S Korea becomes first to pass P2 rules in its dom legislation: PwC

South Korea becomes first to pass Pillar Two global minimum tax rules in its domestic legislation 

January 2023

In brief

South Korea's budget bill for 2023, approved by parliament on December 23, includes the Korean rules on a global minimum tax (the GloBE Rules). The newly enacted rules are added to the existing Korean Law for the Coordination of International Tax Affairs (the ‘LCITA’) by establishing new Section 5. This section includes five sub-sections and 27 Articles that correspond closely to the OECD’s Pillar Two Model Rules. The rules include an Income Inclusion Rule (IIR) and ‘Supplementary rules for income inclusion’ (referred to as the UTPR in the OECD Model Rules). Both rules will be effective for fiscal years beginning on or after January 1, 2024.

The takeaway: Now that the new rules are in force, South Korea is the first country to have codified the global minimum tax rules in its domestic legislation. Given the short timeline before the new rules become effective, non-Korean MNEs that have a Korean presence are highly encouraged to assess the impact of the new rules and understand the additional compliance and reporting obligations. 

Background

Over 140 countries have joined the Pillar Two agreement (the Global Anti-Base Erosion Proposal, or ‘GloBE’) to address international corporate taxation rules. The Pillar Two GloBE Tax Rules aim to ensure that multinational entities (MNEs) pay a minimum effective tax rate of 15%. The OECD released the Pillar Two Model Rules in December 2021 and the Commentary in March 2022 to provide legislative guidelines. Since then, many countries including South Korea, the EU member states, the United Kingdom, Switzerland, Japan, and Australia have initiated domestic legislative procedures to introduce the global minimum tax rules.  

In July 2022, the Korean Government announced its 2023 budget bill, which included domestic legislation to introduce the global minimum tax rules as one of the amendments to the LCITA, which is the Korean tax law that governs international transactions. The South Korean parliament approved the draft legislation without amendments on December 23, 2022, and the amended LCITA entered into force on January 1, 2023. The detailed Pillar Two Rules are expected to be further codified in the LCITA Presidential Decree (or the Enforcement Decree) in February 2023. Soon after the Presidential Decree, the Ministry of Finance is expected to provide additional guidance on the Pillar Two rules in the form of Enforcement Regulations and Basic Interpretation/Executive Rulings.

Highlights of South Korea’s Pillar Two rules 

In-scope MNEs: The rules apply to all Constituent Entities (CEs) of qualified MNEs with annual consolidated revenues of EUR 750 million or more in at least two of the four fiscal years immediately preceding the tested fiscal year.  

Computation of effective tax rate (ETR) and Top-up Tax: The ETR is calculated by dividing the total tax incurred by all of the MNEs’ constituent entities (CEs) that are located in the same country (i.e., jurisdictional blending) by the total income. If the ETR is lower than 15% in a given jurisdiction, a Top-up Tax for the shortfall is calculated and paid by other CEs within the group. 

Paying entities: Based on the new domestic rules, the Top-up Tax must be paid as follows: 

IIR: In principle, the Ultimate Parent Entity (UPE) shall pay the additional tax attributable to the Low-Taxed Constituent Entity (LTCE) within the group in proportion to its shareholding ratio. Exceptionally, a Partially-Owned Parent Entity (POPE) with an ownership interest in the LTCE has the primary obligation to pay the allocated share of the Top-up Tax of that LTCE.   
UTPR: The UTPR is applied in cases where: (1) the ETR in the country where the UPE is located is lower than 15%, or (2) no Top-up Tax is levied because the country where the UPE or any other Parent Entity is located has not implemented a qualified IIR. In these cases, the Top-up Tax is allocated among, and payable by, the CEs located in countries that have implemented a qualified UTPR. 
More specifically, for purposes of the UTPR, Article 73 of the LCITA stipulates that a Korean CE must pay its corresponding share of the Top-up Tax of the LTCE(s) according to this calculation: (A) Top-up Tax of the LTCE(s) × (B) Korean CE's corresponding allocation percentage. 
(A) the Top-up Tax of the LTCE(s) is applied as follows: 
- If the UPE's direct and indirect share ownership in the LTCE is fully owned directly or indirectly by one or more Parent Entities (including the UPE) resident in countries that have adopted a qualified IIR, then no UTPR Top-up Tax is due at the level of a Korean CE, or 
- In all other cases, the Top-up Tax of the LTCE(s) is the difference between the total Top-up Tax and any Top-up Tax paid by any Parent Entity in a country where a qualified IIR has been adopted. 
the Korean CE's corresponding allocation percentage is calculated as follows: (C) × (D) 
- (C) = (Combined Korean CEs' total number of employees / Total number of employees in all CEs located in jurisdictions that have adopted a qualified UTPR × 50%) + (Combined Korean CEs’ total net book value of tangible assets / Total net book value of tangible assets of all CEs located in jurisdictions that have adopted a qualified UTPR × 50%)
- (D) = (Korean CE's total number of employees / Combined Korean CEs' total number of employees × 50%) + (Korean CE's total net book value of tangible assets / Combined Korean CE's total net book value of tangible assets × 50%).

The detailed rules for the charging mechanism are expected to be finalized through a Presidential Decree.

The Korean UTPR is not taxed through a disallowance mechanism. Instead, any computed UTPR Top-up Tax must be paid directly to the Korean tax authorities by any Korean CE(s).
A UTPR Top-up Tax must be paid, even by a Korean CE(s) that has sufficient tax net operating losses to offset any UTPR Top-up Tax that would have been calculated through a disallowance mechanism.

The filing/payment due date is 15 months after the last day of the tested fiscal year. However, for the first year, the due date is 18 months after the last day of the tested fiscal year. For instance, the due date for in-scope Korean companies with December 31 fiscal year-ends to file their first GloBE Information Return and pay the Top-up Tax in Korea – assuming they qualify from 2024 – would be June 30, 2026.

Observations

In addition to Korean MNEs that must comply with the Korean IIR rules, a number of non-Korean MNEs with subsidiaries or permanent establishments in Korea are expected to be subject to the Korean global minimum tax rules and may need to pay the Top-up Tax to the Korean tax authorities in accordance with the Korean UTPR for fiscal years from 2024. In particular, non-Korean MNEs whose parent entities (including the UPE) are located in countries that have not yet announced plans to implement the Pillar Two rules, such as the United States and China, may face significant fiscal burdens under the Korean UTPR.

Even for MNEs whose parent entities are located in countries where the legislative procedures are in progress, such as the United Kingdom and the EU member states, the possibility of an UTPR Top-up Tax allocation to Korean CEs for 2024 cannot be ruled out, in case adoption of the GloBE Rules in those countries is delayed. Therefore, MNEs should monitor the progress of the introduction of global minimum tax legislation in other jurisdictions as well as the OECD’s Implementation Framework. 