As we noted in a previous newsletter (Link), during a Q&A session with the Chairman of the Financial Services Commission in the course of the national audit conducted by the National Policy Committee of the Korean National Assembly (the “NPC”) on October 10, 2024, members of the NPC discussed the need to apply mandatory external audit requirements to limited liability companies (yuhan chaegim hoesa in Korean) – in addition to stock companies (jusik hoesa in Korean) and limited companies (yuhan hoesa in Korean), which are already subject to these requirements – and to amend the Act on External Audit of Stock Companies (the “External Audit Act”) so as to expand its coverage. This discussion has attracted significant attention from the market, including limited liability companies that would be affected by such expanded audit requirements and parties that might be considering establishing, or restructuring an existing enterprise as a limited liability company.
Soon thereafter, on November 7, 2024, National Assemblyman Sang-Hoon Kim, along with nine other lawmakers who initially raised this issue during the national audit, proposed a bill to partially amend the External Audit Act. The aim of the proposed amendment is to impose on limited liability companies meeting a certain size threshold obligations to conduct external audits and to publicly disclose the resulting audit reports.
This proposed bill has come about due to concerns that companies subject to external audit requirements were being restructured as limited liability companies in order to circumvent external audits and to bypass provision of reliable accounting information to interested parties (e.g., shareholders and creditors). The primary aim of the proposed bill is to extend the external audit requirements to limited liability companies, which differ only in legal form and possess the same economic substance as other types of companies. The proposed bill is intended to enhance the fairness of external audits and ensure transparency in accounting in order to strengthen the protection of interested parties.
The proposed bill would apply to limited liability companies substantially the same criteria as those currently applied to stock companies and limited companies in determining whether the relevant company must conduct external audits and publicly disclose the resulting audit reports (which would include information regarding assets, liabilities, numbers of employees, sales revenues, and numbers of members as of the end of the immediately preceding fiscal year). An addendum to the proposed bill provides that the amendments will apply to limited liability companies starting from the fiscal year immediately following the first anniversary of the enforcement date of the amended act.
According to the press release issued by National Assemblyman Sang-Hoon Kim’s Office, when discussions began in 2016 to amend the External Audit Act to require external audits and public disclosure of audit reports for both stock companies and limited companies, at that time, these requirements applied to stock companies only, the number of registrations for the establishment of limited liability companies increased by 126.8% (from 149 to 338) over the previous year. Since 2019, when the external audit requirement also finally became applicable to limited companies, the number of limited liability companies has increased significantly (by 91.6% in the case of Korean-held enterprises and by 84.4% in the case of foreign-held enterprises). Kim pointed out that “foreign players have established their Korean entities as, or changed them to, limited liability companies to circumvent external audit and public disclosure obligations.” He added, “They might exploit loopholes in the system to avoid corporate tax by extracting profits generated in Korea through large-scale dividends or paying royalties to foreign headquarters.”
If the proposed bill is passed, external audits will become mandatory for limited liability companies meeting a certain size threshold. In addition, various kinds of information contained in these companies’ financial statements and their notes (including production costs, costs for services, other expenses, and profit structure) may be disclosed to market stakeholders and competitors. For these reasons, the proposed bill is attracting significant attention from the market, including limited liability companies that would be affected by such expanded audit requirements and parties that might be considering establishing, or restructuring an existing enterprise as a limited liability company.
Currently, a significant number of private companies, including many joint ventures and foreign-invested companies, are in the form of a limited liability company. It is therefore advisable to continue to closely monitor developments related to the possible future amendment to the External Audit Act.
