recognition is also allowed with respect to currency forward transactions and swaps to hedge foreign exchange risks of such assets and liabilities. In this regard, a taxpayer can choose whether to recognise unrealised gains and losses or not for tax purposes. Once elected, the same method must be consistently used.

Foreign income

Resident corporations are taxed on their worldwide income. A Korean company is taxed on its foreign-source income as earned at normal CIT rates. To avoid double taxation, taxes imposed by foreign governments on the foreign-source income recognised by a resident company are allowed as a credit against CIT or as deductible expenses in computing the taxable income.

Generally, income of foreign subsidiaries incorporated outside Korea is not included in the taxable income of a resident company until the declaration of dividends from the foreign subsidiaries. Therefore, the Korean tax impact may be delayed through deferring the declaration of dividends unless the controlled foreign corporation (CFC) rule under the Law for Coordination of International Tax Affairs (LCITA) is applied.

The CFC rule provides that the undistributed earnings of a resident company’s foreign subsidiary located in a low-tax jurisdiction (where the effective tax rate on the income before tax for the past three years averages 15% or less) are taxed as deemed dividends to the resident company that has direct and indirect interest of 10% or more in such subsidiary. The CFC rule does not apply in cases where a foreign subsidiary has fixed facilities (e.g. office, factory) in a low-tax jurisdiction for the conduct of business, it manages or controls the business by itself, and the business is mainly performed in the jurisdiction. Even in this case, however, where passive income (e.g. income from investment in securities or lending loans) is more than 50% of gross income, the CFC rule shall be applicable. Furthermore, in cases where the passive income is between 50% and 5% of the foreign subsidiary’s gross income, the CFC rule will apply in a limited manner (i.e. a CFC’s undistributed earnings will be included in taxable income of the CFC’s domestic related parties in proportion of such passive income to its gross income). However, dividends will be excluded in calculating the amount of passive income if they are derived from shares issued by the company that is 10% or more owned by a CFC.

If dividends from a qualifying subsidiary are included in taxable income of a resident company, the foreign tax paid by a qualifying subsidiary on the subsidiary’s taxable income is eligible for a foreign tax credit in the hands of the resident company regardless of whether there are tax treaties with the relevant foreign countries. For this purpose, a qualifying subsidiary refers to the company in which a resident corporation owns 25% or more of its shares for the period of six consecutive months or more prior to the date of dividend declaration. Unused foreign tax credits can be carried forward for five years.