Since 2022, Retention Tax Imposed on Personal Similar Corporations... The Reason for Targeting 'Nominal Companies'

'Purpose and Design Plan for the Introduction of the Taxation System on Personal Similar Corporations'

To Prevent Income Tax Avoidance with Higher Top Rates than Corporate Tax
Government Considering Expansion of Targets Excluded from Retained Earnings

[Asia Economy Reporter Joo Sang-don] From 2022, the maximum shareholders and their special related parties holding more than 80% of shares in personal-type corporations will be required to pay taxes on retained earnings. This measure aims to prevent the phenomenon of newly establishing corporations or converting sole proprietorships into corporations to avoid the relatively high income tax burden (up to 42%).

Recently, the Ministry of Economy and Finance announced the "Purpose and Design Plan for the Introduction of Taxation System on Personal-type Corporations" containing these details.

According to this, the taxation target is corporations where the maximum shareholder and their special related parties hold more than 80% of shares. This is based on the judgment that the shareholder effectively controls decision-making and that the corporation’s economic substance is identical to that shareholder. So-called "nominal companies" that accumulate retained earnings exceeding 50% of current net income or 10% of equity capital will be considered as dividends and subject to income tax. The Ministry explained, "This applies not to accumulated retained earnings but to current retained earnings generated from the 2021 fiscal year onward."

The Ministry of Economy and Finance also presented items excluded from retained earnings and exemption targets through the draft revision of enforcement ordinances. Companies with passive income such as interest, dividend income, rent, or proceeds from disposal of real estate, stocks, bonds, etc., unrelated directly to business activities, accounting for 50% or more for two consecutive years, will be considered "passive business corporations" and will be taxed on excess retained earnings.

At this time, expenditures essential to the active business operations of corporations engaged in their own business will be excluded from taxable retained earnings. For example, if Corporation B, a manufacturer, distributes 2 billion KRW to shareholders from 10 billion KRW income after corporate tax and then reserves 3 billion KRW for machinery to be purchased two years later, the reserved amount for investment will be excluded from taxation. Also excluded are expenditures and reserves for debt repayment, employment, and research and development (R&D).

The Ministry is considering defining the exclusion scope more broadly. A Ministry official said, "The bill on taxation of personal-type corporations will be actively discussed in the National Assembly starting next week and is expected to be finalized by early December. Based on this, enforcement ordinances will be drafted by early January. At last week’s meeting, the construction industry requested that land purchase costs be excluded from retained earnings, and the shipping industry requested exclusion of ship purchase costs. We will review these and other industry requests."