Examining transactional tax in Korea with a restructuring boom on the horizon
As increased opportunities for consolidation should emerge in the months ahead, Kyu Dong Kim and Jeremy Everett of Yulchon set out the key transactional tax considerations for businesses.
Merger and acquisition (M&A) activity in South Korea for the first quarter of 2020 plunged by 55% and totalled only $2.5 billion (the lowest since 2013), with many large deals placed on hold until the COVID-19 pandemic passes. However, substantial restructuring is expected to take place throughout 2020 and 2021, with an initial focus on Korea's nine low-cost air carriers and the entire hospitality and tourism sector, which has been hardest hit by the pandemic.
In other sectors, shipbuilders, steel makers, refineries, and producers of flat panel displays may have to sell off non-core assets or lay off workers as lower global demand, declining oil prices, and protectionism impact their businesses.
Having seen numerous waves of extensive M&A activity since the 1997 Asian financial crisis, Korean commercial and tax laws have been streamlined to facilitate efficient restructuring. This article summarises the key features of Korea's taxation system when restructuring or engaging in M&A transactions.
When a foreign shareholder (without a permanent establishment in Korea) sells shares in a Korean company, the capital gain is taxed at the lesser of 11% of the gross sales proceeds and 22% of the gain (unless exempt under one of Korea's tax treaties). The capital gain tax, where applicable, is generally withheld by the purchaser. If the Korean company's assets are comprised principally of real estate (i.e. 50% or more of its total assets consist of real property), most of Korea's tax treaties will not provide a capital gain exemption. In such a case, the foreign shareholder would be required to file a tax return in Korea to pay capital gain tax on the share transfer. The buyer would assume any net operating loss (NOL) carryovers and other tax attributes of the target company without any limitation for change in control.
It is possible to defer capital gain taxation in the case of a 'comprehensive share exchange', or a 'comprehensive share transfer', as defined under the Korean Commercial Code (KCC).
A comprehensive share exchange is a procedure available for an established company acquiring 100% of the shares of a target company, in exchange for newly issued shares in the acquiring company. It requires a special resolution between the target company and acquiring company's shareholders.
A comprehensive share transfer involves the formation of a new holding company by the shareholders of the target company, who transfer all their shares in the target to the new holding company in exchange for shares in such company. This requires a special resolution of the shareholders from the company transferring the shares. Dissenting shareholders can exercise their appraisal right to demand that the company redeem their shares.
The prerequisites to qualify for tax-free reorganisation treatment are as follows:
One year requirement: The acquiring company and the target must be Korean corporations that have been in business for one year or longer as of the date of the exchange/transfer.
Continuity of interest requirement: At least 80% of the consideration paid to the target shareholders must consist of shares in the acquiring company.
Distribution requirement: The amount of shares in the acquiring corporation distributed to each of the target's controlling shareholders must equal or exceed each controlling shareholder's ratio in the target multiplied by the total consideration paid in the form of shares of the acquiring company.
Continuing shareholding requirement: Each controlling shareholder of the target must hold at least 50% of the shares distributed pursuant to the distribution requirement through the end of the taxable year in which the exchange/transfer takes place. In addition, the acquiring company must hold at least 50% of the shares in the target until the end of the taxable year in which the exchange/transfer takes place.
Continuity of business enterprise (COBE) requirement: The target must continue to conduct its business at least until the end of the taxable year in which the exchange/transfer took place. If at least 50% of the fixed assets owned by the target as of the exchange/transfer date (by value) are disposed of or not used, the business is deemed to have been terminated and the COBE requirement will not be satisfied.
Unless the following post-transaction requirements are met for two years commencing at the end of the taxable year in which the comprehensive share exchange/transfer takes place, the shareholders of the target company will recognise any deferred capital gain on the transfer/exchange, and other exempted or deferred transfer taxes will be recaptured and borne by the acquiring company.
Having seen numerous waves of extensive M&A activity since the 1997 Asian financial crisis, Korean commercial and tax laws have been streamlined to facilitate efficient restructuring.
Firstly, the target must continue its business throughout this period. The target's business is deemed discontinued if the target disposes of 50% or more of the total value of its fixed assets or fails to utilise such assets in its business. However, this rule does not apply if the assets are sold or discontinued due to a subsequent qualified reorganisation or bankruptcy.
Secondly, the controlling shareholders of the target should not dispose of 50% or more of the acquiring company shares received as consideration to parties other than such controlling shareholders. However, if the disposition takes place due to the death or bankruptcy of the shareholder, subsequent qualified reorganisations, or in order to fulfil a legally imposed obligation, the tax benefits will not be recaptured.
Thirdly, the acquiring company should not dispose of 50% or more of the target shares received as consideration in the transaction. However, if the disposition takes place due to the bankruptcy of the acquiring company, a subsequent qualified reorganisation, or in order to fulfil a legally imposed obligation, the tax benefits will not be recaptured.
Secondary tax liability
Under Korean tax law, the controlling shareholder assumes secondary tax liability with respect to national taxes (e.g. income tax, and VAT) if the company does not have sufficient assets to pay off its tax obligations. This secondary liability applies to the controlling shareholder of the company as of the date such tax liability becomes final and fixed, which, in the case of corporate income tax, is the last day of the relevant tax year.
Securities transaction tax
A transferor is subject to securities transaction tax (STT) at 0.25% of the gross sales consideration (if sold via stock exchange) or at 0.45% in other cases. STT is not imposed if a transaction satisfies the requirements for a tax-free reorganisation (i.e. a qualified reorganisation).
