|A. Adjustment of a Transfer Price Based on an Arm's Length Price
“The Transfer Price” is the price applied to an international transaction in which either party to the transaction is a foreign related party. Adjustment of International Taxes Act(AITA) and Presidential Decree of AITA provide with the matters with respect to Transfer Price. “Foreign related party” means any nonresident or foreign corporation in a special relationship with a resident, domestic corporation or domestic place of business.
|(1) Special Relationship|
(a) A relationship in which either party to a transaction owns directly or indirectly at least 50 percent of the voting stocks (including the equity shares; hereinafter the same shall apply) of the other party;
(b) A relationship between both parties to a transaction where a third party owns directly or indirectly at least 50 percent of their respective voting stocks;
(c) A relationship in which the parties to a transaction have a common interest through an investment in capital, trade in goods or services, grant of a loan, etc. and either party to the transaction has the power to substantially determine the business policy of the other party;
(d) A relationship between both parties to a transaction where the parties have a common interest through an investment in capital, trade in goods or services, grant of a loan, etc. and a third party has the power to substantially determine the business policies of both parties;
|(2) Computation of Indirect Ownership|
|If company A owns a 50% stake or more in company B, and B owns a certain percentage of shares in a third company C, B's equity ratio in C would constitute the ratio of equity which A indirectly owns in C. If company A owns less than a 50% stake of company B, and B owns a certain percentage of shares in a third company C, then A is considered to own C to the extent of the ratio computed by multiplying A's equity ratio in B by B's equity ratio in C.
The tax authority may determine or rectify the tax base and tax amount of a resident based on the arm’s length price(hereafter “ALP”) where the transfer price is lower or higher than ALP.
|B. Methods of computing ALP
The ALP is a price that is established or that can be expected to be established in a normal transaction between independent enterprises without a "special relationship."
The AITA lists the following methods for determining an ALP based on profits arising from controlled transactions: comparable uncontrolled price(CUP) method, resale price method, cost plus method. profit-split method, transactional net margin method(TNMM) and other methods recognized as appropriate.
1.Comparable uncontrolled price method: A method that, in an international transaction between a resident and a foreign related party, regards as the arm’s length price, a trade price between independent unrelated parties in comparable transactions.
2.Resale price method: Where a resident and a foreign related party trade in an asset and the purchaser of the asset, being a party to such transaction, subsequently resells it to an unrelated party, a method that regards as the arm’s length price, the amount computed by deducting the amount considered as the normal profit of the purchaser from the resale price.
3.Cost plus method: A method that, in an international transaction between a resident and a foreign related party, regards as the arm’s length price, the price computed by adding the amount considered as the normal profit of the seller of an asset or the provider of services to the cost incurred in the course of producing and selling the asset or of providing the services.
4.Profit split method: A method that, in an international transaction between a resident and a foreign related party, allocates a net trading profit created by both parties to the transaction according to each such party’s relative contribution, which is measured with a reasonable allocation standard, and regards the trade price computed from such allocated profit as the arm’s length price.
5.Transactional net margin method: A method that, in an international transaction between a resident and a foreign related party, regards as the arm’s length price, a trade price calculated on the basis of an ordinary transactional net margin realized in comparable transactions between a resident and a unrelated party.
|C. Selection of Method for Determining ALP
When computing the ALP in relation to an international transaction, the most reasonable method shall be selected by taking into account the following standards:
1.High comparability shall exist the international transactions among the related parties and the transactions among the unrelated parties. In such cases, "high comparability" means any of the following cases.
(a) Where a difference in the compared circumstances has no serious effect upon the comparative trade price or net trading profit.
(b) Even where the difference in the comparative circumstances has a serious effect upon the compared trade price or net trading profit, a reasonable adjustment, capable of resolving a difference due to the relevant effect, is possible.
2.It shall be highly likely to secure and use the data to be used.
3.The level of realism shall be high for an assumption on the economic conditions, business environment, etc. established in order to compare the international transactions among the related parties with the transactions among the unrelated parties.
4.Errors in the data to be used or in the established assumption shall have little effect on the calculated arm's length price.
5.Conformity between the transactions between related parties and the method of computing the arm's length price shall be high.
|In assessing whether high comparability exists, matters which may affect prices or profits, such as types and features of goods or services, functions of business activities, risks accompanying transactions, assets to be used, contractual terms and conditions, economic situations, and business strategies, shall be analyzed.
