A.

Case Overview and Key Issue

The appellant, a life insurer, paid foreign taxes on income from its investments in foreign bonds and other foreign assets (the “Foreign Source Income at Issue”) and claimed a FTC when filing its Korean corporate income tax return. However, the tax authority considered the PRI indicated in the business report under the IBSR as a funding expense related to the derivation of the Foreign Source Income at Issue^[1], and deducted the PRI from foreign source income in calculating the FTC limit. Accordingly, the tax authority denied FTC for most of the foreign tax paid on the basis that the amount exceeded the FTC limit, and imposed corporate income tax (the “Assessment”).

Article 52 (1) 1 of the former Corporate Income Tax Law (the “CITL”)^[2] and Article 94 (2) of the Presidential Decree^[3] of the CITL require that expenses related to foreign source income be deducted in calculating the net foreign source income for the purpose of calculating the FTC limit, as shown in the table below. Therefore, the FTC limit is reduced if expenses are deducted against the foreign source income.
 

[Formula for Calculation of FTC Limit]

In the case at hand, the issue was whether a certain part of policy reserve (i.e., PRI) should be considered as an expense related to the Foreign Source Income at Issue in calculating the FTC limit and deducted from the Foreign Source Income at Issue.
 

B.

MOEF Ruling

As part of a strategy in appealing against the Assessment, Kim & Chang successfully obtained a ruling from the Ministry of Economy and Finance (the “MOEF”) which held that policy reserve (and by implication the PRI) does not constitute an expense related to the derivation of foreign source investment income in calculating the FTC limit. (MOEF International Tax Regime Division-40, dated January 25, 2022). This ruling played a decisive role in the Tax Tribunal’s final acceptance of the taxpayer’s claim.
 

C.

Judgment of the Tax Tribunal

The Tax Tribunal determined that the PRI may not be considered as an expense related to foreign source income and thus revoked the Assessment in its entirety, on the grounds that (i) the relevant provisions of the CITL do not require that policy reserve be divided into principal and the PRI; (ii) the PRI, which is calculated according to a formula under the IBSR irrespective of foreign source income, is included as an expense in calculating profit/loss from investment business merely for regulatory analytical review purposes; and (iii) the MOEF ruling also confirmed that policy reserve does not constitute an expense required to be deducted from foreign source investment income when calculating the FTC limit.
 

D.

Implications

The Tax Tribunal’s decision is precedent setting and has clarified for the first time that the entire policy reserve relates to insurance business and that the PRI cannot be classified as an expense related to foreign investment business.

Our firm focused on the point that the entire policy reserve (and therefore by implication any PRI) constitues an expense related to insurance business in light of the relevant laws and nature of the policy reserve.

While the PRI is deducted as an expense in the profit and loss from the investment business in the business report under the IBSR, our firm explained that this was only for the purpose of calculating the share in participating policies and had nothing to do with taxation. Furthermore, given the size of the PRI, our firm noted that the tax authority’s argument would lead to insurance companies not being able to receive any FTC for foreign taxes paid on income from their foreign investments, which could have a negative impact on the insurance industry. As a result, our firm successfully obtained a decision from the Tax Tribunal to cancel the Assessment in its entirety.

The Tax Tribunal’s decision is of great significance in terms of legal precendent and is also likely to have a significant impact on the insurance industry in terms of the FTC claims given the recent expansion of investments in foreign bonds and ETFs by domestic insurance companies for yield enhancement and portfolio diversification.