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Controlled Foreign Company (“CFC”) Rule

Controlled Foreign Company(“CFC”) Rule


a. Outline of Anti-Tax Haven Rules

Under the LCITA and its Enforcement Decree, if a Korean company (individual) invests in a company located in a tax haven, which unreasonably has reserved profits in the controlled foreign company, the profits reserved shall be treated as dividends paid out to that Korean company (individual), despite the fact that the reserved profits are not actually distributed.


In case where the sum of shares in a controlled foreign company directly or indirectly held by a Korean resident individual or company and directly held by his/her/its family members as defined in the Civil Law combined accounts for 20% or more of the voting shares in the foreign company, such Korean resident individual or company is subject to anti-tax haven rules.


Anti-tax haven rules are intended to regulate a company that has made overseas investments of an abnormal nature. Thus, these anti-tax haven rules apply to those Korean companies that have invested in a company incorporated in a foreign country with an average effective tax rate of 15% or less on taxable income for the past three years (previously it was one year).


However, if a company incorporated in such a tax haven country actively engages in business operations through an office, shop, or a factory, then anti-tax haven rules will not apply.


b. Scope of a Tax Haven

According to the LCITA and its Decree, a country that meets any of the following conditions is regarded as a tax haven.

- A country or an area whose average effective tax for the past three years is 15% or less of actually accrued income (i.e., net income before corporate income tax computed based on GAAP) of a company incorporated.

- A country or an area which the Commissioner of the National Tax Service designates with the approval of the Minister of Finance and Economy after factoring into those countries or areas designated as tax haven by the OECD or its member countries on the grounds that they impose no or little taxes on a company's actually accrued income.


For this purpose, if the company has paid foreign taxes, such foreign taxes will be deemed to have been paid to the resident state.


Effective tax rate = (Tax paid to resident country ≪ Foreign taxes paid) / Net income before corporate income tax.


c. Computation of the Reserved Income to be distributed

The reserved income that can be distributed is computed by subtracting the items listed below from the adjusted amount of earned-surplus. The earned-surplus is represented on the income statements prepared in accordance with the GAAP of the resident state of the foreign company subject to the anti-tax haven system:


- Distribution of earned-surplus based upon an appropriation of retained earnings

- Bonuses, severance pay, and other types of outlays paid based on the appropriation of retained earnings

- Reserves to be retained under the law of the resident state

- Reserves remaining after the distribution of the earned-surplus for the year, which was subject to tax in the previous taxable years


If the resident states that GAAP is significantly different from the Korean GAAP, the earned-surplus shall be computed pursuant to the Korean GAAP.

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