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Subject [Newsletter - Mar. 2023] Which currency is the most cost-efficient option for funding a subsidiary in Korea?

KOREA EXPANSION AGENCY

[Newsletter]

 

Which currency is the most cost-efficient option for funding a subsidiary in Korea?

 

March 30, 2023



 

1.      Arm’s length interest rate for intercompany loan

Multinational companies often use related party loans for tax planning and cash management. In South Korea, if foreign related parties don’t adhere to arm’s length interest rates, the tax authorities can adjust the rates and rectify the tax base.

 

Arm’s length interest rate can be derived in one of the following two methods:

 

1)    Comparability factors

When a company in South Korea conducts a financial transaction with a foreign related company, it must use an interest rate that is considered fair and reasonable. This rate can be determined by considering factors such as the amount and maturity of the debt, whether there is a guarantee, the credit rating of the debtor, and other factors specified by the tax law.

 

OR

 

2)    Safe harbor rules

 

2.      The safe harbor rules on intercompany loan

1)    Korean entity lending funds to be foreign related party

 

Safe harbor interest rate: 4.6%

 

2)    Korean entity borrowing funds from foreign related party

 

Safe harbor interest rate: Currency Index rate + 1.5%

 

Effective for loan transactions starting on or after March 18, 2022

(Prior rule was LIBOR 12M + 1.5%)



[Safe harbor rules currency index rate]

Currency

Index rate

Korean Won

KOFR (The Korea Overnight Financing Repo rate)

US Dollar

SOFR (Secured Overnight Financing Rate)

Euro

ESTR (Euro Short-Term Rate)

British Pound

SONIA (Sterling Overnight Index Average)

Swiss Frac

SARON (Swiss Average Rate Overnight)

Japanese Yen

TONA (Tokyo Overnight Average Rate)

 

3.      What does this mean?

Due to the shift from a simple LIBOR to an individual index rate, taxpayers can now weigh which currency to be used to fund their Korean subsidiary in the most cost efficient manner.

 

4.      Interest expense deductibility

Interest expenses related to business activities are normally tax deductible.

However, if a company borrows from a foreign controlling shareholder and the debt-to-equity ratio exceeds 2:1, interest payable on the excess portion may not be tax deductible. This also applies to funds borrowed from a third party if a foreign controlling shareholder guarantees the loan.

 

Moreover, the deduction of net interest (i.e., interest expense paid to overseas related parties minus interest income received from overseas related parties) is limited to 30% of the adjusted tax earnings before interest, taxes, depreciation, and amortization (EBITDA) of the Korean subsidiary.

 

Finally, interest expense that has accrued but not yet paid on an intercompany loan for more than one year may not be tax deductible for corporate income tax purposes effective from fiscal years beginning on or after Jan. 1, 2021.

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