Tax Treatment of Executive-related Expenses
31 Mar 2018
Generally, executives, unlike employees, have decision-making power over corporate activities. Therefore, the tax law has various restrictions on the recognition of executive-related expenses. For example, expenses incurred without a due process or legitimate reason by an executive with a decision-making right are not allowed as deductible for Korean tax purpose.
2. Main Contents
(1) Definition of Executives
According to Article 42 (1) of the Enforcement Decree of the Korean Corporation Tax Act, executives are referred to as persons engaging in the following duties:
- All members of the board of directors, such as the chairperson, president, vice president, chief director, director representative, managing director and executive director of such domestic corporation and a liquidator;
- A managing staff member or director of a limited partnership, joint-stock company, and limited-liability company;
- The executive partner of a limited liability company
- An Auditor
- Other persons engaged in the duties similar to those specified in items ① through ④
The executives stipulated in ① through ④ above are the ones that must be registered under the company pursuant to the Korean Commercial Code. The ⑤ above is not an executive listed in the registration or articles of incorporation, but is the one who participates actively in management and actively participates in decision-making and execution of overall management or exercises a right to monitor accounting and other work-related matters. That is, regardless of being registered or member of the board of directors, if one engages in the foregoing duties, he or she will be deemed as an executive for Korean tax purpose.
(2) Remuneration of Executives
The remuneration paid to executives is the amount of salary, exclusive of bonuses and severance payment, paid by the corporation in exchange for its work and services in accordance with the delegated relationship, including salary, allowance, payment in kind, and other economic benefits. As a rule, these remunerations are deductible for tax purpose unless payment at issue is made by the appropriation of earnings.
However, even though the ceiling of the remuneration of executives is not determined per Korean tax law, pursuant to Article 388 of the Korean Commercial Code, as the ceiling of the remuneration for executives is supposed to be determined by resolution of the general meeting of shareholders in case it is not articulated in the articles of incorporation, any excess amount over the prescribed limit per either articles of incorporation or resolution of the general meeting of shareholders shall not be regarded as deductible for tax purpose.
In addition, in the event that the amount of remuneration paid to an executive is deemed unreasonably high for the compensation in light of the description of the job undertaken by the executive, the excess amount deemed unreasonable shall not be deductible for tax purpose. The criteria for judging whether the remuneration of executives is appropriate is as follows:
- Whether or not it is a reasonable amount in light of the contents of the duties performed by the executive;
- The level of the payment to the executives of comparable peer group (with comparable business size and within similar industry);
- The level of the payment made to the employees of the same company;
- Whether it is a significant and material amount in the light of the company's performance and scale
(3) Bonus of Executives
Pursuant to the Korean Corporation Tax Act, the bonuses paid under the payment standard determined by the Articles of Incorporation, General Meeting of Shareholders, General Meeting of Partners, or the resolution of the Board of Directors are allowed as tax deductible. The main authoritative interpretations relating to the foregoing are as follows:
ㆍ Even if the amount of the executive's salary ceiling is specified at the general meeting of shareholders, if the payment standard for bonus is not specified but a company still pays bonuses to its executives, then such payment of bonus shall not be allowed as tax deductible.
ㆍ If a corporation determines the salary payment standard for executives, inclusive of bonuses, in such a way that it only includes the total salary ceiling for all executives by the resolution of the general meeting of shareholders, and if the bonus payment ratio being applied to employees is adopted when actually paying the bonus to the executives, then the bonus paid may be regarded as a deductible bonus for tax purpose as it is in accordance with the foregoing salary payment standard, which is inclusive of bonus.
The bonus paid by the corporation to the executives through appropriation of earnings shall not be allowed as deductible, except for the specific cases such as performance bonus paid by treasury shares through employee stock ownership association.
(4) Other Employee Fringe Benefits and Expenses of Executives
Any reasonable amount of fringe benefits and other expenses of executives, in light of social norm and customary practice of society, is deducted for corporate tax purpose (Same with the standard applicable to employees)
(5) Severance Payment of Executives
Severance payment made to an executive as a result of the termination of his or her service, is allowed as deductible to the extent that:
- the amount determined by the Articles of Incorporation if the amount to be paid as severance payment, inclusive of any severance bonus, is set forth in the Articles of Incorporation;
- In cases other than ①, Total annual salary x 1/10 x years of service
Even though the phrase “the amount is set forth in the Articles of Incorporation” above means that the direct amount is prescribed for each executives in the Articles of Incorporation, the cases where the criteria for calculating the severance payment of executives are described in the Articles of Incorporation are also included. If there is separate severance payment standard delegated by articles of incorporation, the amount above means the amount in accordance with such severance payment standard. Actually, severance payment made to executives whose service has yet to be terminated should actually be deemed as loan to such executives till the date of termination, which is not related to his/her duty at the company, and, therefore, deemed interest revenue should be recognized by the company for Korean tax purpose. For reference, executives do not qualify as employees under the Labor Standards Act, and therefore, except for certain cases, any interim settlement of severance payment to executives shall be deemed as loan to such executives, which is unrelated to his or her service.
Any expenses paid to executives shall be allowed as deductible to a limited extent compared to expenses paid to employees as set forth above, and the summary of deductibility of executive-related expenses is as follows:
Deductible. However, any excess amount over the prescribed amount in the articles of incorporation or determined amount by the resolution of the general meeting of shareholders, or, under related party transaction, any amount that is not in compliance with the market price set forth in Korean Corporation Tax Act shall be non-deductible.
Deductible. However, any amount paid in excess of the amount stipulated in the payment standard or any bonus payment made out of the appropriation of earnings shall be non-deductible.
1. In the case where articles of incorporation includes a related provision: Deduction is allowed to the extent the articles of incorporation prescribes.
2. In the case where articles of incorporation does not includes a related provision: deductible within the amount calculated using the following formula:
1-year worth of salary (1-year roll back from the termination date), exclusive of any non-deductible bonuses, multiplied by 1/10 and years of service
Any amount deemed to be reasonable in light of social norm and customary practice of society shall be allowed as deductible