[cases] of more than $100 million, which means multinational companies, were just 27, instead of less than $1 million were 2,700, so it’;s the most part of the FDI from the small and medium-sized.
I think small and medium-sized companies are more affected by the economy condition. When we look at the FDI amounts of less than $1 million for this recent three years, it was $400 billion in the year 2007, and then to 395 and then to 315 in 2009. But for the same period, the FDI of more than $100 million was $4 billion, to 5 and then $7 billion in 2009.
I think what it means is that multinational companies have increased their investment in Korea during the economic downturn while the small and medium-sized really shrink in their investment in Korea.
But again, in terms of numbers, small and medium-sized investments are far more than multinational companies.
Tom: You identified kind of this downward trend in recent years for the small to mid-size companies. Do you see signs of things turning around?
Young: Not yet actually, but the economy generally is recovering from the United States and some of my clients from the US says that the consumption trend is recovering. So, maybe I am expecting a couple of more new clients from overseas or planning to set up a new business in Korea as maybe the sign of recovery. It’;s getting better I think.
Tom: Do you see companies from particular countries who are primarily opening up shop in Korea?
Young: Yeah, sure. Like I said, almost 3,000 FDI is reported every year and 2,000 are coming from Asia, and roughly 500 from America and another 500 from Europe. If you look at the specific countries, United States are major source of investment from the America and from the Europe it’;s usually Germany and the UK. And from Asia, it’;s mostly Japan.
Tom: How about China?
Young: China — if you look at the number of investment, the new business being set up in Korea in terms of just a number of entities, it’;s almost sometimes 1/3 of the total FDI reported from Asia. So, it’;s really a big number in terms of numbers, the amount invested, it doesn’;t play a very good portion of FDI.
Tom: I see. For new companies setting up in Korea, from which industries or sectors are most of them coming?
Young: Industry sectors as you might guess, manufacturing accounts for 15% of the total FDI in Korea and the percentage is decreasing because the overall manufacturing headquarter is shifted to China rather than other countries due to labor costs or something like that, while service industry accounts for almost 80% of the FDI in Korea.
If you look at the manufacturing side, they’re mostly coming from the electronics and the machinery. And if you look at the service side, it’;s mostly coming from wholesale or retail industry.
Tom: I see. The Korean government is talking a lot about attracting foreign investment to Korea. What are some of the key industries in which foreign companies can now get preferential government support?
Young: Those industries which can get the preferential government support is called “business accompanying high-level technology” and “business of industrial support service”;. These terms might sound quite unclear, but the point is this.
If you want to get this special incentive or a benefit in Korea, you have to improve Korea industry international competitiveness. So, if you qualify for any of these categories, you can get a lot of preferential government support. Maybe you can check in advance with the Korean government whether or not your business qualified for this kind of preferential support.
If I talk about the time when I worked for a public company based in the US, we submitted a company brochure, manufacturing process technology description before we set up the factory in Korea and we got the government approval on those preferential government supports. So, I think it really matters how you communicate about your business as well as what your business really is.
Tom: Can you give us a more specific example of what it is you’re talking about here in terms of foreign companies getting a preferential government support? Can you give us a specific type of an example of the type of company that might be able to achieve this and how they might go about doing that?
Young: If you have, like I said, a special technology which is very high tech or something like that, you communicate with the local government that this kind of technology can improve and enhance the general technology level of Korea.
Then they have something like a committee to review that technology and if they approve it, they can give you big tax incentives like five-year or seven-year tax exemption on the corporate income tax. They give you the free land to set up the factory on there and they give them cash grant so that you can hire more people where you can get some kind of benefit for the fixed asset investments; something like that.
Tom: I see. Can you explain a little bit about location-based incentives for opening foreign invested companies in Korea? For example, how is the government working to induce FDI to specific locations in Korea, such as foreign-invested industrial complexes?
Young: Yes, when we talk about the location-based incentives, we usually talk about foreign investments zone which is called FIZ. Currently, there are 16 complex-type FIZ and 36% are stand-alone FIZ.
If you invest, say, $30 million for the manufacturing facility in one of these locations, you will get 100% exemption of corporate income tax as I said, for like seven years and you will get exemption for all the local tax including the property tax for 15 years. You get the free land for like 20 years. So basically, if you can qualify for this kind of allocation, it’;s a huge benefit you can enjoy.
