ΆΓ  [Tips on Tax] Merits of Branch, Subsidiary in Korea

Korea Times 2001. 3.12   

By Lee Hyung-soo

In structuring a business entity in Korea, which would be better - a branch or subsidiary? It may differ depending on the kind of business, sales volume, laws of the home country, etc. However, a general idea of each option's merits and demerits could be mainly based on tax.

A branch is easier to establish and operate. Requirements for filing tax returns, auditing accounts and complying with business law are less burdensome. A branch is not subject to mandatory audits, while a subsidiary with total assets amounting to seven billion Korean won or more is. The major advantage of a branch lies in the probable offset of its losses against profits of the parent company at home. Losses are often incurred in the early years of a new business. The home country's tax rules will often permit those losses to be offset against domestic profits. Assets may be transferred between the Korean branch and its home country head office, in either direction, free of tax.

It is because a branch and its head office belong to the same entity and ownership. As time goes on, the branch may generate more and more profits, which will be combined with domestic profits for higher progressive domestic tax rates. Then, the branch may be closed and transformed to a subsidiary, which is an entity legally independent from its parent company.

A subsidiary provides a better local image and profile, and better access to local borrowings. A president of a subsidiary is higher than a branch manager in Korean society.

Under the Special Tax Treatment Limitation Law, local tax exemptions available to subsidiaries for their investment in Korea may not be granted to branches. If the effective tax rate in Korea is lower than at home, the taxpayer may defer taxes by retaining profits in the Korean subsidiary.

It is easier to justify overheads such as royalties and management fees paid by a Korean subsidiary to its affiliates at home, while the payments by a Korean branch to its head office are not tax deductible. Moreover, a Korean subsidiary affords greater flexibility in the manner and timing of its profit repatriation to the home country.

Its accumulated profits can be repatriated either as a dividend or as a capital gain upon sale or liquidation of the foreign subsidiary. The dividend or capital gain can be timed so as to be taxed in the home country at the best point in time, for example, when tax rates are low or losses are being incurred. These choices are not available to a branch operation.

In most countries, its profits are automatically taxed at home as they arise.