Is your business domestic or foreign?

KOREA Herald 2000/04/07

The tax collector needs to knowFollowing is the second in a series of articles on the Korean tax system to be contributed every other week by Lee Young-suk, a certified public accountant and tax attorney at the law office of Kim, Shin & Yu. Mr. Lee can be reached at yslee@ksy.co.kr. - Ed.

By Lee Young-sukMost foreign investments in Korea are made in the form of corporate investment. Thus, the corporate tax is the most important tax that must be considered by a foreign firm operating in Korea.

The present Korean corporate tax laws are classified into two large groups: domestic corporations and foreign corporations. The domestic corporation is a firm that has its head office or principal office of business in Korea, while the foreign corporation has its head office or principal office of business overseas.

Korean commercial and civil laws stipulate that a corporation must be registered in the area where its head office or principal place of business is located. Thus, those corporations established under Korean commercial and civil laws are considered domestic corporations, while those established under overseas laws as foreign corporations.

A typical example of a foreign corporation would be the Korea branch of a corporation whose head office is located overseas.

On the other hand, a so-called "joint company" established with a foreign investment fund and under the Korean commercial or civil laws is considered a domestic corporation if its head office is located in Korea. Usually, it is similar to a subsidiary of the foreign investor.

There is a growing tendency these days of foreign investors to enter the Korean market in the form of a subsidiary rather than of a branch office. However, there are merits and demerits for both types of corporations.

Corporate income tax issues for a branch-type foreign corporation are quite complicated, as they are not subject to corporate tax only. In order to understand Korean corporate tax, a comprehensive understanding on international tax coordination laws, the foreign investment promotion act, the special tax treatment control law and tax treaties between nations are required.

• A tax treaty is an agreement between nations. In international trade, particularly, it is necessary to define which nation has the taxing authority in order to prevent double taxation for corporations investing overseas. Hence, a tax treaty will prevail over all domestic laws when a tax issue is raised, as it represents promises between nations. Domestic laws are considered when there is no applicable provision in the tax treaty or no tax treaty exists.
• The International Tax Coordination Law sets forth the provisions for preventing tax evasion. It includes the tax system based on transfer price, taxing system for extraordinarily thin capital, tax heavens, etc, as well as the provisions for taxing cooperations.
• The Foreign Investment Promotion Act and the Special Tax Treatment Control Law mainly define tax reductions for foreign corporations and their procedures.
• Chapter 4 of the Korean Corporate Tax Law deals with the corporate tax for foreign corporations, and a substantial part of the provisions for domestic corporations is also applied to foreign firms under the law.

As indicated above, various laws are individually or collectively applied when taxing the income of foreign firms.

Special attention is needed, especially on the following four items, when a corporate tax is levied on the income earned by a foreign corporation.

First, it has to be determined whether or not the income earned by the foreign corporation during its fiscal year originated domestically as defined in the Article 93 of the Corporate Tax Law. Since the foreign firm is liable for tax payment for only the income earned domestically, the above will be an important question to ask. For example, let's suppose that a foreign firm earned an interest income during its fiscal year. The Article 93 of the Corporate Tax Law defines such interest income as the income earned domestically. Thus, it is subject to tax.

Second, it is important to confirm whether or not a tax treaty exists. Usually, the corporate tax for a foreign corporation is subject to the provisions of the domestic tax laws such as the Corporate Tax Law. However, in case the foreign firm is applicable to the tax treaty, the provisions of such a tax treaty prevails over any other provisions of Korean law.

Third, it has to be determined whether or not the foreign firm qualifies for any exemptions on its income. Even though income is defined as domestically earned income, it can be exempt from taxation under certain items provided by the tax treaty.

Fourth, it also has to be determined whether or not the domestically earned income originated from the domestic business office.

The domestic business location means that the business activities are conducted partially or wholly in a fixed domestic location. Whether tax is to be paid based on "consolidated taxation/voluntary tax filing" or on "tax withholding/separate taxation" will be determined based on whether or not the income originated from the domestic business location.

The consolidated taxation/voluntary tax filing means that a corporation aggregates all its income earned during a one-year period and voluntarily pays tax for the aggregated income. "Tax withholding/separate taxation" means that tax is withheld and paid every time a transaction is made. Therefore, a foreign corporation with a fixed business location can voluntarily calculate and file for corporate tax on its income. All incomes earned domestically during a fiscal year are added for calculation.

On the other hand, a foreign corporation without a fixed business location that earns income from a temporary business is subject to the "tax withholding/separate taxation."