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Some international investors continue to shy away from Korea and its complicated tax system, but improvements may be on the way
More than a year after the fall of Lehman Brothers, the world economy is showing signs of recovery. Korea's second-quarter output recorded a particularly strong performance, leading many market watchers to predict it will be first to come fully out of the crisis. Second-quarter output grew 2.6%, the highest rate among the 30 Organization for Economic Cooperation & Development countries. Korea's main KOSPI stock index has gained 757 points in the past 12 months, up 84% on Oct. 28, 2009 from last year's low of 892 points, and recovering 87% of last year's peak of 1,900 points.
Investors have started to take note. On Sept. 2, Fitch Ratings upgraded Korea's sovereign ratings to stable from negative. Declared foreign direct investments to Korea posted a 32.5% same-period growth for seven months ended July 2009, whereas major economies in the region posted dramatic declines.
However, as much as investors are attracted to the Korean market, they become uneasy when reminded of media images of "unannounced visits" by tax auditors and strong local reaction to foreign investors depicted as "snatching and fleeing" with their Korean profits.
As someone heading Korea's central revenue body, I have to concede these investor concerns are not entirely ungrounded. For all good intentions, some of our practices and operations may have resulted in shaping those negative perceptions. Having stated that, this would be a timely moment to offer the Korean perspective to potential investors having second thoughts about entering the Korean market.
Foreign Investment Benefits
The National Tax Service of Korea views foreign investment as a significant contributor to the full recovery of our economy. The benefits of foreign investment are clear: It drives economic growth through job creation and technology transfer, and it empowers consumers by creating competition. In this regard, the NTS is fully aligned with the market policies advocated by President Lee Myung-Bak's administration.
From a tax perspective, companies can be assured that their Korean operation will not face discriminatory stereotyping or prejudices. The only exception will be where distinctions need to be made for statistics tracking, delivery of taxpayer-specific services, and administration of tax codes that apply exclusively to foreign companies (e.g., thin-cap rules governing inter-company debt-to-equity ratios for income deduction purposes). Otherwise, any attempt from within and outside the NTS to shape a biased and distorted view against foreign investment in terms of tax treatment vis-à-vis domestic companies will be brought to account, both officially and unofficially.
Investors can also expect to obtain earlier certainty on their tax positions. They now have access to advance rulings that are binding to the NTS in relation to a specific current or future transaction. We began issuing advance rulings in October 2008 as a response to calls made by foreign companies that wanted to comply with the Korean tax law but found it difficult to do so because of a lack of clear guidance on tax law interpretation. Since last October we have issued 118 advance rulings.
Tax certainty will also be made available through the Horizontal Compliance Program, which will be tested in a pilot program beginning this month and lasting until December 2010. Eligibility for participation will be given to companies (both domestic and foreign) meeting a size requirement and having a strong internal tax control framework.
Under the program, participants will be able to settle tax issues through regular meetings with a dedicated unit of the competent regional tax office. This creates the same effect for participants as having their own full-time team of tax officials writing out advance rulings.
Program participants can expect a significant reduction in the risk of being audited or imposed additional taxes as a result of an audit. In addition, since the opportunity to participate is given only to companies meeting our compliance requirements, participation itself will be construed by the market as a credential, or a seal of approval by the tax authorities vouching for transparency in a company's accounting and management practices. For the NTS, we anticipate a reduction in administrative costs associated with processing taxpayer appeals and an improvement in risk assessment because tax issues will be brought to our attention as they emerge.
The above programs, however, will be balanced with an adequate level of compliance activities. The NTS is a revenue collection body accountable to the public for ensuring that tax laws are followed and properly enforced. This mandate may at times put us at odds with foreign investors and even create tension. But media hype or the emotional outbursts of a casual observer will not sway the administration of taxes. The NTS will measure itself against the highest standard of professional integrity and follow universally accepted rules in enforcement and protection of taxpayer information.
It only makes sense that Korea provide a tax environment appealing to the international investment community. It is a win-win for Korea and foreign investors. With our assurance of greater fairness, transparency, and certainty in tax treatment, investors should feel more at ease with their decision to invest in Korea.