[Income Tax in Korea] - Understanding Necessary Business Expenses

Understanding Necessary Business Expenses

 

In this blog post, we will delve into the concept of necessary expenses for business income in Korea. Understanding these expenses is crucial for businesses to accurately compute their taxable income. Let's explore the scope and categories of necessary expenses for business income.

Scope of Necessary Expense

Necessary expenses for business income encompass the total amount of expenditures incurred to generate revenue within the relevant taxable period. According to Article 55 of the Enforcement Decree of the Income Tax Act, the following expenses are generally considered necessary for businesses:

• Purchase price of raw materials for commodities or products sold (excluding purchase allowance and purchase discount) and expenses incidental thereto
• Book value of real estate (building construction business, real estate development and supply business) at the time of transfer ‒ Employees’ salaries and wages
• Expenses for the repair, management and maintenance of assets for business, and rent for such assets
• Depreciation costs of fixed assets for business
• Interest paid on debt directly incurred for gaining the gross revenue
• Bad debt loss (including the amount of receivable output VAT to which bad debt tax credit was not applied)
• Appraisal losses on assets
• Expenses paid for geological survey, etc. for prospecting minerals, and development expenses thereof
• Advertisement expenses and sales supporting expenses 
• Donations and entertainment expenses within the prescribed limit
• Reserves, allowances, and other necessary expenses
• The amount of expenses for at-work sports, entertainment, etc. for employees

 

Necessary Expenses for Reserves and Allowances

The following are recognized as necessary expense within the prescribed ceiling:

Retirement benefit allowance ( Article 57, Enforcement Decree of the Income Tax Act)

• Retirement benefit allowance is recognized as necessary expense within the set limit.
• The upper limit of retirement benefit allowance included in necessary expense shall be the lesser of ① and ②.
  • ① 5% of the total salary paid to employees who have served continuously for one year
  • ② 0% of the estimated retirement benefit* ‒ Balance of retirement benefit reserve + Amount converted to retirement fund*
    • * Amount converted to retirement fund: Balance of the amount paid to the National Pension Service on or before March 31, 1999
    • * Estimated retirement benefits: An estimation of the amount that needs to be paid if all employees who have served continuously for one year or more as of the last day of the relevant year retire

Allowances for bad debts ( Article 56, Enforcement Decree of the Income Tax Act)

• Where a business operator has appropriated bad debt allowances for accounts receivable, etc. as necessary expense, an upper limit will be applied to the amount included in necessary expense.
• Such upper limit shall be the larger of the following: 1) 1% of the sum of business-related credit including account receivables as of the last day of the taxable period, and 2) the amount calculated by multiplying the credit balance by the actual ratio of bad debt.
  • Upper limit of bad debt allowances = Year-end credit balance x Rate of setting*
    • * Rate of setting: The larger of 1% and the actual ratio of bad debt
    • * Actual ratio of bad debt = Bad debt incurred during the taxable year ÷ Credit balance as of the last day of the preceding taxable year

Necessary Expense for Computing Business Income

Gains on insurance claims ( Article 31, Income Tax Act) 

• Where a business operator uses the gains on insurance claims for extinguished or damaged fixed assets to acquire or replace with fixed assets of the same kind or to improve the assets, the gains on insurance claims spent on the acquisition or improvement of such assets can be appropriated as necessary expense. However, to include gains on insurance claims in necessary expense, the gains should be used for acquisition or improvement of fixed assets in the year in which the insurance claim was paid or within two years of the first day of the following year.

National subsidies ( Article 32, Income Tax Act)

• Where a business operator receives national subsidies to acquire or improve business assets and spends the subsidies for such purpose, the expenditure can be appropriated as necessary expense

Necessary Expenses for Donation

Under Article 34 of the Income Tax Act, necessary expenses for donation can be accounted for in the business income calculation.

 

[Income Tax in Korea] - Understanding Donations and Necessary Expenses

 

Necessary Expenses for Entertainment Expenses

Expenses related to entertainment, as stated in Article 35 of the Income Tax Act, are considered necessary within certain limits.

 

[Income Tax in Korea] Understanding Necessary Entertainment Expenses for Income Tax

Necessary Expenses for Depreciation Costs

Article 62 of the Enforcement Decree of the Income Tax Act recognizes necessary expenses for depreciation costs.

 

[Income Tax in Korea] - Understanding Depreciation Costs and Methods

Non-Inclusion of Necessary Expenses

Some expenses are excluded from necessary expenses as per Article 33 of the Income Tax Act.

The following are not included in necessary expense when calculating income:

• Income tax, local income tax, and tax paid or payable as a result of non-compliance with tax collection as prescribed by tax-related laws (including penalty taxes thereof)
• Penalties, fines (including penalties and fines imposed by disposition of notification), and administrative fines
• Penalties as prescribed by the National Tax Collection Act and other tax-related laws and expenses incurred for the collection of delinquent tax
• Loss on valuation of fixed assets, etc.
• Expenses not related to business
• Individual consumption tax on products that were taken out but not sold, or the amount of unpaid liquor tax
• Interest on borrowings used as construction funds as prescribed by presidential decree, interest on loans whose lenders are unclear
• Public charges or imposts that are not mandatory under Acts and subordinate statutes or those imposed for non-performance of duties or violation of prohibited or restricted acts under Acts or subordinate statutes
• Over-depreciation amount ‒ Household expenses and prepaid expenses
• Input VAT

Special Cases Concerning Exclusion of Expenses Related to Business-Use Vehicles

Article 33-2 of the Income Tax Act addresses special cases where expenses related to business-use vehicles may be excluded.

 

[Income Tax in Korea] - Understanding Special Cases and Expenses Related to Business-Use Vehicles

Conclusion

Understanding necessary expenses for business income is vital for businesses operating in Korea. By correctly accounting for these expenses, businesses can compute their taxable income accurately and fulfill their tax obligations.