Limited Companies in Korea: Key Changes and Strategic Options

On January 16, 2018, the Financial Services Commission of Korea (“FSC”) released its interim report (“Report”) regarding the upcoming accounting reform in Korea. The Report has hinted some of the detail government regulations that will follow from the National Assembly’s recent passage of an amendment bill to overhaul the Act on External Audit of Stock Companies (“AEASC”). This article explains some of the new requirements under the amended AEASC applicable to certain Limited Companies (Yuhan Hoesa) and explores several strategic options that may be considered by the Limited Companies.

Amendment of the AEASC

The amendment of the AEASC last October was in response to the recent cases of large-scale accounting fraud scandals in Korea. Also, the government had to react on the public criticism that many foreign-invested companies are set up as a Limited Company?in order to allegedly avoid the disclosure requirement of financial statements under the AEASC, thereby making it difficult for the taxing authority to access to such Limited Companies’ financial information necessary to investigate and impose taxes.

The title of the AEASC has been changed to the Act on External Audit of Stock Companies and Others (“AEASCO”), and starting from November 1, 2018, the AEASCO will extend to certain Limited Companies the requirements of (i) financial audit by an external auditor and (ii) public disclosure of audited financial statements. The government is expected to produce an initial draft amendment of the Enforcement Decree to the AEASCO (“ED-AEASCO”) by the end of March 2018 in order to provide detailed guidance on such requirements under the AEASCO.

Requirement of External Audit

Certain Limited Companies will be required to have their financial statements audited by an independent external auditor (“External Auditor”) for the fiscal years beginning on and after November 1, 2018. The AEASCO provides the following criteria to assess whether a Limited Company will be subject to the external audit requirement: (i) the amount of its assets/liabilities/revenues, (ii) the number of its employees/members, and (iii) the period after reorganization as a Limited Company. The numerical thresholds for the criteria, however, will be set forth in the ED-AEASCO.

In the meantime, the Report makes it clear that the same thresholds will be applied to both Limited Companies and non-listed Stock Companies (Chushik Hoesa). As such, the following current thresholds for the requirement of external audit applicable to non-listed Stock Companies will likely be used for Limited Companies as well:

• 12 billion KRW (appx. US$12M) or more of assets at the end of the preceding fiscal year;
• 7 billion KRW (appx. US$7M) or more of each liabilities and assets at the end of the preceding fiscal year; or
• 7 billion KRW (appx. US$7M) or more of assets and 300 or more employees at the end of the preceding fiscal year.

In addition to the criteria as explained above, a new “revenue” criterion has been added under the AEASCO. According to the Report, the threshold for the new revenues criterion will be determined in consideration of those used in advanced countries. The Report provides the case of the United Kingdom, indicating 10.2 million GBP as the maximum threshold for exemption from external audit requirement. As such, it is being speculated that the government may use the equivalent 15 billion KRW as the minimum threshold for the revenue-based criterion.

In that case, those Limited Companies and non-listed Stock Companies with annual revenues of 15 billion KRW (appx. US$15M) or more will be subject to the external audit requirement even if they do not meet any one of the existing criteria as discussed above. At the same time, the government has suggested that those with less than 15 billion KRW revenues may not be subject to the external audit requirement even if they meet any one of the existing criteria above.

Appointment of External Auditor

Those Limited Companies subject to the external audit requirement (“Subject LC”) must appoint an External Auditor within 45 days from the start of each fiscal year (or within 4 months if no financial audit was performed in the preceding fiscal year). For the purpose of the AEASCO, an External Auditor is defined as either an accounting firm registered with the FSC or an audit team of three or more Certified Public Accountants (“CPAs”) registered with the Korean Institute of Certified Public Accountants (“KICPA”).

An External Auditor may be selected by the Subject LC’s statutory auditor or audit committee; however, if the Subject LC has no statutory auditor or audit committee, an External Auditor may be selected by an approval of the general meeting of members in case the size of the company exceeds certain amount to be prescribed in the ED-AEASCO. The Subject LC may reappoint the same External Auditor from the preceding fiscal year.

Preparation and Submission of Financial Statements

The AEASCO provides that it is the responsibility of both representative director and accounting executive of the Subject LC (in the absence of accounting executive, an employee who carries out accounting function) to prepare its financial statements for relevant fiscal years. In this connection, the Subject LC is prohibited from asking its External Auditor or any CPA associated with the External Auditor to prepare the Subject LC’s financial statements.

The Subject LC must submit its financial statements and, if applicable, consolidated financial statements to its External Auditor within the timeframe to be provided in the ED-AEASCO (currently, it is, for financial statements, six weeks before the company’s general meeting of members; and it is, for consolidated financial statements, four weeks before the company’s general meeting of members in case K-IFRS is used, or within 90 days of the end of fiscal year in case K-IFRS is not used).

Public Disclosure of Financial Statements

Pursuant to the AEASCO, an External Auditor will be required to submit its auditor’s report to its client Subject LC, the Securities and Futures Commission (“SFC”), and the KICPA. The SFC and the KICPA, in response, must then make the auditor’s report available to the public for the duration and in the manner to be prescribed in the ED-AEASCO.

The Subject LC will be also required to keep and publicly disclose its audited financial statements along with the relevant auditor’s report in the manner to be prescribed in the ED-AEASCO. The government has clarified in this respect that a single standard will be applied to both non-listed Sock Companies and Limited Companies when it comes to the scope of the public disclosure/availability.

Options for Consideration

First of all, the Subject LC is encouraged to participate in the legislative process of the ED-AEASCO. Since the government is planning to come up with an initial amendment draft of the ED-AEASCO by the end of March 2018, there is still sufficient time for the Subject LC to have their voice heard before the initial draft becomes available as well as thereafter.

The Subject LC may also consider converting its legal form to either Stock Company or Limited Liability Company (Yuhan Chegim Hoesa). The name Limited Company not only carries a rather negative connotation due to many years of bad publicity in connection with alleged tax evasion by foreign-invested Limited Companies, but also does not give the status of a larger and more reliable company than the Stock Company does when such status is important for business and marketing purposes. For the smaller Subject LC, another form of entity may be also considered as an alternative, such as Limited Liability Company which does not require external audit and public disclosure of financial statements.

Those who decide not to take any action at this time will still have to keep up with the new rules by proactively educating internal resources from top management to employees in accounting and financial functions.