Tax implications of intercompany loans in South Korea

Nov 02, 2022

Key takeaways

Whether an intercompany loan may trigger disallowed interest expense in South Korea or the United States.

Whether the interest rate on an intercompany loan is in line with the relevant tax regulations.

Whether an intercompany loan may have additional U.S. tax impacts, such as GILTI or the base erosion anti-abuse tax (BEAT) for a U.S. parented company.

Business tax Global services International tax

Many multinational companies use related party loans as a key tax planning tool and for general cash management. While dividend payments are not tax deductible, interest is generally deductible from taxable income. Therefore, investors prefer using debt financing versus equity financing when capital is needed.

Under South Korean tax law, when foreign related parties fail to adhere to interest rates prescribed by arm's length principles, the South Korean tax authorities have the ability to adjust such interest rates and rectify the tax base, so each party does not unreasonably reduce their tax burden. As the South Korean tax authorities have a history of scrutinizing the reasonableness of interest rates applied to intercompany loans, this article sets forth the South Korean transfer pricing safe harbor rule that is applicable to intercompany loan transactions and discusses issues relevant to the deductibility of interest expense from a South Korean tax perspective. In addition, this article notes some of the additional considerations U.S. multinational companies with South Korean operations will need to evaluate with respect to these rules

The definition of ‘related party’

Presidential Decree, a form of administrative legislation issued by the President, provides a definition of the “special relationship”, which should be used to determine whether there is related party relationship:

  • A relationship in which either one party to the transaction owns directly or indirectly at least 50% of the voting shares of the other party.
  • A relationship between both parties to a transaction where a third party owns directly or indirectly at least 50% of their respective voting stocks.
  • A relationship in which the parties to a transaction have a common interest through investment in capital, trade in goods or services, grant of a loan, or similar financial provision, and either party has the power to substantially determine the business policy of the other.
  • A relationship between both parties to a transaction where both parties have a common interest through investment in capital, trade in goods or services, grant of a loan, or similar financial provision, and a third-party has the power to substantially determine the business policies of both parties.

When evaluating whether one party has the power to substantially determine the business policy of the other, the amount that has been borrowed; the level of dependency of one party on the other; the control of the board and management; and other similar factors should be considered under a general facts and circumstances analysis.

Under South Korean law, “the term ‘foreign related party’ means any nonresident or foreign corporation (excluding a domestic place of business of a nonresident or foreign corporation) in a special relationship with a resident, domestic corporation or domestic place of business”.

Transfer pricing safe harbor rules on intercompany loan transactions

From a South Korean tax perspective, the arm’s length interest rate should be used when conducting a financial transaction with a foreign related party. This rate can be computed in one of the following two ways:

  • Consider comparability factors such as the amount of debt, maturity of the debt, existence of a guarantee, credit rating of the debtor and other factors under the Enforcement Rules of the Law for Coordination of International Tax Affairs (LCITA).
  • Use the simplified “safe harbor” interest rate prescribed in the Enforcement Decree of Corporate Tax Act (EDCTA) and LCITA.

In the latter case, when a South Korean taxpayer lends funds to a foreign related party, an interest rate of 4.6%, the current market interest rate imposed on an overdraft (i.e., an overdraft is a form of a loan whereby a bank allows a borrower to spend more money than what's in their account), is deemed to be safe harbor. However, if a South Korean taxpayer borrows funds from a foreign related party, the simplified interest rate of 1.5% plus a 12-month London Interbank Offered Rate (LIBOR) of the last day of the previous fiscal year was deemed as a safe harbor rate under LCITA. Since 2021, the LIBOR has been phased out of use as a result of multiple scandals. As a result, the South Korean government approved a bill on Feb. 8, 2022, which amends the base rate from the LIBOR approach to the index interest rate for the following major currencies prescribed in the Enforcement Rules plus 1.5%. This amendment shall be effective for loan transactions arising on or after March 18, 2022.


Index rate

Korean Won

KOFR (The Korea Overnight Financing Repo rate)

US Dollar

SOFR (Secured Overnight Financing Rate)


ESTR (Euro Short-Term Rate)

British Pound

SONIA (Sterling Overnight Index Average)

Swiss Franc

SARON (Swiss Average Rate Overnight)

Japanese Yen

TONA (Tokyo Overnight Average Rate)

Thus, multinationals will be able to mitigate any tax risks associated with intercompany interest rates by using a specified rate proposed by the relevant tax regulations as discussed above. For U.S. parented multinationals, additional consideration will need to be given to the intercompany interest rates to ensure compliance with U.S. transfer pricing regulations.

Limitation on the deductibility of interest expense

In general, interest expense incurred in connection with a trade or business is deductible for South Korean corporate tax purposes. However, certain interest expense related to intercompany loans could be limited if interest paid to the foreign controlling shareholder exceeds the lower of the two limitations provided under the thin capitalization rules described below:

  1. Thin capitalization rules: When a South Korean company borrows from its foreign controlling shareholder and the debt-to-equity ratio exceeds 2:1 (six times the equity for financial institutions), interest payable on the excess portion is not tax deductible. Please note that money borrowed from a foreign controlling shareholder includes amounts borrowed from an unrelated third party based on guarantees provided by a foreign controlling shareholder.
  2. Limitation of interest deduction to 30% of adjusted tax earnings before interest, taxes, depreciation and amortization (EBITDA): In line with the OECD’s recommendation on the limitation of interest expense deductions (BEPS Action 4), net interest (i.e., the amount of interest expense paid to overseas related parties minus the interest income received from overseas related parties) deductions will be limited to the 30% of the adjusted tax EBITDA (taxable income before depreciation and net interest expenses) of the domestic company. The non-deductible amount of interest is treated as other outflow of income.

Additionally, interest expense accrued, but not paid, on an intercompany loan for more than one year may not be deductible for corporate income tax purposes under the recent tax amendments.

U.S. parented multinationals with South Korean operations will also need to consider the U.S. interest expense limitation rules. Similar to South Korea, the U.S. interest expense limitation rules generally limit interest expense to 30% of adjusted taxable income of a taxpayer, including a controlled foreign corporation, for a tax year. This limitation can have an impact on the computation of global intangible low-tax income (GILTI), which may give rise to a U.S. taxable income inclusion. Due to the potential for permanent or temporary timing differences regarding the deductibility of interest under South Korea and U.S. income tax laws, respectively, care should be taken to understand the interaction of these two provisions. Understanding this interaction can be complex and may require modeling, as additional U.S. tax variables such the GILTI high-tax exception or controlled foreign corporation group election regime may be of significant impact as well.

Withholding tax on interest payments for an intercompany loan

When a South Korean taxpayer pays interest on an intercompany loan to a foreign related party, such interest payment will be subject to a 22% withholding tax, including local surtax. This withholding tax rate may be reduced where the recipient is a foreign lender resident in a jurisdiction that has an applicable tax treaty with South Korea.

RSM contributors

  • Greg Pudenz
  • Ayana Martinez
  • Michael Min
    Partner, RSM South Korea

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