South Korea’s Investment Incentives: Opportunities in 2023
With South Korea signing the BEPS MLI (Multilateral Convention to Implement Tax Treaty-Related Measures to Prevent Base Erosion and Profit Shifting) in 2017, its tax reform in 2019 also brought about a 180-degree change in incentives related to foreign direct investment. Change. The reform eliminated most incentives, including a 100% income tax exemption for the first five years and a 50% income tax reduction for the next two years for foreign-invested enterprises engaged in qualified high-tech businesses. In addition, the tax reform also removed incentives for foreign investors operating in specific areas, including foreign investment zones, free economic zones, free trade zones, and strategic industrial parks specially developed for foreign-invested enterprises.
Despite this major reform, South Korea’s 1998 Foreign Investment Promotion Act ( FIPA ) ensured that some incentives for qualified foreign investors remained. These include investment companies investing in new “growth engine industries” and key technologies in specially designated fields. These tax incentives are designed to promote foreign investment and boost the country’s long-term economic growth momentum.
Among the remaining benefits of FIPA are property acquisition taxes and registration taxes. Under FIPA, companies are exempt from these taxes for the first five years of their operations, followed by a 50% reduction for the following two years. This clause is specifically designed to encourage and simplify the process for foreign investors to set up business in Korea. Local governments are also offering more generous tax packages, including longer exemptions and discounts. Some districts and cities in South Korea can even be exempted from local taxes for 10 to 15 years if the recipient company meets the requirements of FIPA.
FIPA also provides relief from congestion taxes on buildings and factories, another factor designed to incentivize foreign direct investment. Exempt foreign direct investment (FDI) projects that cause traffic congestion in specific areas from the tax. The measure is aimed at mitigating the extra costs of infrastructure congestion due to increased business activity. FIPA also includes exemption from customs duties on capital goods and special excise duty and value-added tax (VAT) on imported capital goods for three years from the date of FDI notification.
Finally, it also allows tax breaks for investments in specific facilities. Depending on the size of the company, there is a corporate tax deduction of up to 7% for investments in research and vocational training and energy-efficient facilities. Deduction rates range from 2-10% for investments in productivity improvement facilities; 3-10% for investments in environmental protection and worker welfare; and 1-7% for investments in worker safety. These regulations are intended to promote sustainable practices and welfare measures within FIEs.
To apply for any tax incentives, businesses must submit an application to the Korean Ministry of Economy and Finance (MOEF) , who will notify investors of the status of their application (whether approved or not) within 20 days. Investors have the flexibility to apply for tax exemptions or reductions when registering a foreign investment or before the end of the first tax year. Before notifying foreign direct investment (FDI), potential investors can determine through the MOEF whether their intended business is eligible for tax exemption or reduction. Foreign-invested companies seeking exemption or reduction of special consumption tax, value-added tax, and customs duties on imported capital goods for authorized investment projects must file a separate application with the corresponding customs. To simplify the application process, InvestKorea, the national investment promotion office of South Korea, can handle these procedures on behalf of foreign investors.
The Special Tax Treatment Control Act ( STTCL ) of 1999 initiated the process of consolidating tax incentives, mainly in the form of reductions or exemptions. These incentives are strategically targeted and typically grant exemptions to projects in priority industries or regions. Capital investments, reserves, research and development, relocation to remote locations, and increases in paid-in capital will generally qualify.
STTCL operates in conjunction with the Foreign Investment Promotion Act (FIPA) and other laws that provide specific tax incentives. Several amendments have been made to these laws, including the STTCL, FIPA and the Corporation Tax Act which came into force in January 2021. The amendments brought notable changes, such as the introduction of a new “negative list” of tax credits covering industries such as real estate leasing, hotels, land and vehicles.
The 2021 reforms also introduce new tax credits for R&D spending. There are also tax credits for wages paid by small and medium-sized businesses to workers returning from nursery, female workers returning to work after prolonged absences, and older workers. These measures underscore the government’s commitment to incentivizing research, development and a diverse workforce.
In 2003, a major amendment to FIPA made major changes to the incentive system. Businesses can now receive cash grants equal to a percentage of the funds they commit to spend on factory construction, facility investment, employment and training. The government’s Foreign Investment Committee can also provide cash rebates for foreign investment in high-tech fields and industrial support services, provided that the proportion of foreign investment reaches or exceeds 30%. The tax rebate amount is 5% to 15% of the FDI of a single company with a foreign shareholding of more than 30%, which can be paid in one lump sum or in five years.
In 2009, the government expanded eligibility for these incentives to include green industries and new growth engine industries. The minimum investment for the cash rebate is $10 million, but this requirement can be waived upon application. These changes reflect the government’s awareness of the changing investment landscape and its commitment to fostering a sustainable and innovative economy.
In addition to financial incentives, FIPA also offers real estate incentives. Central and local government property can be leased for up to 50 years, renewable for another 50 years. For foreign investors buying central government property, payments can be deferred for a year or they can choose to pay in installments for a period of up to 20 years. Local governments have the right to set their own payment terms. In addition, real estate rental support and discounts are available to establish international schools, hospitals, housing and other facilities to meet the needs of foreign investors and their families and employees.
