Kent Wong, Foreign Attorney at Jisung Horizon graciously shared this article he co-authored. It provides details on the special laws that govern Korean FDI and possible pitfalls.
Korea’s Foreign Investment Promotion Act is providing incentives for overseas companies to locate in the country’s special economic zones
Date: November 2008
In line with Korea’s efforts to position the country as a global logistics hub, an increasing number of free economic zones have been created with the aim of improving the management environment and living conditions for foreign-invested companies. These zones are subject to special laws that offer numerous benefits and incentives for foreign investors.
A free economic zone (FEZ) is an area which has been designated in accordance with Article 4 of Korea’s Act on Designation and Management of Free Economic Zones (DMFEZ) with the aim of improving the management environment for foreign-invested companies and living conditions for overseas workers. The Incheon Free Economic Zone Authority (IFEZA) defines an FEZ as “a specially selected 21st-century free economic metropolis which is allowed benefits and exceptions for certain economic activities”.
Typically, an FEZ will incorporate conditions likely to attract overseas companies. These include foreign-friendly living conditions, such as the mitigation of domestic laws within the specified zone. Special laws that correspond with the management and designation of FEZ are, or will be enacted. The zones are also built in favourable locations, being either in a central hub of the North Eastern Trade Zone or close to a city with an airport or harbour as well as tourist and leisure attractions. An FEZ will also typically provide a digital infrastructure supportive of corporate activities, high-tech industrial parks for the development of information and business technology, and outstanding housing environments to attract high quality personnel.
In addition to its three well established FEZs (Incheon, Busan/Jinhae, and Gwangyang Bay area), Korea has recently designated a further three: Daegu/Gyeongbuk, Gunsan/Saemangeum, and the Yellow Sea areas (Pyeongtaek-Dangjin).
For foreign-invested companies, there are many advantages to choosing to locate in one of these zones. However, it is necessary to have an understanding of the special laws that apply in order to enjoy the benefits and negotiate any possible pitfalls.
In order to develop reclaimed land in an FEZ such as Incheon, companies must first obtain the exclusive right to develop the land from the IFEZA and relevant Korean local and central government authorities. Typically, a consortium (consisting of domestic and foreign investors) would negotiate with IFEZA and obtain the exclusive rights to the land. A special purpose company (SPC) would then be established in the developer’s name in order to be a party to the development agreement and sale and purchase of land agreement.
In order to strictly comply with the purpose of promoting foreign investment in an FEZ, IFEZA requires the developer to be registered as a foreign-invested company pursuant to Article 2 of the Foreign Investment Promotion Act (FIPA), as of the date of entering into the development agreement. This means the SPC will need to be financed by a foreign investor by way of purchasing shares in the SPC, and the object of investment must include a foreign means of payment, as prescribed by the Foreign Exchange Transaction Act, and be financed with capital goods, proceeds from shares, industrial and intellectual property rights and other technologies in accordance with Article 2 of FIPA.
Moreover, IFEZA requires that the SPC must maintain its status as a foreign-invested company for at least five years from the time that the title of reclaimed land is transferred to the SPC in accordance with the land supply agreement. Not fulfilling this obligation would be deemed to be a material breach which would cause IFEZA to repurchase the land.
While IFEZA provides incentives to foreign-invested companies, it will also seek to reinforce its right to terminate arrangements where a developer materially breaches any of the agreements. Typical material breaches of the project development agreement and development agreement include the delayed submission of a business plan without justifiable cause; failing to comply with the business schedule in the phasing plan (in case of the development agreement); failing to establish the SPC within the designated time period; the SPC failing to be registered as a foreign-invested company; and if the consortium fails to submit its preliminary master plan and/or business plan within the designated time period without justifiable cause (in case of the project development agreement).
It is interesting to note that one of IFEZA’s main concerns would be whether the development plan could be delayed due to the developer’s failure to submit its business plan.
