In simple terms, the following forms of business organisations are commonly used by foreigners in Korea: Liaison Office, Branch Office and Subsidiary. A Liaison office is one which is established by a foreign company for the purposes of prospecting for business / assessing the market. The other two forms are for actually generating revenue.
General Differences among Liaison Office, Branch and Subsidiary
1. Permissible Business Activities
The first and primary difference among the three different legal forms of business organisations lies in the types of local business activities which can be conducted. A Liaison Office may engage in only non-income generating activities. A Branch may engage in any income generating business activities, and a subsidiary may also engage in any activities in Korea within the scope of its business objectives.
2. Tax Treatment
Another difference can be found in their tax treatment. The activities of a Liaison Office are limited to non-income generating liaison activities exclusively for its head office. The non-income generating activities include PR, collection and supply of information or other similar activities of a preliminary or auxiliary nature solely for its head office.
Since a Liaison Office, by definition, acts only for its head office and does not generate income in Korea, it is not subject to Corporation Tax and need not file a corporate tax return in Korea. However, if the Liaison Office is engaged in any type of income generating activity or conducts liaison activity for foreign affiliated companies other than its head office, such liaison office could be deemed to be a taxable business presence (permanent establishment) in Korea under the “substance-over-form” principle, and thus such Liaison Office may be treated as a “resident taxpayer” which is subject to Korean taxation. Indeed, the Korean tax authorities are often keenly aware of the activities of liaison offices of foreign entities and have been conducting regular and occasional audits/investigations of the local operations of such offices.
On the other hand, a Branch of a foreign corporation engaging in income generating activities is most likely to be deemed a permanent establishment for Korean tax purposes. A permanent establishment is a fixed place of business located in Korea through which the business of a foreign enterprise, other than business activities of a preparatory or auxiliary nature, is wholly or partly carried on. Once it is determined that a branch constitutes a permanent establishment of a foreign corporation, then the foreign corporation will be subject to Korean taxation on Korean source income in the same manner as a domestic company is taxed. Where a tax treaty is applicable, only the Korean source income attributable to the Korean branch’s activities may be subject to Korean taxation (most of Korea’s tax treaties adopt this attribution principle.).
Subsidiaries will be subject to Korean taxation on all of their income at the normal corporate income tax rates applicable to domestic corporations, and the dividends paid by the subsidiary to its parent company will be subject to withholding tax pursuant to the applicable tax treaty between Korea and the home country of the parent company.
The obvious downside of a Branch, which amounts to the creation of a permanent establishment in Korea, entails the possibility of unnecessary disputes with the Korean tax authority as to the scope of Korean source income attributable to the Korean branch. Since the Korean tax authority usually attempts to attribute as much income of the foreign corporation as possible to its Korea branch, the foreign corporation is directly exposed to Korean taxation. This complication may be avoided by opting for the incorporation of a subsidiary. As a subsidiary is an independent legal entity from its parent company, its taxable income is rather clearly defined and the parent company’s exposure to Korean taxation is limited to the dividends paid to it out of the subsidiary’s profits.
3. Exposure of Foreign Corporation to Legal Liabilities in Korea
For the purpose of determining the scope of exposure to legal liabilities, only a subsidiary is, in principle, treated as an independent legal person. A corollary to this different treatment is that the foreign parent of a Korean subsidiary is, in principle, legally insulated from the liabilities of the subsidiary, whereas the head office of a liaison office or branch has to assume full responsibility for liabilities arising in connection with the operations of such liaison office or branch in Korea.
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