GLobalization seems to be a cliché that has been around for some time. However, it is still very much alive as it is a phenomenon that is constantly evolving. Whether companies have already made investments or are making new investments overseas, tax laws are constantly changing in response to the evolving practices of globalization. This article sheds light on the most important tax concepts and considerations for South Korean investors making a foray abroad.
Kim Sunyoung (sunny)
Senior foreign lawyer
Tel: +82 2 316 4655
With globalization, international trade and investment are steadily increasing, as national borders are no longer obstacles to global transactions. Directly related to the increase in cross-border trade are international tax uncertainties that intertwine taxpayers with the government authorities in the investing and holding countries. In most cases, this leads to double taxation, i.e. the same income is taxed twice – even three times.
To monitor the various levels of potential taxation, one can look at the overall effective tax rate of the facility. The simplest way to calculate the effective tax rate would be the total amount of taxes paid on world income divided by income earned on world income, which would allow taxpayers to monitor how much taxes are being paid worldwide. The higher the effective tax rate, the higher the tax burden.
There are two measures to lower the effective tax rate: the states agree to reduce the tax burden through tax treaties, or decide to unilaterally grant relief through national laws. These two double taxation concepts should be considered by every investor in order to minimize taxes and maximize profits from their overseas investments.
South Korea has tax treaties with over 90 countries. The meaning of double taxation treaties is that they assign the countries taxation rights for certain types of income prescribed in the double taxation treaty. Of course, if a lower rate applies under the domestic tax laws of the country in which the dividend is paid or interest is paid, we do not have to rely on the double taxation treaty. As a rule of thumb, however, when planning investments abroad, the first thing to do is to check whether a tax treaty with South Korea is in force. This enables the application of a reduced withholding tax rate for types of income such as dividends, interest and royalties, which are prescribed in the double taxation treaty.
Kim Minhyung (Michelle)
Tel: +82 2 316 7283
In the US, for example, passive income such as dividends or interest would be subject to a 30% withholding tax rate without the double taxation treaty. This rate can be reduced to 10% or 15% for dividends and 12% for interest under the tax treaty between South Korea and the US. One point to always keep in mind is that, like in South Korea, there will be tax compliance issues that need to be addressed. For example, tax forms must be submitted in order for the reduced tax treaty rates to apply. Such compliance can be quite time consuming and tedious. However, in order to benefit from the reduced tax rate, it is imperative that the correct forms are submitted to the withholding taxpayer before the income is paid out. Just because the double tax treaty prescribes a lower tax rate does not mean that the lower tax rate is automatically available. This type of compliance is important and applies to both strategic and financial investors.
A double taxation treaty does not completely eliminate double taxation. It serves to reduce the tax burden by agreeing two countries to restrict the exercise of taxation rights. After paying taxes abroad at a lower rate prescribed in the double taxation treaty, these taxes paid abroad can be offset against the tax payable in South Korea.
There are two types of tax credits: direct foreign tax credits and indirect foreign tax credits. Taxes paid by the South Korean company directly can be claimed for a direct foreign tax credit that would be equivalent to withholding taxes on income such as dividends and interest, possibly at a reduced rate under the applicable treaty. A South Korean company can claim an indirect foreign tax credit on the dividend income received by a subsidiary in relation to the corporate income tax paid by the subsidiary, and to the extent that the income on which the subsidiary paid the tax is distributed as dividends to the South Korean parents .
In the past, South Korean foreign tax credit laws allowed indirect foreign tax credits for corporation tax paid by tier one and tier two subsidiaries. However, under current law, the indirect foreign tax is only offset against the tax paid by the first tier subsidiary. In addition, the amount of foreign tax credit available is the amount of South Korean corporate tax that would have been due if the income had been earned in South Korea. If the amount of foreign tax paid exceeds this limit, the surplus can be carried forward for 10 years.
Some points to consider are local regulations regarding permanent establishments, regulations limiting interest expenses, and transfer pricing issues.
With regard to the permanent establishment problem, a South Korean investor should always monitor his activities abroad and take care not to conduct business activities as prescribed by the respective double taxation treaty or the domestic tax laws of the foreign country, in order to give the foreign tax authorities in the country no room to believe that the South Korean investor has a place of business abroad instead of the local subsidiary or branch. Such a permanent establishment would expose the South Korean investor to the tax authorities abroad.
With regard to the interest cap rules, investors wishing to use a mix of debt and equity for investments should ensure that the capital structure is within the scope of the interest cap rules so that such interest expense is not accidentally withheld and / or the interest denied is recorded as dividends for corporation tax purposes. There are three different ways to limit the interest deduction:
(1) Many countries prescribe a debt-equity ratio for intercompany loans. South Korean investors should bring in capital in the form of debt and equity within the legally prescribed ratio so that the respective interest expense is fully deductible. South Korea, for example, has a debt-to-equity ratio of 2: 1;
(2) Refusal to pay interest in excess of 20-30% of earnings before interest, taxes, depreciation and amortization in countries that follow the Organization for Economic Co-operation and Development (OECD) Action Plan “Base Erosion and Profit Shifting” (BEPS) 4 have implemented; and
(3) Refusal to pay interest on hybrid financial instruments in countries that have implemented BEPS Action Plan 2 of the OECD.
In addition, if investors plan to take advantage of related party transactions, preliminary measures such as a transfer pricing study should be carried out to ensure that interest rates are in line with the market.
There will always be legal compliance issues that need to be addressed first, but tax planning should also be in place when investing overseas to ensure investors can maximize the return on their overseas investments. Finally, the authors would like to provide you with a simple checklist to keep in mind when making such outbound investments.
Because taxes affect all phases of an investment – acquisition, operation, and disposal – financial investors can find the right investment structure to minimize the amount of taxes paid at each level of the investment and to maximize returns. Depending on the investment strategy and the type of income expected from the investment, different structures can be used to achieve the highest possible return.
For strategic investors, preliminary tax planning provides a broad perspective to see how a particular investment fits into the investor’s global business and supply chain. South Korean investors should pay close attention to the effective tax rate when expanding their business overseas. Some important tax factors to be aware of are:
(1) Holding structure of participation. Whether the use of a holding company could negatively affect the effective tax rate or how the use of the holding company would affect the flow of funds and the overall financing structure;
(2) Financing structure. To ensure that the interest expense can be fully utilized, for example in an M&A deal, using an acquisition debt allows the company to deduct interest expense and minimize the corporate tax burden;
(3) Global supply chain model. To understand the impact of the investment within global business operations; and
(4) Tax compliance. To minimize the risk of unnecessary penalties or fines.
These key tax drivers ultimately consist in seeing how an investment fits into the current global structure of the investor and what steps need to be taken to ensure that it is fully integrated.
Kim Sunyoung (Sunny) is a senior foreign lawyer at Shin & Kim. You can reach them on +82 2 316 4655 and email@example.com
Kim Minhyung (Michelle) is a foreign lawyer at Shin & Kim. You can reach them on +82 2 316 7283 and firstname.lastname@example.org
Shin & Kim
23 / F, D tower (D2), 17 Jongno 3-gil
Jongno-gu, Seoul 03155, South Korea
Tel: +82 2 316 4114