Korean companies that decide to relocate overseas operations to Korea will also receive incentives. Companies that move operations to the country within five years of closing overseas facilities are entitled to a five-year income tax exemption and a 50% tax cut for the next two years. From June 2021, this period will be extended from one year. Reduced incentives will also be offered to South Korean companies that reduce overseas operations and choose to build or expand production domestically.
In 2020, the South Korean government enacted several supplementary budgets to mitigate the negative impact of the outbreak on workers and businesses. In March 2021, a supplementary budget of 14.8 trillion won was approved to provide support for small businesses, provide emergency relief for the tourism and leisure industries, and continue to provide subsidies to help businesses retain workers. This was followed by a supplementary budget worth 34.9 trillion won in July 2021, including 5.3 trillion won to compensate businesses for losses due to the government-imposed lockdown and an emergency loan program for businesses. When he assumed the presidency in May 2022, Yoon announced the largest supplementary budget in the country’s history, providing 59.4 trillion won to aid small businesses severely affected by the epidemic and individuals vulnerable to inflation, among others.
Under the Foreign Investment Promotion Act ( FIPA ) of 1998, the South Korean government established strategic advanced technology industries to be considered eligible for incentives, which must also meet one or more of the following conditions:
- The technology has proven difficult to develop in South Korea
- The industrial/manufacturing process required by the technology must be primarily performed in Korea
- The research and development of this technology significantly enhances the existing technology in South Korea and is no more than three years old
- The technology is economically and technically superior to existing technologies (existing for more than three years)
In January 2022, South Korea’s unicameral National Assembly passed the Act on Special Measures for Strengthening and Protecting the Competitiveness of National Cutting-Edge Strategic Industries. The law aims to provide less stringent regulation for certain strategic industries in terms of infrastructure development and financing. While no beneficiaries have been publicly announced as of the end of July 2022, expected beneficiary industries will include semiconductor and battery manufacturing as well as vaccine development and production companies.
The 1999 “Special Tax Treatment Control Law” ( STTCL , the Special Tax Treatment Control Law of 1999) regulates the company’s internal research and development (R&D) and human resource development. Under the law, companies are eligible to claim a tax credit equal to 25% of incremental R&D expenses in a given year (40% for medium-sized companies and 50% for small companies), or between 2-25% of R&D expenses ( depending on company size). In addition, higher tax credit rates (20-40%) are available for R&D expenditures in specific areas of “New City Engines and Core Technologies” designated by Presidential Decree. In July 2021, a new category called “National Strategic Industries” was introduced, including the semiconductor, vaccine and secondary battery industries. Companies operating in these sectors will be able to claim the maximum tax credit, with a basic tax credit of 6% and an additional 4% tax credit for investments made after July 2021.
28 specific categories of SMEs can enjoy preferential treatment from the government. Official standards for SMEs vary by industry and include restrictions such as fewer than 300 full-time employees or no more than 8 billion won in shareholder equity in manufacturing. For mining, construction and transportation, the limit is less than 300 full-time employees or shareholder equity not exceeding 3 billion won; for retail and hospitality, the limit is less than 300 full-time employees or turnover not exceeding 30 billion won. These SMEs have access to specially set aside bank funds.
In addition, SMEs engaged in qualifying businesses may be eligible for tax credits ranging from 5% to 30% depending on their location, size and type of business. The deduction is capped at KRW 100 million and applies to taxable income arising in a tax year ending before December 31, 2022. The government also provides tax credits for technology transfer between SMEs. 50% reduction in income tax arising from the transfer of patents by SMEs to Korean nationals. SMEs are entitled to a 25% tax credit on income derived from the lease of patent or utility model rights, applicable to transfers or leases that occur before the end of 2023.
Central government ministries, local governments, state-owned enterprises, public organizations, business associations, and financial institutions also offer a variety of policy-based lending schemes. These loans are linked to industrial policy programs and are disbursed on a first-come, first-served basis. Information on public grants, loans and subsidies can be obtained from the Small Business Administration and its industry division Small Business Corporation.
Finally, governments provide indirect incentives to investors in certain types of companies through income tax breaks. For example, venture capital firms that invest in newly formed SMEs are exempt from capital gains tax when they sell shares or equity in these SMEs. This is one of the ways the government encourages investment in the growth and development of SMEs in the country.
The Foreign Investment Promotion Act (FIPA) of 1998 stipulates certain features that encourage foreign investment in Korea. First, municipalities and local governments have the right to designate foreign investment zones (FIZs) as corporate tax havens. These areas are then approved at the discretion of the Minister of Industry and Energy. Investments in free industrial zones are exempt from all state taxes for five years until 2019. From January 2019, the corporate income tax for new applications is no longer applicable. However, eligible companies continue to be exempt from local tax for the first five years. 50% off for the next two years, extendable for up to 15 years. There is also a three-year tax exemption on imported capital goods entering these zones.