The Korean government, they’re trying to expand this kind of special locations to induce more foreign companies to Korea. So, the number of these FIZ is actually increasing and I think they are still trying to develop new sites for foreign investment and foreign investors to build that new factory.
If I just, again, talk about my experiences that the company which I worked for in California — we rented almost 200,000 sq. ft. — that’;s a big site — and the rent was literally zero in Korea for 20 years. We also got the local financing for the plant construction with the help of the local government and got the tax benefit of seven years exemption on the corporate income tax, which was pretty much a good benefit for the company to start their new business in Korea. This was something the Korean government is trying to achieve I think.
Tom: Those certainly sound like fantastic and aggressive offerings from the Korean government. I don’;t know if you know the answer to this, but would you be able to compare Korea’;s effort in this regard to other countries in Asia?
How does Korea stack up against the competition in terms of the special incentives and preferential treatment that it is offering compared to its other Asian neighbors? Can you comment on that?
Young: Yeah. I can just talk a little bit about the main competitor in Asia. Korea’;s competitor can be like Singapore, Hong Kong or China. When we talk about Hong Kong and Singapore in terms of tax rate or tax incentive, I think Korea is really good because in general in Hong Kong, they give you exemption on the offshore income and they give you the exemption on the interest income and something like that, but the basic tax rate is flat like 16–17%.
But in Korea, as long as you can be qualified for this kind of FDI promotion industry, you can get 100% corporate income tax for seven years and then 15 years there is no local taxes like property tax.
That’;s a huge benefit even in comparison with Hong Kong and Singapore I think. If you look at China — because I ran the manufacturing facility which we had almost 4,000 working staff there when I worked for the company based in California, the efficiency and the general environment of running a business is totally different in China and Korea because this is more reasonable society.
That’;s my personal opinion. So, I think Korea is still very competitive even for the manufacturing industry, especially for the service industry; it’;s very attractive.
Tom: What are some of the other notable efforts by the Korean government to attract more foreign companies to Korea?
Young: It’;s like FIZ; they tried to develop new location-based incentives like free trade zone, free economic zone and you can get the similar benefit. They run a help desk for the foreign companies which are considering investment in Korea and they take care of all the red tape process to set up a new business. They consult you with every local legal environment, whatever you should need.
I guess many foreign companies are concerned about the labor relations in Korea and most of the local governments are subsidizing the 90% of the training expense to prevent labor disputes.
When there is a labor dispute, they subsidize 60% of the arbitration expense. That’;s one of those efforts by the government. And also, because some of the people are concerned about their expatriate’;s income tax burden in Korea; so the government has set the maximum tax rate for the expatriates in Korea at 16.5%. So, those are one of the benefits they can enjoy in Korea.
Tom: What business areas do you see as the most open to foreign companies in the next decade?
Young: I think it’;s definitely green business or recycle-the-energy business as you can guess. Solar power and secondary battery is a good example since they are really something the government is trying to boost in Korea.
Other than that, Korea has also focused on parts and materials industry, and that lead to recent increase in Japanese investment in Korea since — Japan is traditionally regarded as very strong in the parts and materials industry. Korea wants to introduce those kinds of technologies of fundamental side of industry, like parts and materials.
Also, another target is R&D center of the high technology business like Google or IBM R&D center. So, those kind of areas like green business, and parts and materials industry I think is the most open areas to foreign companies in the next decade.
Tom: When you say parts and materials, specifically what are you referring to?
Young: If you think about Hyundai Motors, they produce a lot of cars which has been very popular in the global market. Whenever they produce one car they have to import a lot of parts from Japan. So, what they say is that by selling a lot of Korean cars, actually they are making the Japanese company make a lot of money.
So that’;s why Korean companies make most of the parts internally from Korea. That’;s why they want to build that kind of strong infrastructure of parts industry or materials industry.
Tom: I see. Let’;s talk a little bit about the nuts and bolts of setting up and running a company in Korea. I know that the Korean government has made it much easier in recent years to establish a company in Korea both in terms of reducing the capital requirements as well as in providing other additional assistance. What exactly are the basic regulations on establishing a corporation in Korea?