In assessing whether high comparability exists, matters which may affect prices or profits, such as types and features of goods or services, functions of business activities, risks accompanying transactions, assets to be used, contractual terms and conditions, economic situations, and business strategies, shall be analyzed.
|D. Secondary Adjustment
If it is not verified the fact that a foreign related party has returned the amount to be included in gains to a domestic corporation within 90 days after the tax authority increases the taxable income of the Korean company by adjusting the transfer price between a Korean company and its foreign related party based upon an ALP, such amount shall be adjusted as a dividend to or an investment in the foreign related party. The amount of which the return has not been verified shall be disposed of or adjusted in accordance with any of the following methods:
1.If the foreign related party, who is the other party to an international transaction, is one of stockholders of the relevant domestic corporation, it shall be treated as a dividend vested in the foreign related party.
2.If the foreign related party, who is the other party to an international transaction, is a corporation in which the relevant domestic corporation invests, it shall be treated as an increased investment in the foreign related party.
3.If the foreign related party, who is the other party to an international transaction, is a person exempt from subparagraphs 1 and 2, it shall be treated as a dividend vested in the foreign related party.
|E. Corresponding Adjustment
Where any other Contracting State adjusts a transaction price between a resident and a foreign related party at the arm’s length price and the mutual agreement procedure(hereafter “MAP”) thereon are completed, the tax authority may adjust and calculate the amount of income and the assessed amount of tax of the resident for each taxable year pursuant to the relevant agreement. A resident who intends to have his/her amount of income and final amount of tax adjusted shall file a revised return or a request for rectification, together with the notice of the conclusion of MAP within three months from the date of receiving a notification with respect to MAP closing.
|F. Sanctions against Non-Compliance with Obligation to Submit Data
The tax authority may request a taxpayer to submit related data, such as the method of computing transaction prices. If a taxpayer fails to submit data by the deadline without any justification or submits false data shall be subject to an administrative fine not exceeding 100 million won. The tax authorities may request the following data from a taxpayer:
1.Various relevant contract documents concerning the transfer, purchase, etc. of assets
2.Price list of products
3.Statement of manufacturing costs
4.Schedule of transaction by item, in which related and unrelated parties are separately assorted
5.Documents corresponding to subparagraphs 1 through 4, in the case of supply of services or other transactions
6.Organizational chart of a corporation and a table of assignment of office duties
7.Data for determining international trade prices
8.Internal guidelines for pricing applicable to transactions among the related transactions
9.Accounting standards and methods relating to the relevant transactions
10.Details of business activities of the parties involved in the relevant transactions
11.Current status of mutual investments with related parties
12.Forms or items omitted when filing returns on the corporate tax and income tax
13.Data with which it is possible to grasp the details of transactions intra-group services under Article 6-2, as specified by Ordinance of the Ministry of Economy and Finance
14.Data specified further by Ordinance of the Ministry of Economy and Finance, including an agreement on cost sharing, in connection with the tax adjustment by arm's length cost sharing under Article 6-2 of the AITA
15.Other data necessary for computing appropriate prices
|G. The Advance Pricing Arrangement(APA) Program
The APA is an agreement made between a taxpayer and a tax authority on an appropriate transfer pricing methodology(TPM) and an ALP range for that taxpayer’s future international transactions with its foreign related parties. The APA program has been started with the introduction of the AITA in 1997 to help multinational companies eliminate the risk of double taxation arising from transfer pricing audits.
The APA procedure is initiated at the taxpayer’s request and finalized through the approval by the Commissioner of the National Tax Service of Korea(NTS). The taxpayer’s transfer price is accepted as ALP during the APA-covered period as long as the taxpayer complies with the terms and conditions set out in the APA.
The APA can be concluded either bilaterally or unilaterally. Bilateral APAs(BAPAs) involve an engagement with the Competent Authority(CA) of a treaty partner, whereas unilateral APAs(UAPAs) are concluded directly with the taxpayer. BAPAs are desirable for a complete elimination of double taxation, but do tend to take longer to conclude as they involve the process of reaching an agreement with the other CA. The APA is an agreement pertaining to the transfer pricing of future intercompany transactions, but taxpayers may also request for the APA results to be rolled back to past years.
* For more information, please refer to “APA Annual Report”
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