Deemed acquisition tax
The acquiring company would generally be subject to a 2.2% deemed acquisition tax (DAT) on the book value of registrable assets (such as real property, vehicles, and golf memberships) on the books of the target company multiplied by the acquiring company's ownership ratio in the target.
If the transaction satisfies the requirements for a tax-free reorganisation, a portion of the DAT will be exempted until December 31 2021.
Registration license tax
Registration license tax is imposed when a company is initially capitalised and at the time of subsequent capital increases. The tax rate is 0.48% of the par value of the issued shares. The rate increases three fold to 1.44% if the issuing company is located in the Seoul metropolitan area. This tax applies even when all the requirements for a tax-free reorganisation are satisfied.
Tax clearance certificates
National and local tax clearance certificates can be obtained from designated tax authorities. These certificates confirm that tax returns and tax payments that are due have been filed and paid. Tax clearance certificates may be useful in verifying whether the taxpayer has generally been compliant in filing tax returns and paying taxes specified in the tax returns; however, they do not verify whether tax returns were accurately filed.
In an asset transfer, any historical tax attributes (NOLs, tax credits, etc.) will not be preserved in the hands of the acquirer.
Until the end of 2017, it was possible to structure an asset transfer as a qualified 'comprehensive asset transfer', based on requirements analogous to a qualified comprehensive share exchange/transfer, resulting in tax-free treatment for the target company and its shareholders. Unfortunately, this category of tax-free reorganisation was repealed from 2018. Tax-free reorganisations are still available if the transaction can be structured as a qualified in-kind contribution.
If the seller of the assets is a foreign party (without a permanent establishment in Korea), the acquirer would be the withholding agent responsible for collecting and paying income tax and transaction taxes (such as STT).
Depreciation and amortisation
The acquirer of the target assets would generally be able to depreciate and amortise the assets over prescribed useful lives. Buildings and fixed assets are generally amortised over 15-50 years (40 years being most common).
Goodwill and most types of registered intellectual property are amortisable over five years, while patents are amortisable over seven years. The goodwill should be appraised using a method prescribed in the tax law and should give rise to specific economic benefits or potential residual profits (e.g. licenses, permits, favourable geographic locations, trade secrets, reputation, customer lists, or business relationships).
Transaction taxes and VAT
Korea imposes a 10% VAT on goods and services. The supplier (seller) has the obligation to collect VAT and pay it to the tax authority. The purchaser is generally entitled to an input VAT credit, which it can offset against VAT collected and receive a refund to the extent in excess of VAT collections.
However, if the asset transfer is characterised as a 'comprehensive business transfer', it is exempt from VAT. In practice, there is no fine line between a comprehensive business transfer and a regular asset transfer, resulting in frequent tax disputes. This issue can generally be addressed by utilising the proxy VAT regime.
If the purchaser (in lieu of the seller) takes the position that the transaction is not a comprehensive business transfer, and files a proxy VAT return, the possibility of a retroactive VAT assessment and the assessment of penalties can be avoided even if the tax authority later disagrees with the position taken.
Any gain derived from the sale of assets should be included as ordinary income in the seller's tax return, subject to regular corporate income tax rates. To the extent registrable assets are transferred (e.g., real property, vehicles, golf club memberships, etc.), the acquirer will be subject to acquisition and registration tax. The rates vary depending on the asset category. For real property, the base rate is generally 4.6% (though higher if located in the Seoul metropolitan area).
The two most common corporate entities are the joint stock company (jushik hoesa) and the limited company (yuhan hoesa). Both provide limited liability to shareholders and are treated as corporations for Korean tax purposes. Other types of entities that can elect to be treated as pass-through entities for tax purposes could also be considered.
Limitation on interest deductions and interest withholding tax
Under Korean tax law, several long-standing anti-abuse rules limit interest deductions with respect to borrowings from a foreign controlling shareholder (or related party), as well as third party borrowings secured by a foreign controlling shareholder (to the extent in excess of an equity multiple).
Interest payments to a foreign lender would generally be subject to withholding tax at 22% unless reduced by one of Korea's tax treaties. Interest on foreign-currency denominated bonds issued outside of Korea is exempt from withholding tax under Korean domestic tax law.
Although the Corporate Income Tax Act does not specifically address earn-outs, the fixed portion of the sale price should be reported at the time of the sale, while amended returns are generally filed to adjust the final sale price for any contingent payments. Interest or penalties associated with the filing of amended returns for earn-out payments, based on the performance of the acquired target or business, are generally waived when it would have been difficult to accurately determine the final sale price at the time of the original tax return.
Kyu Dong Kim
T: +82 2 528 5542
Kyu Dong Kim is a tax partner primarily focusing on international tax matters and currently co-leading Yulchon's international tax team. He has extensive knowledge and experience dealing with the challenging tax issues multinational corporations face, including cross-border transactions and Korean tax matters, with a particular focus on global technology companies and financial institutions. He also specialises in structuring overseas fund investments into Korea and Korean fund investments overseas.
Before joining Yulchon, Kyu Dong worked with PwC in London and Seoul. He is a director of the Korean branch of the International Fiscal Association (IFA) and serves as an advisor to the government committee on tax law amendments.
T: +82 2 528 5133
Jeremy Everett is a tax partner in Yulchon's international tax group. He has lived in Korea for 26 years and has been advising foreign and Korean companies on inbound and outbound tax matters since 1994. He has extensive experience assisting a wide range of industrial and financial service clients with tax audits and dispute resolution, M&A, tax planning and effective tax rate optimisation.
Jeremy previously led two of the largest corporate tax departments in Korea. He was the first foreigner to serve as the global head of tax for a Korean conglomerate, Doosan Group, and also formed and led General Electric's tax team in Korea.