Young: Yes. The basic regulation is the Commercial Code, which is like a model business corporation acting as in the United States, but there is also a special law to promote FDI. We call it Foreign Investment Promotion Act, or FIPA. So, the law provides really the backbone of the special incentives and benefits for the foreign companies investing in Korea.
If you establish a corporation in Korea, you follow the same process like Korean local companies and then, additionally, you report your incorporation to the designated bank under FIPA which is to get the special benefit or incentives available to the foreign companies.
Tom: So, what does it cost to get started? What are the running costs for an entry level operation?
Young: The cost is I think very competitive, even competitive with Singapore or Hong Kong. To get an entry level business — as you know, it really depends on how much capital you invest and what city you incorporate it in.
Assuming you set up in Seoul and invest a minimum capital requirement of 50 million Korean won, which is $45,000, it would cost like $700 US dollars for the tax and government fee. And if you use the professional incorporation service provider, it would generally cost $1,100 including the tax and fees and all the service fees.
And about the running cost, aside from the payroll and the rent and the like, the maintenance cost itself would be like just $3,000 per year assuming you’re running like a virtual company, just the maintenance cost. Other than that, about the rent and payroll, it really depends on where you can get your office and what kind of people you hire.
Tom: If a non-Korean wishes to establish a company in Korea, where should he or she start the process?
Young: I think the government agency called KOTRA is running the desk to provide that kind of assistance and maybe you can also check the website www.investkorea.org to get the information.
But my opinion, though, is that it’;s usually better to contact your professional service provider so that they can guide you through the process from the first time and do it on behalf of you to just to customize to your specific need.
Tom: What other resources are available to foreigners in setting up a company? Can it be done independently or is assistance truly required?
Young: I think you can do it independently, but even in the States, I haven’;t seen people do that kind of setting up independently and I never heard of Korean local people do it by themselves. So, like I said, we just better use the service provider and I think that’;s the same in other countries, too.
Tom: How long does the company setup process generally take?
Young: In the case of local companies, it’;ll just take two to three days. But again, you have one more process to report as a foreign company and, usually, it will take another two to three days. So, as long as you prepare all the relevant documents before you start the process, it would take like one week.
Tom: Okay. Can you explain the differences involved in establishing the different types of businesses; maybe an independent corporation, a liaison office, a branch office and then maybe a subsidiary in Korea? Can you talk about the differences in these different types of operations?
Young: Sure. Maybe the easiest way to explain the difference between those different kinds of forms of business is from the tax point of view because a liaison office is not taxed at all in Korea. A branch is taxed only for its Korean source income while the subsidiary is taxed for its global income because it’;s regarded as a domestic company.
But in terms of what it can do with the liaison office, the scope is very limited. We can only perform the preliminary or auxiliary activities, like market research, or information gathering and sourcing of products which is not for sale in Korea.
So, if those activities like market research is performed for the products for sale in Korea or performed for the entities other than its head office, it will be regarded like a branch or a subsidiary and it will be taxed even if it’;s registered as a liaison office. So, the scope and the work you can do with the liaison office are very limited.
And talking about the branch and subsidiary, basically the branch is a foreign company doing business in Korea, while a subsidiary is regarded as a domestic company. So, from the business standpoint, Korean customers may appreciate the locally incorporated entity more than a branch because it shows more a commitment to the Korean market and local community. But, from the tax point of view, a branch can remit their profit to its head office without any dividend tax, while subsidiary must face a double-tax issue when they remit profit to its parent company.
If I talk about the process involved toward making [unclear] free options, it doesn’;t differ so much and can be done with, as I said, local service providers. So, you need just focus on what your purpose to have business presence in Korea and what should be the best form to accommodate your purpose.
Tom: Do some industries have special requirements for getting set up in Korea? I imagine they do.
Young: Yes. Yes, they do. Some industries have restrictions on foreign investments such is defense industry, as you can easily guess, and broadcasting, atomic energy and telecommunication. Those kinds of industries are not available for foreign investment.
Other than that, some industries like finance, asset management, construction or import of motor vehicle — those kinds of industries need to get a license or permit from the government before you get the business set up.
