[Tax Story] Free Trade Agreements and Network Korea

Baek Jeheum, Lawyer at Kim & Chang

The year 2020, the Year of the White Rat (Gyeongja Year), has dawned. Traditionally, rats have symbolized agility, representing animals that diligently move into every nook and cranny. Similarly, in recent times, trade has been recognized as a key area where countries around the world vigorously pursue their national interests. Recently, U.S. President Donald Trump promised close cooperation on the US-UK Free Trade Agreement (FTA) negotiations to British Prime Minister Boris Johnson, who is seeking Brexit (the United Kingdom's withdrawal from the European Union). In response, Chinese Foreign Minister Wang Yi has extended gestures toward the UK for an FTA with the EU, which the UK is leaving. Likewise, South Korea, China, and Japan in East Asia agreed in December to pursue comprehensive and high-level FTA negotiations during their trade ministers' meeting. This is truly a scene of intense competition and strategic alliances in economic diplomacy among nations.

An FTA is a form of loose regional economic integration aimed at realizing free trade by mutually agreeing to eliminate trade barriers such as tariffs between the contracting countries. The stages progress from free trade agreements to customs unions, common markets, single markets, and eventually to full economic integration. Although the World Trade Organization (WTO), a multilateral organization launched in 1995 to promote global economic development through trade liberalization, exists, the trade market is increasingly characterized by bilateral agreements or regionalism represented by FTAs. Especially after the Doha Development Agenda (DDA) negotiations, which began in 2001, stalled, many countries pursued FTAs as an alternative to establish preferential trade regimes with suitable partners. While it was difficult to reach consensus among WTO members due to conflicting interests under the multilateral WTO framework, FTAs, concluded as bilateral treaties, have relatively easier consensus-building. FTAs typically cover goods trade, services, investment, trade remedies, rules of origin, technical barriers to trade, sanitary and phytosanitary measures, intellectual property rights, government procurement, e-commerce, competition, labor, environment, economic cooperation, and dispute resolution. FTAs also allow relatively flexible agreements in areas like investment, environment, competition, and labor, which have yet to be fully regulated by the WTO. Under the WTO-centered multilateral trade system, uniform norms and dispute resolution procedures applied, but as FTAs spread, individual countries face practical burdens in implementing multiple differing FTAs domestically. A prime example is the 'rules of origin and certification system' that determine the application of preferential tariffs under FTAs.

Starting with the Korea-Chile FTA in 2004, the Korea-US FTA in 2012, and the Korea-EU FTA in 2015, a total of 16 FTAs with 55 countries worldwide are currently in operation. This number is comparable to the 14 FTAs of the United States, 15 of Japan, and 16 of China as of the end of October last year. Additionally, FTAs with the UK, Israel, and Indonesia have been signed or concluded, and numerous FTAs are under negotiation, including the Korea-China-Japan trilateral FTA, the Regional Comprehensive Economic Partnership (RCEP) in East Asia, and the Southern Common Market (MERCOSUR) in South America. As an open trading nation whose foreign economic scale accounts for over 80% of its Gross Domestic Product (GDP), South Korea benefits from the relaxation of tariff and non-tariff trade barriers through FTAs, which activates overseas market access for its key products. At the same time, by adopting leading trade norms, it gains significant benefits from improving related domestic systems. A public opinion survey conducted on the 15th anniversary of FTA adoption showed that 67.5% of domestic consumers responded that FTAs positively impacted the domestic market by enabling the import of a wider variety of goods at lower prices than before.

Meanwhile, South Korea has a separate law concerning special provisions in the Customs Act for FTA implementation, known as the 'FTA Special Act.' The 'FTA Special Act' was enacted in 2005 as a basic procedural law for FTA implementation, to avoid inefficiency in enacting separate implementation laws for each FTA concluded with different countries. The most problematic issue in interpreting and applying the FTA Special Act is the 'rules of origin certification system.' The term 'origin' literally means the country where the goods were produced or manufactured. However, the WTO Agreement on Rules of Origin and the Kyoto Convention on the Simplification and Harmonization of Customs Procedures only stipulate basic principles regarding origin. Therefore, the preferential origin system related to the application of preferential tariffs is governed by each country's laws or treaties. The preferential origin system is designed to determine origin for granting tariff reductions or exemptions on imported goods and applies when an FTA is concluded between two countries, reducing tariffs between contracting parties. The methods for determining origin are broadly divided into △ wholly obtained or produced criteria and △ substantial transformation criteria (such as change in tariff classification, value-added criteria, or processing criteria).

Despite these rules of origin, determining the origin of certain products in practice is challenging. For example, when seafood caught in international waters is imported into the country and then processed to some extent before being exported overseas, the question arises as to when the origin can be considered South Korea. To address this, the FTA system includes the 'rules of origin certificate' system, often called the 'flower' of the FTA, but the regulations differ by individual FTA agreements, increasing difficulties for traders. The rules of origin certificate system is divided into △ the issuing authority method, where a designated institution in the origin country verifies and issues the certificate, and △ the self-certification method, where exporters autonomously verify, prepare, and sign the certificate for the goods. However, each FTA varies widely in certification methods, certifying parties, validity periods, formats, languages used, and usage frequency, making errors common. Moreover, many documents must be attached to the application for issuing the certificate, and importers, exporters, and producers are generally subject to a mandatory five-year retention period for origin verification documents.

In a survey of small and medium-sized enterprises, 50.5% of business owners cited 'collecting certificates of origin for raw materials and preparing origin verification documents' as the most difficult aspect of utilizing FTAs. Cases where expired certificates of origin were submitted, incomplete origin verification documents such as import declarations were detected, or documents proving origin were not properly stored and managed, leading to judgments that origin criteria were not met, resulted in exclusion from preferential tariff application and imposition of administrative fines such as additional taxes due to taxpayer errors. With an FTA utilization rate exceeding 80% among exporting companies, many still harbor vague fears about issuing FTA certificates of origin or suffer disadvantages due to incorrect certificates, which ultimately harms national interests. While expanding the number of contracting countries as a leading FTA nation is crucial, simultaneously, legal reforms commensurate with the reputation of 'Network Korea' are necessary for the effective operation of certificates of origin and related systems. In 2020, the Gyeongja Year, South Korea stands at a timely and appropriate juncture to enhance 'regulatory infrastructure' as a stepping stone to maximize the benefits of FTAs in expanding export markets and creating jobs.

Baek Jeheum, Attorney at Kim & Chang