Insufficient Capital Tax System
Date: Nov 13, 2020
Funding measures for a foreign invested companyin Korea include equity investment and loans. Equity investment is not deemeddeductible expense even it is dividend income from a domestic subsidiary butloans are subject deductible expense which is a benefit of it.
For this reason, a domestic subsidiary preferto use loans when raises funds. Insufficient capital tax system is a kind ofeffort to raise funds artificially reducing investment and increasingborrowing.
Where a domestic corporation including adomestic place of business of a foreign corporation; hereafter in this Chapterthe same shall apply borrows funds from a foreign controlling stockholder includingfunds borrowed from a related party of a foreign controlling stockholder orfrom a third party under a payment guarantee including security provided toguarantee payments by a foreign controlling stockholder, and such borrowingsexceed twice the amount invested by the foreign controlling stockholder, theinterest and discount fees paid in relation to the excess amount shall beexcluded from deductible expenses of the domestic corporation and shall bedeemed to have been disposed of as a dividend of or an outflow from thedomestic corporation. In such cases, the scope of borrowings and the methods ofcomputing the amount deemed excluded from deductible expenses.
III. Disposition of income
If there exist different interest or discountfees where to separate interest rates apply, the interest or discount feesshall be excluded from deductible expenses in order of those subject to ahigher interest rate.
IV. Determinationof special relationship
☞ A foreign stockholder who, directly or indirectly,owns at least 50/100 of voting stocks of a domestic corporation;
☞ A foreign corporation, at least 50/100 of whosevoting stocks are owned, directly or indirectly, by a foreign stockholderdescribed in subparagraph 1;
☞ A foreign stockholder having a relationship underArticle 2 (1) 4 with a domestic corporation.
V. Reasons for exemption of taxation carriedforward
1) The scope of borrowings shall be theliabilities which generate the interest and discount fees: Provided, That thefund borrowed in a foreign currency by a domestic branch of a foreign bankunder the Banking Act upon request of the Government including the Bank of Koreaunder the Bank of Korea Act, or the amount deposited by and borrowed from, inforeign currency, the head office or branch office of the relevant foreign bankin order to use it by one of the following methods, shall be excluded:
☞ Method to deposit or lend inforeign currency to a nonresident or a foreign exchange bank under the ForeignExchange Transactions Act
☞ Method to accept or trade the bonds in foreign currency issued by anonresident or a foreign exchange bank under the Foreign Exchange TransactionsAct.
2) Theamount deemed not included in deductible expenses shall be the amount ofinterest and discount fees computed by aggregating each total from multiplying respectivedebts by respective loans by relevant interest rates in order from the highestinterest rate. Where at least two loans to which the same interest rate appliesexist, in order of the latest loan shall apply among total loans of a domesticcorporation from its foreign controlling stockholder, and the limit on such sumshall be the time the accumulated amount of loans from the loan of the highestinterest rate reaches the excess accumulated, and the accumulated amount of thelast loan when the accumulated amount surpasses the accumulated excess, whichexceeds the accumulated excess shall be excluded. In such case, the accumulatedexcess shall be calculated according to the following formula;
★ Computation of accumulated excess
Accumulated excess = Accumulated amount oftotal loans of a domestic corporation (including a domestic place of business aforeign corporation; hereinafter the same shall apply in this Chapter) from itsforeign controlling stockholder (including a third party providing loans to thedomestic corporation under guarantee issued by the foreign controllingstockholder) (accumulated amount of equity investment of foreign controllingstockholder in the domestic corporation × standard multiplier
★ Investment amount of a domesticcorporation
1) An amount computed by deducting the totalliabilities (including reserves and excluding the unpaid corporate tax) fromthe total assets on the statement of financial position as at the end of therelevant business year
2) The paid-in capital calculated using thefollowing formula as at the end of the relevant business year:
Amount of capital + (amount in excess of parvalue of stocks issued and gains from capital reduction) - (discount on capitalstock and loss arising from capital reduction)
3) The scope of interest and discount fees
The economic substance of which corresponds tointerest, such as the amortization of bond discounts and discount charges onaccommodation bills, which a domestic corporation must pay to its foreigncontrolling stockholder: Provided, That the interest on construction capitalfunds shall be excluded from the scope of interest and discount fees.
VI. Loans under Ordinary Terms and Conditions
Where a domestic corporation, whose multiplierof loans exceeds a foreign controlling stockholder's equity investment by asmuch as two times, it shall submit the following data to the competent taxauthority by the deadline for filing a return.
1) Data attesting that the relevant loans arenot actual capital contribution, based on the interest rate, maturity, paymentmethod, possibility of conversion into capital, priority over other claims,etc.;
2) Data on the multiplier of loans against theequity capital of a comparable corporation carrying on the same business typeas that of the relevant domestic corporation. In such cases, the comparablecorporation means a corporation having a representative nature based on itsmultiplier of loans among domestic corporations having a scale of business andmanagerial conditions, etc. similar to those of the relevant domesticcorporation.
3) Where the multiplier of loans against a foreigncontrolling stockholder's equity investment in a domestic corporation exceedsthe comparable multiplier, shall apply to the method of computing thenon-deductible expense of the domestic corporation.
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