So, usually during the process of setting up the business, you consult with a local service provider. You tell them what kind of business you’re going to do in Korea. They will check out first whether or not you need those license or permit before you get a business set up.
So, usually those who are licensed, the requirement is that you must have a certain level of capital or certain level of qualified people hired, so mostly, it’;s about capital requirement or personnel requirement for those kinds of industries.
Tom: Of course, setting up a company is just the beginning of the process and once a company is set up, running the company requires ongoing management. At least in North America, we say that the two advisors most important to a company owner are his attorney and his accountant. Is that true in Korea as well?
Young: Yes. It’;s the same thing in Korea. Once you have business presence in Korea, you really have to comply with all the local regulations. Those two advisors let you focus on business itself and not be distracted by any unnecessary problem from non-compliance. And also, good CPAs and attorneys will try to find incentives and benefits available for your business, and I think they will be a big help I think.
To be honest, I have always had a thought that the CEOs need a coach, a counselor, a mentor, an advisor; whatever you call them — somebody you can frankly talk with about how to manage your business.
In the early stage of small and medium-sized companies, CPAs and attorneys can do that kind of role because they have this expertise in certain area that CEOs need, and also because they are outside people who are dealing with a lot of similar situations. That’;s why that’;s very important to have good CPAs and attorneys lined up on your side.
Tom: From an accounting standpoint, what are the basic tax regulations, and filing and statutory requirements?
Young: Let me put it just as simple. Every month, you need to file a payroll tax return if you hire people in Korea. Every quarter, you need to file a value-added tax return which is like a sales tax in the States. Every year, you need to file a corporate income tax return and from the second year, you need to also file a preliminary half-year corporate income tax return. That’;s really the first three requirements and usually those are what your CPA takes care of.
As for the audit requirement, you don’;t need to get the audit on your financial statement unless your business has more than US$9 million assets in the previous year. To be specific, Korean won of 10 billion.
Tom: The Korean accounting system is being harmonized with international standards. What impact does that have on running a foreign company in Korea?
Young: Like I said, Korean accounting has been harmonizing with international standards. You know what? One big thing is the introduction of IFRS which is International Finance Reporting Standard. From year 2011, all the public companies in Korea are required to present their financial statement in IFRS.
Considering that the companies need to file two years of financial statements, they really need to apply IFRS from this year. And along with this, even the private companies can choose to apply IFRS better than Korean GAAP, Korean generally accepted accounting standards. That means a lot especially to foreign companies in Korea.
Let me just take an example. One of our Japanese clients has spent a lot of time and resources to maintain his accounting in Japanese GAAP for his head office in Japan and a Korean GAAP for the local compliance and also in IFRS for the investors from Europe. This is triple work.
From this year, they are just doing it in IFRS and that’;s it, because you can just choose to apply IFRS from this year. So, it saves a lot of time and resources. But, not only that, you can get the on-time relevant information about your business because you don’;t need additional time to see the translated financial statements, not just in terms of language, but also in terms of accounting standards.
Tom: Can you explain about the national pension scheme and the medical healthcare requirements to which companies must pay?
Young: Yeah. We say we have four key social insurance which is national pension, national medical insurance, national unemployment insurance and also national workers’; compensation.
So, to mention the percentage, for your information briefly, national pension is 9% of the gross income and half paid by the employer and half by the employee. Medical insurance is 5.6% and half and half on employment, 1.3% and half and half almost on the workers’; compensation; it really depends on what kind of business you do.
So, basically, the employer person portion of those four key social insurances are around 9% of the salary you pay to your employee.
Tom: Let’;s talk about labor a little bit. You brought up the issue of labor briefly a few moments ago. Labor issues are critical in being able to operate successfully in Korea for any company as you know, whether it’;s foreign owned or locally owned.
What are the government regulations on labor and considerations companies need to be aware of, especially when it comes to hiring and firing, and things like maternity leave and some of the other areas?
Young: Like in the United States, Korea obviously has labor standard laws and also labor relations laws. I think the standard is almost the same and just up a little bit about firing. You can fire with 30-day notice when you have cause which is acceptable in society. Once you mention it, paternity leave is a three-month and a leave is a two months paid by the company, and one month paid by the government. And after three months, you have to accept her back to the equivalent position.
