As a member of both the G20 and the OECD, Korea is highly engaged in the BEPS consultations and appears likely to adopt many measures that the OECD ultimately recommends. Korea plans to gradually roll out the Action Plan by revising its domestic tax laws and renegotiating its tax treaties.
In response to Korea’s BEPS-driven tax amendments, private consulting groups are offering customized services to large Korean companies as well as mid-sized companies with intercompany transactions. However, the latest survey by Korean Economic Federation shows that the majority of Korean big companies are still slow to adapt to the BEPS environment. Korea is implementing the OECD BEPS Action Plan in response to the OECD’s schedule and has set a priority on the minimum standard for implementing the OECD BEPS Action Plan (i.e. Actions 5, 6, 13 and 14).
As of 2016, Korea has introduced a new transfer pricing documentation requirement that reflects the relevant BEPS Actions. Korea has suggested its reasons for adopting the new transfer pricing documentation rule are:
Under the new requirement, as of 1 January 2016, taxpayers having annual sales revenue of 100 billion Korean won (KRW) or more and intercompany transactions of KRW50 billion or more are required to submit a ‘comprehensive report’ on international controlled transactions by the due date of filing of tax return.
The comprehensive report consists of an individual entity report (‘local file’) and integrated entity report (‘master file’). Korea has not yet introduced the country-by-country report but may do so in the future, depending on foreign countries’ legislation and implementation status. Korea has already introduced legislation on several OECD BEPS Action Plan items. Two instances include:
Controlled foreign company rules on passive income:
To curb perceived tax avoidance through foreign retention, Korea is extending application of its controlled foreign company rule to passive income as of 1 January 2015. Obligations to submit information on controlled foreign companies have been strengthened, and a harsh new penalty of up to KRW100 million (about 92,000 US dollars (USD)) of additional tax may be levied for not complying with these rules (Action 3).
Exchange of information:
Korea has strengthened the intergovernmental exchange of information to prevent BEPS by entering agreements with more governments, including an agreement with the US under the Foreign Account Tax Compliance Act, wich took effect in July 2014. Korean exchange of information rules apply not only to non-resident and foreign entities but also to Korean residents and domestic companies. Financial institutions that fail to submit information as required face a new penalty of up to KRW30 million (about USD27,000).
Korean tax law contains a substance-over-form rule that allows the tax authority to re-characterize a related-party transaction based on its substance where the tax burden of a company has been unjustly reduced. Thin capitalization and transfer pricing rules are also in place. In recent treaty negotiations, Korea has worked to resolve treaty shopping problems by introducing limitation on benefits clause.
In addition, Korea’s tax authorities have increased both the frequency and level of scrutiny of international tax audits, sharpening their focus on outbound investments, transfer pricing and foreign tax credit abuses in the past few years.
The Korean government has formed a task force consisting of National Tax Service officers and tax professionals to plan for the effective implementation of the OECD BEPS proposals. The Korean government has also set up a BEPS response center to help Korean companies respond to BEPS developments.
At the same time, the Korean tax authorities are working to raise awareness of the BEPS-based transfer pricing regulations among Korean companies and global companies doing business in Korea. Penalties for non-compliance with the new regulations do not appear harsh, but non-compliance could also trigger a transfer pricing tax audit. If an audit results in a transfer pricing adjustment, significant tax consequences would arise – a penalty of 10 percent of underpaid taxes for underreporting taxable income and a penalty of 10.95 percent of underpaying taxes. Further, if a transfer pricing adjustment is returned, the tax authorities may make a secondary adjustment by deeming the unreturned income as dividends.
Taxpayers can appeal transfer pricing adjustments through the domestic appeal process and mutual agreement procedures under an applicable tax treaty. However, it can take at least 3 to 5 years to reach the final conclusion through these routes, which can create substantially costs for taxpayers.
Despite government efforts, a recent survey by the Korean Economic Federation7 indicates that the majority of the Korean companies are not well aware of details of the BEPS Action Plans. Larger Korean companies are increasing their tax resources and strengthening their tax risk management controls and processes. They are also investing in training to equip internal tax professionals with more sophisticated international tax skills. By contrast, small and medium-sized Korean companies are struggling to add substance and staff to their tax departments. Therefore, it is anticipated that larger Korean companies will be able to adapt to the BEPS environment, but small and mid-sized companies may suffer a competitive disadvantage.
As Korean companies seek to expand operations and compete in the global economy, they are showing interest in global structures that could help reduce their effective tax rates. Compared with other global companies, however, Korean global companies have fewer in-house professionals with international tax skills. As a result, in the BEPS environment, Korean global companies will need to devote more of their limited in-house tax resources to compliance work at the expense of strategic planning activities, which may impede the ability of Korean global companies to compete.