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Jipyong News|KOREA LEGAL INSIGHT

Sunset Period on PFV Tax Benefits Set to Expire

2021.10.05

The sunset period for one of the most attractive tax benefits enjoyed by project finance vehicles (PFVs) will expire at the end of 2022.  With no announcement of extension or alternative taxation regime yet in sight, project development investors and insiders should keep on the lookout for changes. 
 
For now, Article 104-31(1) of the Restriction of Special Taxation Act (effective as of January 1, 2020) permits PFVs to deduct dividend payments exceeding 90% or more of their distributable profits from their taxable income until the fiscal year ending on December 31, 2022 (the “Deductions”). 
 
Further, (i) under Article 180-2(1)3 of the Restriction of Special Local Taxation Act, real estate acquisitions made through PFVs prior to December 31, 2021 will not be subject to higher real estate acquisition taxes even if the acquired property is located within an area designated for overpopulation control and (ii) under 180-2(2)5 of the Restriction of Special Local Taxation Act, PFVs incorporated prior to December 31, 2021 will not be subject to higher registration and licensing taxes. 
 
These tax benefits are some of the reasons PFVs are still being actively used by investors for their major development projects.  Other reasons include the fact that PFVs are not subject to the borrowing restrictions or lengthy approval processes applicable to other popular pass-through entities used in major development projects such as hedge funds established under the Financial Investment Services and Capital Markets Act (the “FSCMA”) and real estate investment trusts (REITS) established under the Real Estate Investment Company Act (the “REICA”). 
 
PFVs, hedge funds and REITs are preferred by investors in major development projects involving multiple stakeholders as these entities are scrutinized under established legal and regulatory schemes and utilize third parties including asset managers and trustees to operate and/or manage the assets and have financial institutions participating as promoters. 
 
However, hedge funds are subject to borrowing restrictions under Article 249-7(1) of the FSCMA and Article 271-10(1) of the Enforcement Decree of the FSCMA, which forbid them to borrow in excess of 400% of the differential between their total assets and total liabilities.  As for REITs, the approval process is often prolonged and Article 29(2) of the REICA also prohibits the incurrence of financial indebtedness or issuance of bonds exceeding 2 or 10 times the REIT’s equity capital. 
 
PFVs, however, are not subject to the above borrowing restrictions or lengthy approval processes, which makes them more attractive for major projects that require loans far exceeding their equity capital, and such loans are being made readily available in the current liquid market (as we have been witnessing these days).  And it goes without saying that investors would be reluctant to opt for any kind of pass-through entity that requires more time for any reason, given the fast-paced nature of development projects and need for quick decision-making. 
 
For that reason, the appetite for utilizing PFVs for development projects has not dissipated despite uncertainties that may follow the lapse of the sunset period.  The thinking is that the sunset period would and should be extended, given that (i) PFVs are being utilized in many major development projects (including projects being developed with local governments) and (ii) their expected profits would be significantly impaired if the sunset period is left to expire, due to the time it takes before sufficient distributable profits (to which the Deductions may apply) are generated. 
 
If the sunset period is not extended, the incentive disappears for existing PFVs to comply with the legal requirements asked of them, and PFVs will cease to be considered as reliable pass-through entities for development projects in the existing market (albeit an undertaking or an agreement between the parties to maintain and comply with a substantially similar form to the existing PFV requirements may be used to maintain viability ).  Accordingly, there will be significant impact on development projects involving existing and soon to be incorporated PFVs if the sunset period is permitted to lapse without any sound alternative being offered. 
 
Parties to development projects are thus advised to be on the lookout for an upcoming decision with respect to the extension (or not) of the sunset period applicable to the Deductions.

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