Conditions of sale
There are two typical types of real estate sale and purchase agreements in FEZ cases. The first type is a land supply agreement, which is when the developer purchases land that has been reclaimed by the local government. The second type is when a foreign-invested company purchases already-formed land in order to build a factory or to move into a building. In either case the same rules govern how foreign-invested companies can acquire land and whether the foreign-invested company purchaser agreement should be strictly observed.
The regulations that deal with how a foreign invested company can acquire land in Korea are found in the Foreigner Land Act (FLA). This act states that a foreign-invested company with at least 50% of its shares held by a foreign person or corporation is categorised as being a foreigner and is thus required to make a land acquisition report to the si-gun-gu (the local government authority in Korea). A company with less than 50% of shares held by a foreign person or corporation, however, is considered to have the same status as that of a Korean national, and no report is necessary.
In addition, articles 13 and 14 of FIPA provide exceptions for foreign-invested companies and local and central government administrators in the sale and lease of government and public-owned properties, permitting leases or sales under private contracts. When land is sold to a foreign-invested company, if the purchaser is unable to pay for the purchase in a lump sum, the payment date can be postponed or the payment can be made in installments, at an annual interest rate of 4% or less.
While the FEZA provides incentives to developers by supplying the land cheaply at a price below the actual land formation fee or by allowing payment in installments, the purchaser assumes the responsibility to maintain its status as a foreign-invested company under FIPA and not to sell or encumber the land for five years once the land title has been transferred to the purchaser. The foreign-invested company is also required to complete a codicil registration of repurchase and sale agreement at the same time that the sale and purchase agreement is executed. Should the developer breach any of the main obligations, the FEZA can repurchase the land in accordance with this agreement.
Research and educational infrastructure
A factor considered critical for enhancing the standard of living for foreigners in FEZs as well as improving domestic education and technology is the presence of foreign educational and research institutions. According to Articles 5 and 6 of the Special Act on Establishment and Management of Foreign Educational Institutions in Free Economic Zones and the Jeju Free International City (EMFEI), in order to establish institutions, foreign educational organisations must obtain a permit from the Ministry of Education, Science and Technology.
In Article of 13 of EMFEI, with regard to the rental or sale of state-owned, publicly-owned property, Article 13 of FIPA is applied mutatis mutandis to foreign educational organisations so that foreign-invested companies can acquire the land through a private contract; that the rental period may be up to fifty years; and any foreign-invested company having difficulty in making a lump-sum payment of the purchase price may postpone the payment or make it in installments. Article 14 of EMFEI states that foreign educational institutions may be provided with financial support from the state or local government in accordance with mutatis mutandis application of Article 14 of FIPA.
Like the foreign educational institutions under EMFEI, foreign research institutions can establish a branch office under the provisions of Article 50 of the Civil Act and the Korea Supreme Court’s ruling regarding branch offices of a foreign non–profit organisation.
This arrangement has an advantage over registration as a foreign-invested company under FIPA in that the establishment of a branch office is far less complicated and there is no requirement for the foreigner to contribute or invest. As a further incentive, foreign-invested companies are also eligible for the exemption or reduction of corporate tax, income tax, acquisition tax, registration tax and property tax to carry on a business located in an FEZ pursuant to Article 2 of DMFEZ. Further tax exemptions or reductions may be available if the company carries out its business and undertakes it as an FEZ development project.
While FEZAs are open and willing to promote foreign investment in the FEZs by providing incentives for foreign-invested companies in areas such as development and land supply agreements, they are also acutely aware of the need to reinforce their right to terminate in instances of material breach such as the developer failing to maintain its foreign-invested company status. Foreign research institutions have the added benefit of being able to bypass the complicated registration process by establishing a branch office under EMFEI.
These special laws aim to correspond with the management and designation of FEZ and will help enhance Korea’s status as one of the primary financial and logistics hubs of Asia.
By Jong Baek Park; Hyeyoung Kim; and Kent Wong