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Tax law changes for 2008

It is reported that the Ministry of Finance and Economy (MOFE) unveiled the 2008 tax law revision proposal on 22 August 2007, which will be submitted to the National Assembly when its regular sessions begin in September 2007. If passed, the proposal will go into effect in 2008. The proposal focus is to enhance redistribution, support growth and broaden the tax base. The details of the proposal are summarized below.

Encouraging foreign direct investment

In order to encourage the growth of foreign direct investment (FDI), the following proposals have been made:

-   all cities and counties in Korea (Rep.) would be grouped into four "grade" areas in terms of regional development. The small and medium enterprises in these areas are to be taxed at between 30% to 100% of the regular tax rate;
-   the benefits enjoyed by foreign enterprises making large-scale investments (with a minimum FDI of USD 30 million for manufacturing, USD 20 million for tourism or USD 10 million for logistics) in Free Economic Zones (FEZs) is to be extended. The corporate tax cut, the VAT exemption on imports of capital goods and the tax benefit for research and development is to be extended from 5 to 7 years; and
-   the introduction of corporate tax cuts for domestic corporations in the Jeju Free International City (JFIC). Pursuant to the proposal, large corporations which move from the metropolitan Seoul region to the JFIC will enjoy a corporate tax reduction by 70% for the first 10 years and by 35% for the following 5 years. The establishment (i.e. not relocation) of large corporations in JFIC would enjoy a corporate tax reduction by 70% for the first 7 years and by 35% for the following 5 years. The relocation or establishment of such large corporations must be completed by the end of 2012.

Introduction of partnership taxation

A specific partnership taxation regime is to be introduced as follows:

-   the preliminary draft was issued by the government in August 2007. The proposed partnership taxation will cover legal and accounting firms;
-   the proposed partnership taxation also allows for special tax exemptions for corporate reorganizations. The corporate tax on the liquidation income and the individual tax on deemed dividend income from the corporate reorganization would be waived if a professional company is converted into an entity type that falls under the proposed partnership tax regime. The provision would apply to reorganizations beginning in 2008; and
-   it is unclear if the partnership taxation would apply to investment vehicles under the Capital Market Consolidation Act.

Reinforcement of rule against tax avoidance

The following changes to the rules against tax avoidance have also been proposed:

-   Clarification of substance-over-form rule: The "step transaction rule" developed by the US judiciary is to be added to the Basic Law for National Taxes to effect meaningful changes in the practices of the tax authority and possibly the South Korean courts.   
-   Artist/athlete company tax rule: The "artist/athlete company" was once frequently used to avoid the artist and athlete article of a tax treaty. Under the current legislation, the tax authority often does not obtain enough evidence to prove the substantial attribution before the payment has been made to the artist/athlete company. Under the proposal, the Corporate Tax Act (and specifically, the Income Tax Act) will be amended to require the payer to withhold tax from payments even if there is no anti-abuse rule in the tax treaty. The tax authority will determine the tax amount to be withheld to the extent of the actual payment to the artist or athlete by the company.
-   Strengthening thin capitalization rule: Currently, the six-times rule for expense deduction is applied to the financial industry. In order to achieve consistency, the government has proposed to apply the three-times rule for expense deduction across all industries including the financial services industry. The revised rule will be applied to the fiscal year starting after 1 January 2008.

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