Improving the Withholding Procedure - By comparing with the U.S. withholding tax system -

In Korea, the term ‘withholding’ refers to a system where the income payor collects a tax imposed on the income recipient and remits to the government of the tax so collected. The rationale behind the withholding tax system is that it is easier for the government to administer one income payor comparing to a few thousand income recipients. For example, in case of payroll withholding tax, it is easier for the government to deal with a company than a few thousand individuals who work for the company. Also, in case of foreign income recipients, it is rather difficult for the Korean government to administer the tax on foreign persons that do not have a business place in Korea. Therefore, the withholding gives the convenience as well as efficiency. In the U.S., the meaning of withholding and the rationale for the withholding tax system are more or less the same. The basic concept behind the rules of withholding tax is that the person who is responsible for making the payment has access to both the proceeds that represent the income and the information necessary to determine the status of the taxpayer and the collect tax on the income. The requirement to withhold is most important in cases where the relevant taxing authority has effective jurisdiction only over the payor, and not over the recipient, of the income. The term “withholding” is defined for U.S. tax purposes under the § 1441 regulations to mean the deduction and withholding of tax at the applicable rate from the payment. A withholding tax is feasible only if it is imposed at a flat rate on gross income because it is usually impractical to require payors to obtain and verify the information necessary to administer a withholding tax based on payees’ annual net income. The inherent unfairness of taxing gross income is minimized by a tax confined to items like dividends, interest and royalties, which are often earned without substantial expense by ordinary investors, which are collectively referred to as fixed or determinable, annual or periodical (“FDAP”) income. This is the reason why withholding, as a general rule, focuses on whether the withholding agent (that is, the person who pays money to the foreign person) is paying FDAP income. It is no different in Korea and a withholding tax generally focuses on FDAP income though there has been some attention to the withholding tax on capital gain derived by non-residents from disposition of Korean securities recently. Disputes around withholding tax have been increasing in Korea, particularly so because the provisions of the law do not provide the guidance that is clear and predictable. Also, the fact that heavy burden is placed on withholding agents coupled with the uncertainty and ambiguity inherent in the law can make foreign investors shy away from an otherwise attractive investment opportunity in Korea. This paper will describe the withholding tax system of two countries, Korea and the U.S., briefly and generally with a focus on the procedural aspects with respect to the role of withholding agents when Korean source FDAP type of income is paid to foreign persons with no business place in Korea, and discuss whether the Korean withholding tax system can be improved to give clearer guidance and predictability to both withholding agents and foreign income recipients.