Second, municipal and local governments can offer free trade zones to qualified foreign companies free of charge. The law also provides for rental discounts ranging from 75% to 100% for foreign companies. Depending on the size and type of investment, these discounts apply to foreign companies operating in special industrial parks. The central government provides financial assistance for the development of infrastructure in the free zone.
The minimum investment required to obtain these incentives is divided into different levels according to the nature of the business. The investment required for manufacturing operations is $30 million. For logistics operations, the minimum amount is US$10 million. This is $20 million for a tourism business and $2 million for an R&D center, provided the business employs at least 10 master’s degree holders in full-time positions. Barriers to entry have also been lowered for smaller companies leasing space within existing free zones. In this case, the threshold drops to $10 million for manufacturing companies and $5 million for logistics companies. There are no minimum investment requirements for additional investments or investments made using dividends.
A Special Act on the Designation and Operation of Free Economic Zones was implemented in 2003 to provide additional incentives for companies operating in these areas. Foreign investors in free economic zones, free trade zones, or industrial parks reserved exclusively for foreign companies are eligible for the same incentives as free trade zones. However, the minimum investment threshold for accessing these incentives is different from that of a free industrial zone. For manufacturing or tourism, it is $10 million. For the logistics and medical business, it is $5 million. Research and development costs are $1 million.
FEZs also offer unique benefits to businesses and individuals that set them apart from FEZs. Foreign companies operating in a free economic zone are exempt from various business restrictions, such as antitrust regulations that prohibit large companies from conducting certain types of business designated as small and medium-sized enterprises. These companies are also exempt from the paid leave rules under the Labor Standards Act and the Dispatched Worker Protection Act.
In addition, free economic zones have higher caps on current account transactions settled in foreign currencies. Transactions in the free zone are limited to $10,000, compared to $1,000 elsewhere. The Ministry of Industry, Trade and Energy has the power to establish free economic zones at the request of local mayors and governors. Local governments are free to offer more aggressive incentive packages to attract foreign companies.
As of January 2023, there are 9 free economic zones in the country. One of them, the Saemangeum Gunsan Base, operates as an independent project area outside the free economic zone system. In 2002, the “Jeju International Free City Special Act” was promulgated, transforming the capital city of Jeju Island into a visa-free, tax-free regional center for international tourism, education and technological research. Investment incentives are available to domestic and foreign companies investing in the region. These include tax exemptions or reductions for the first five years of operation. The minimum investment required to enjoy these benefits is $5 million. Jeju Liberty International City Development Center provides administrative services to investors.
The 2004 Special Law on National Balanced Development aims to ease the concentration of population and business to the capital region. It does this by incentivizing businesses to move their operations to other parts of the country. The relocation subsidy can cover up to 50% of the cost of land acquisition. Local governments can also provide subsidies to cover costs associated with investment, employment and property purchases.
Finally, the 2005 Special Law on Enterprise City Development provides tax incentives for domestic and foreign companies to develop enterprise cities, technology parks, tourist enclaves, and other planned communities. Qualified enterprises in the national food industry cluster can enjoy 100% corporate income tax exemption for three years, and 50% corporate income tax exemption for the next two years. This “corporate city” is a self-sufficient urban community developed by private companies in an area far from large cities and developed areas.
Export Orientation Incentives and Zones
Korea’s general export incentives mainly include tariff rebates and value-added tax rebates on imported raw materials for export, special depreciation allowances, export financing, and related insurance provisions. Specifically, the Foreign Investment Promotion Law of 1998 made unique regulations on foreign-invested enterprises. Several Free Trade Zones (FTZs) operate across the country, offering various tax holidays and tax breaks to foreign investors. The 2000 Designated Free Trade Zone Law stipulates that under the same qualification conditions, enterprises in free trade zones can enjoy the same tax benefits as enterprises in free economic zones.
According to InvestKorea, the national investment promotion office, seven industrial complexes and six ports have been designated as free trade zones by 2023. This brings the total number of export-oriented tax havens to 13. In July 2021, the Ministry of Industry, Trade and Energy made amendments to facilitate the establishment of high-tech and reshoring companies in the free trade zone. These companies are now required to ensure that exports only account for 30 percent of their total sales, down from the previous threshold of 50 percent.
The adjusted export ratio is also applicable to foreign-invested enterprises in the pilot free trade zone, and the export ratio of small and medium-sized enterprises is slightly lower, at 20%. For other domestic companies, the required export ratio remains between 30% and 50%, depending on the size of the company. Various special tax deductions are also available to cover the cost of exporting business.
Specifically, these deductions include no more than 1% of the enterprise’s foreign exchange income for overseas market development (the enterprise using its own trademark can increase to 3%), an export loss reserve equivalent to 1% of the enterprise’s foreign exchange income, and whichever is lower. – 50% of monetary income or net foreign exchange income. In addition, a reserve for overseas business losses of up to 2 percent of foreign exchange earnings from the export of factories, equipment and construction, and an annual overseas investment reserve equivalent to 20 percent of a company’s overseas investment are stipulated. All these export-related tax incentives are governed by the Special Tax Treatment Control Act.