Special Tax Reductions for Small and Medium-Sized Enterprises: Key Requirements and Practical Considerations

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The SME Special Tax Reduction is a key tax support system that alleviates the tax burden on SMEs that meet certain requirements, thereby fostering their growth. While this system can easily generate tax savings if the requirements are met, misunderstanding the requirements or failing to properly manage them poses the risk of surcharges and additional taxes. This column will comprehensively summarize the basic requirements for applying the SME Special Tax Reduction, the reduction rate, and practical considerations.

1. Basic requirements

To qualify for the special tax reduction for small and medium-sized enterprises, a company must meet both of the following requirements:

1) Small and medium-sized enterprise requirements
(1) Sales standard: Sales by industry must not exceed the standard amount (e.g., wholesale and retail sales: KRW 120 billion or less).
(2) Independence criteria: There must be substantial management independence (e.g., companies controlled by large corporations are excluded).
(3) Industry criteria: Not to be engaged in consumer service business as its main business.
(4) Based on total assets: Total assets must be less than KRW 500 billion

2) Industries eligible for tax reduction
The tax reduction applies only to the industries listed in Article 7 of the Special Tax Exceptions and Restrictions Act. Examples of key industries eligible for the tax reduction are as follows:
Examples: manufacturing, construction, wholesale and retail trade, passenger transport among transportation industries, publishing, telecommunications, computer programming, system integration and management, advertising, etc.

Additionally, under the Special Tax Exceptions and Limitations Act, if all of the following requirements are met, it is considered manufacturing even if no direct production is performed. Therefore, domestic production OEM contract manufacturing is eligible for tax reduction.

(1) Take the lead in planning, designing, and producing samples of products to be produced.
(2) Manufacture (consign) products under one's own name.
(3) Purchase the product and sell it directly under your own responsibility.
(4) The factory requesting the manufacturing must be located in Korea or in the Kaesong Industrial Complex.

2. Discount rate

The discount rate varies from 10% to a maximum of 30% depending on the company's location, industry, and size.

3. Notes

1) Overseas OEM
OEMs produced in overseas factories are not considered manufacturing under the Special Tax Treatment and Limitation Act, so they are considered wholesalers and may be subject to a lower tax reduction rate, or in the case of medium-sized businesses in the metropolitan area, the reduction may not be possible at all.

2) Business relocation
Since the reduction rate and applicability will differ when moving from outside the metropolitan area to the metropolitan area or vice versa, the reduction must be re-examined based on the location of the head office or main office as of the end of the tax year.

3) Exceeding sales volume
In practice, there are frequent cases where the deduction continues to be applied out of inertia even after the small business sales standard has been exceeded. However, it is important to note that the deduction is not applicable after the standard is exceeded.

4) Insufficient income classification by business location
Even when operating a manufacturing/wholesale/retail business or a single business, if you do not distinguish between income eligible for tax reduction, you may incorrectly receive tax reduction, so it is essential to manage your profits and losses by distinction.

5) Reduction limits and personnel reduction regulations
The basic tax reduction limit is 100 million won per year, but if the number of regular employees decreases, 5 million won is deducted for each reduced employee. Therefore, the tax reduction effect must also be considered when restructuring personnel.

4. Conclusion

The SME Special Tax Reduction is a system that can yield significant tax savings if properly understood and applied. However, misjudgement of the actual industry classification, OEM structure, and whether the company exceeds the location and size requirements can lead to tax risks that can last for years. Therefore, when significant changes occur, such as industry changes, sales surges, or business relocations, the safest approach is to consult with an expert to determine whether the reduction is applicable in advance.

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