Problems and Improvements of the Korean Tax Rules on the Corporate Reorganization
Asian Tax Journal Vol. 13 No. 2 (2012), pp. 173-196
Abstract
Before 1997, the corporate reorganization was not common in Korea, but the Korean Government enacted systematic tax rules governing corporate reorganization under the Foreign Exchange Crisis bailout program and continuously revised the regulations since then. Particularly,the two－pronged amendments to the Corporate Income Tax Act ("CITA") in 2010 implemented wide－ranging changes with respect to the special tax regime applicable to mergers, demergers,and other changes in corporate forms. The purpose of this study is to evaluate our system and consider how the tax rules on corporate reorganization can be improved. The scope of this study includes the Korean tax rules on corporate reorganizations, as well as key tax benefits provided by the Special Tax Treatment Control Act ("STTCA") since 1997 to date. The result of this study can be summarized as follows. The current law deals with merger,demerger, comprehensive transfer/exchange of shares or assets, in－kind contribution, establishment of a holding company, etc. as forms of corporate restructuring. In particular, merger and demerger satisfying certain requirements are treated as qualifying merger and qualifying demerger, which would be eligible for tax deferral on unrealized gains by treating the value of the transferred assets equal to their book value instead of their fair market value. Special tax treatment of corporate restructurings is fundamentally based on the notion that if a company's economic substance remains the same － i.e., its ownership and governance structure, continuity of business, etc. remain the same － the company's continuity should be respected. In comparison to our tax system, the tax rules of the US and Japan recognize a much wider range of corporate restructuring types. In particular, the US comprehensively regulates the corporate reorganization by dividing companies into 7 types. In addition, while the Korean tax rules take a formalistic approach and require strict satisfaction of all requirements to be eligible for special tax benefits, the US rules evaluate the substance and purpose of the transaction concerned to determine its eligibility, granting the special tax benefits to all parties to the transaction if the requirements are met. There also exist differences in terms of the contents of the special tax regime. The US and Japanese tax regimes tend to include a relatively smaller number of formulary requirements and do not mandate succession of employees, which could be subject to substantive restriction. Also,triangular mergers, which are proscribed in Korea, are dealt with more flexibly overseas. With respect to net operating loss ("NOL") carryforwards as well, Korea only allows deduction of NOL against profits generated by the transferred business, whereas the US and Japan do not impose such restriction at all or take a more indirect approach (pre－merger deduction ratio of NOL carryforward). Furthermore, while Korea provides tax deferral as the special tax treatment of qualifying restructurings, the special tax benefit provided by the US and Japan takes the form of non－taxation, which would make follow－up measures much simpler. Based on the result of this study, it can be concluded that the current system on the corporate restructuring can be positively evaluated in terms of legal stability. However, it is necessary to remedy its shortcomings to implement a tax system conducive for more permanent and smooth tax support. In this regard, establishment of an independent tax system (referred to as the "Restructuring Tax Rules") similar to the German system could be an alternative solution. Meanwhile, the special taxation regime based on specific types of corporate restructurings (as the current rules) has inherent limitations to achieve the policy objectives. Therefore, it is recommended to set out comprehensive requirements of corporate restructuring and reinforcing detailed requirements according to the types by referring to the regulatory attitude of the US tax systems. Moreover, it is necessary to take decisive actions aimed at complete overhaul of the relevant rules related to the double taxation at the time of a qualifying demerger, excessive restriction on the combined stock, and unreasonable follow－up measures, all of which can deter active corporate restructurings by companies. Conversely, it is necessary to implement certain legislative measures to prevent tax avoidance attempts by taxpayers using corporate restructurings. For instance, solutions to address the issue of deemed dividends resulting from a merger or addition of employee succession requirement to secure effectiveness of eligibility requirements for the tax benefit should be considered. Lastly, rules applicable to corporate restructuring similar to a business transfer that is exempt from VAT should be clarified to avoid any confusion, and discussion and review of tax issues in relation to cross－border corporate restructurings in this global world should continue in the future.
Keywords
- corporate reorganization
- Merger
- Demerger
- tax deferral
- triangular merger
- net operating loss carryforward
- the combined stock
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