One thing is about the severance payment. You have to pay a one month full pay of severance payment for every single year the employee worked. For example, the employee worked for three years. You have to keep severance pay of three months full salary. Other than that, the minimum wage for working hours and stuff like that is almost the same with the global standard I think.
Tom: Let’;s talk about some success and failure factors of companies doing business in Korea. I’;m sure you have a lot of experience working with foreign companies doing business in Korea and, based on your experience, what are some of the keys to business success in the Korean market?
Young: I think that’;s the most difficult question. I’;m not an entrepreneur, so I don’;t think I have the capacity to properly answer the question from business standpoint. But even to me, some of the foreign companies seem like they come to Korea without enough preparation in market research or information gathering and then they simply do what they have done in their country, just the same way they have done there.
They end up spending all the initial capital and, suddenly, the parent company feels they’;ve done something wrong and doubt the business prospect in Korea and they cut their budget. They just maintain the Korean business nominally.
So, I would recommend to take time to do market research and study Korean market before you just execute your business in Korea. As far as I know, there are lots of seasoned management who are foreigners and also who will have deep experiences and insights on the Korean market.
So, why don’;t you hire them and try to understand the Korean market first and the business environment and also special culture, customs which might affect your business, and then push the start button?
Tom: Who are three small to medium-sized foreign companies in the Korean market who have been successful, and what do you see as the biggest reasons for their success?
Young: Let me answer the question this way. From time to time, KOTRA the government agency promoting the foreign investment announces the successful foreign companies operating in Korea. They recently mentioned names which people are not familiar with.
The biggest success factor they mentioned is communication by transparent management. Every business is done by people and if you want to be successful, you really need to motivate the talented people. So those companies communicated with their employees about company performance using the financial statement and other financial data, motivated their people by better compensation system with performance-based incentives.
So, I think that’;s the biggest reasons for their success. Once you have many talented people lined up on your side, fully motivated, then your business will be on the right track to success because they will successfully handle your customers, regulators and they will come up with creative ideas which will contribute to your company’;s success.
Tom: Finally, what are three accounting-related mistakes that foreign companies often make in their business dealings in Korea?
Young: In terms of accounting, there’;s not much actually to make mistake actually which can impact the business success. But, what I can say is that some of the companies tried to install the accounting system which is compatible with their head office system.
But sometimes, considering the operation size of the Korean subsidiary, it really doesn’;t just define the maintenance expenses. They end up worse than, just using the expression, because they can’t get the on-time, accurate information from their accounting system. That’;s maybe one of the mistakes a lot of companies do in Korea if it is related to accounting.
Another thing I want to mention is the extremes in choosing the accounting firms. Some of the companies use only the big four accounting firms even for the low-level work, paying expenses, which is very expensive, while some of the companies just choose the cheapest maybe thinking that the accounting service is just auxiliary and doesn’;t matter so much. I think neither of these extremes are wise.
Some of the areas like transfer pricing where you really need to show the reliable, big paying backup, you need to hire big firms rather than the small firms. In case of just auxiliary and routine service, maybe you better just choose a smaller firm. So, to fit into your specific need, you can just choose between the big four accounting firms and sometimes just smaller-sized firms.
Tom: Certainly sounds like some great advice. You shared a lot of really interesting and useful information with us today, and I know that our audience at Korea Business Central will certainly enjoy your insights and certainly benefit from what you’;ve shared today. Is there anything else that you’;d like to say in closing that we haven’;t mentioned yet?
Young: As I said, Korea is I think a very competitive environment and the government is really trying to induce more FDI, so think about Korea as a potential investment site and I think you will be just satisfied about every incentive this provides. So, include Korea in one of those options in your action plan.
Tom: Sounds like a great recommendation. Young, thanks so much for joining us today. It’;s been a pleasure.
Young: Thank you. It was my pleasure.
Tom: Our guest today has been Young Ham who is the managing partner and co-founder of Hanmi Accounting Corporation in Seoul. This has been the latest in our ongoing Korea Business Interview series. I’;m your host, Tom Tucker, inviting you to improve your business results in Korea by joining KoreaBusinessCentral.com today. Thanks for listening and have a great day.