We provide below comparison of the merits and weaknesses of establishing a subsidiary and a branch in Korea from tax perspectives.

1. Establishment of a Subsidiary in Korea

1.1 Merits

① A subsidiary of a foreign company tends to have more flexibility in transferring its net income to its parent company than a branch of a foreign company, as the former can make a determination on the timing of dividends payment. While the net income of a branch automatically becomes a part of net income of its head office and thus is included in the taxable income of its head office, the net income of a subsidiary may be retained by the subsidiary. Thus, by deferring the timing of its dividends payment until the parent company records operating loss, the parent company may reduce its tax burden on its net income. If the parent company sells its subsidiary to a third party, and the dividends of its subsidiary are deferred until the time of sale of the subsidiary, the net income of the subsidiary may be realized in the form of capital gain on sale of equity shares, instead of as dividends. According to some tax treaties between Korea and other countries, capital gain from sale of equity shares is exempt from Korean tax. Consequently, the typical double taxation applicable to a foreign subsidiary may be avoided.
② A subsidiary of a foreign company will be established as a local company and thus may have a closer relationship with the local community and a better image than a branch of a foreign company. That may lead a subsidiary to a better position to run a business and raise funds than a branch.
③ Royalties and interests paid by a branch of a foreign company to its head office are not accepted as tax deductions in calculation of its taxable income. However, royalties and interests paid by a subsidiary of a foreign company to its parent company are normally accepted as tax deductions in calculation of its taxable income.
④ A subsidiary is eligible to receive tax incentives provided by the Special Tax Treatment Control Law (“STTCL”) in calculation of corporate income tax, if it meets the requirements prescribed by the STTCL. No such tax incentives are available to branches.

1.2 Weak Points

ⓛ It is more expensive to establish a subsidiary than a branch, since establishing a subsidiary requires incorporation of a separate entity.
② The net income of a subsidiary will be subject to double taxation. Normally, a company has to pay corporate income tax in Korea for its taxable income, the rates of which are 14.3% of tax base until tax base reaches 100,000,000 Korean Won and 27.5% of tax base exceeding 100,000,000 Korean Won. Additionally, shareholders have to pay a certain percentage of tax on the dividends received from its subsidiary (usually 10% in accordance with the tax treaty between Korea and other countires). (However, as explained in 1.1 ① above, if the net income of a subsidiary is realized in the form of capital gain from sale of equity shares instead of as dividend income from the subsidiary, double taxation may be avoided.)
③ As the subsidiary will be liquidated upon completion of the project, some additional cost may be incurred for such liquidation.
④ Under the Korean Commercial Code, dividends which are paid out of the net income of a subsidiary to its parent company may be allowed only pursuant to a resolution of shareholders' meeting held after the close of a fiscal year. Therefore, a parent company will have to wait until after the close of a fiscal year to receive dividends from its subsidiary.
⑤ Additional costs may incur, such as fees for external audits if the size (assets) of a subsidiary is larger than 7 billion Korean Won.

2. Establishment of a Legal Branch in Korea

2.1 Merits

① Usually, operating losses would occur at an early stage of a new business. In case of a branch, such losses are automatically included as a part of net income of the head office, and thus the head office may get a tax benefit from such losses. However, operating losses of a subsidiary are not automatically included in net income of its parent company.
② A branch is not subject to audits of external auditors in Korea, and thus a branch may be easily managed by its head office without any interference of external entities and may also reduce the cost related to external audits.
③ In case of a branch, double taxation issues are not raised regarding transfer of its net income to its head office, as the net income of a branch is directly vested in its head office, rather than paid as dividends. However, an additional taxation issue relating to branch tax may be raised for branches from some countries as explained below.

2.2 Weak Points

① Tax incentives under the STTCL are not available to a branch of a foreign company.
② According to the tax treaty between Korea and some countries including France, Canada, Australia, Indonesia, Philippines, Brazil, Morocco and Kazakhstan, a branch of the company in the above mentioned countries is subject to a branch tax of 5.5% of its tax base (including residence surtax) in addition to normal corporate income tax. This branch tax is not applied to a subsidiary of a foreign company.
③ In case of a subsidiary of a foreign company, its liability with respect to its Korean business operation is limited up to its investment amount. Further, when a subsidiary is subjected to a tax inspection by the tax authorities in Korea, only data relating to the subsidiary would be within the scope of such tax inspection. On the other hand, a tax inspection of a branch may also involve inspection of its head office or other branches.
④ Royalties and interests paid to its head office by a branch of a foreign company are not allowed as deductions in calculation of corporate income tax of the branch.
⑤ As explained above, according to the tax treaty between Korea and some foreign countries, capital gains from sale of equity shares by foreign companies are exempt from Korean taxation. However, any gains upon close of a branch of a foreign company will be included in the taxable income.
⑥ The net income of a branch of a foreign company is automatically included in the net income of its head office, and thus there is no room for choosing the timing of inclusion in the net income of its head office, while such choice is available to a subsidiary of a foreign company.
⑦ If a branch of a foreign company is expected to grow big enough to necessitate establishment of a subsidiary in Korea in the future, then it would be more cost effective to establish a subsidiary from the beginning instead of a branch.
⑧ Like in the case of a subsidiary, transferring money earned by a branch of a foreign company is only allowed after the close of a fiscal year of the branch under the Foreign Exchange Transaction Regulations of Korea.

3. Establishment of a Branch for Tax Purposes

Even if a foreign company does not have a legal branch in Korea, it may still be deemed to have a permanent establishment ("PE") in Korea, if it maintains, for example, a construction site in Korea more than 12 months, or monitors/directs a construction site in Korea more than 6 months. Then, the deemed PE will be treated the same as a legal branch for tax purposes. This means that the PE has to register its tax ID number, file tax returns for VAT and corporate income tax and has withholding obligations applied to a legal branch. In this case of a branch for tax purposes, all the money earned by the PE is directly credited to the head office account when it receives money in return for the service provided.