Taxation on funneling of business replete with unrealistic clauses
As part of legislative programs for economic democratization, a new taxation system provides that deemed gift profits from related party transactions are subject to a gift tax for the first time in July this year. FKI has recommended alternatives to improve the defects of the system as well as difficulties corporations are facing to the government based on its recent survey of the nation's major businesses on 'Taxation on funneling of business under inheritance tax & gift tax act: problems & improvements.' The following is a summary of the recommendation.
According to the recommendation, the move to levy a tax on a profit from funneling of business has quite a few clauses that are not sensitive to business conditions.
Normal transaction ratio must reflect sectoral characteristics
First and foremost, FKI asserted that the new taxation scheme has a problem of uniform regulation of a normal transaction ratio which is leaving aside sector-specific characteristics. By definition, a normal transaction ratio means a proportion of business which is not considered as part of transactions supporting related parties. The enforcement decree of the inheritance tax and gift tax act provides for a single 30% ratio. Moreover, since deemed gift profits are calculated on the sales being made in 2003 which exceed a half of 30%, burdens on businesses will be far greater. The integral part of the recommendation is that the ratio needs to be made flexible enough to reflect the realities of each industry.
Despite the reality that the ratio of insider trading in some industries, due to their own business attributes, is inevitably higher, the normal transaction ratio is still pegged at a uniform 30%, exposing a number of illogical aspects. Most seriously, although the inheritance tax and gift tax act provides that the ratio shall be determined in consideration of each industry's characteristics, the enforcement decree is not in conformity with the act. In other words, the actual execution of the decree is contradictory to regulatory directions of the act.
In a survey conducted by the Federation of the nation's top 1,000 companies in terms of sales (112 of them responded) on the defects of the new tax system, 42.3% responded that it did not sufficiently take corporate features into account, and 33.4% of the respondents prioritized raising the normal transaction ratio. All things considered, it is imperative for the government to lift the ratio, especially for some industries like System Integration (SI), from 30% to a significant level to answer the actual corporate needs.
Export of services, export via domestic subsidiaries need to be tax-exempt
Second, the Federation pointed out that while exempting export of products and commodities from taxation, the system which makes services export taxable is illogical. Acknowledging that exemption of exporting products and commodities from taxes aims at promoting export which takes a lion's share in our economy, we do not see any rationale for leaving services export taxable. It is reasonable for the tax authority to exempt services export from taxation on funneling business.
Third, FKI maintained that it is irrational to exempt export via overseas subsidiaries from taxes, while export via subsidiaries at home is subject to taxation. For the sake of convenience and efficiency, many companies are exporting through sales subsidiaries in Korea. Therefore, it is not rational to determine taxation, depending on the locations of corporations.
Government urged to minimize burden on corporate activities
Other alternatives in the Federation's recommendation include: deduction of dividends when calculating the operating profit after tax of a beneficiary company to determine the gift tax; when a beneficiary company suffers an operating deficit, it is exempt from the deemed gift income for the next ten years; and improvement in retroactive application of the deemed gift.
Taxation on funneling of business will entail further defects in the process of implementation in the future. In this sense, the government is asked to keep revamping this unrealistic scheme, while taking the lead in minimizing burdens on corporate activities