The Korean transfer pricing (TP) regulatory regime is set out in the Law for the Coordination of International Tax Affairs (LCITA), and the enforcement and interpretative regulations, namely the Presidential Enforcement Decree of the LCITA and the Ordinance of the Ministry of Economy and Finance of the LCITA.
In addition to the TP legislation, the commissioner of the National Tax Service (NTS) may issue administrative orders and rulings to ensure consistent application of the laws. These do not constitute binding authority in South Korea. Instead, the courts have final authority in interpreting the tax laws, including those governing the TP regulatory regime.
Since its inception in 1990, the Korean TP regime under the LCITA has undergone continuous developments, keeping pace with similar developments that took place in other OECD countries. Broadly, there were four major milestones, which are as follows.
The Origins of the Korean TP Regulatory Regime
The need for a TP regulatory regime first emerged amidst the backdrop of South Korea’s rapid economic growth in the 1980s, and the ensuing increase in the volume of cross-border transactions by multinational businesses. In these conditions, the need for a TP regulatory regime to govern cross-border transactions between related parties emerged, and the first TP regulation was introduced in 1988.
Initially this TP regulation was contained within a provision of the Presidential Enforcement Decree of the CITA, under an article relating to the denial of unfair transactions. This particular article regulated unfair transactions among related parties (at that time, applicable to both domestic and cross-border related-party transactions). Subsequently, the TP regulatory regime was made more robust when in 1990 the Ministry of Economy and Finance (MOEF) and the NTS introduced specific standalone TP rules and regulations, to assist with interpretation of the aforementioned CITA provision.
The Emergence of a Separate Statute Regulating TP and International Taxation
In the 1990s, there were significant changes to the US TP regime – ie, Section 482 and the accompanying regulations thereof – as well as to the OECD TP Guidelines (the “OECD Guidelines”). To align South Korea’s tax law and practices with international norms in anticipation of joining the OECD, the LCITA, a separate statute governing TP and international taxation, was newly introduced in January 1996. The then-existing TP regulations under the CITA were relocated to the LCITA to reflect these international changes, with the LCITA and its regulations adopting the main contents of the OECD Guidelines.
The Korean TP Regime Overhauled
In the 2000s, cross-border transactions of multinationals became increasingly complex, and it became apparent that South Korea's TP regime lacked the sophistication and detail to keep pace with modern developments. As a result, disputes between taxpayers and tax authorities increased significantly during this period. To tackle this issue, the Korean government completely overhauled the TP regime in 2010. The new regime gave the NTS the right to adjust income and tax liability per the arm's-length principle, abolished the preferential application of the traditional transaction method, and introduced more sophisticated TP methods that entailed features such as integrated analysis and multi-year analysis of related transactions.
BEPS Actions 8–10 and 13 Codified into the Korean TP Regime
With the emergence of the OECD’s base erosion and profit shifting (BEPS) project in 2015, the government codified the contents of BEPS Actions 8–10 and 13, as well as the new OECD Guidelines published in July 2017, into the Korean TP regime. Consequently, new taxpayer reporting obligations were introduced into the LCITA, including preparing and submitting a “local file” and “master file”. In addition, country-by-country (CbC) reporting was newly introduced, the concept and scope of intangible assets was refined, and the arm’s-length principle was further refined.
Out of this historical background, the modern Korean TP regime has emerged as one that is highly synchronised with the OECD Guidelines.
The Definition of “Related Party” under the LCITA
The basic test of whether the parties to a transaction are related is based on percentage of ownership, as follows:
De facto control test
In addition, a related-party relationship also exists when one party to a transaction has de facto control over the other party in respect of the transaction being tested. Such control is deemed to exist if one of the following criteria is satisfied:
When assessing whether one party has the power to substantially determine the business policy of the other, the amount of borrowings, the level of dependency of one party on the other, the control of the board and management, and other similar factors should be considered under a general facts and circumstances analysis.
Article 8 of the LCITA lists six methods of calculating the arm's-length price, as follows:
The last category in 3.1 Transfer Pricing Methods, “other reasonable methods”, should be applied only when any of the first five TP methods cannot reasonably be applied to derive an arm’s-length price. In this situation, other reasonable methods can be considered if their application can be deemed reasonable in light of the customary practice and the substance of the transaction in question.
CUP, RPM and CPM are categorised as “Traditional Transaction Methods”. By contrast, PSM and TNMM are categorised as “Transactional Profit Methods”. Previously, the Traditional Transaction Methods were applied first, taking priority over the Transactional Profit Methods.
However, the LCITA was revised at the end of 2010, abolishing this prioritisation, and since that time taxpayers have been free to select the most reasonable method amongst the five TP methods available.
However, as described above, “other reasonable methods” can be applied only when none of the five specified TP methods can be reasonably applied. So in that limited respect only, there is a limited hierarchy of methods.
It is possible for either the NTS or taxpayers to adjust the tax base based on the arm's-length range, where the price applied to the cross-border related-party transaction is lower or higher than the arm’s-length price. More specifically, the NTS cites the concept of “interquartile range” as an example of a reasonable method of calculating the arm’s-length range.
Comparability Adjustments per the LCITA
When calculating the arm's-length price, if there is some factor that makes it difficult to compare directly between the related-party transaction and comparable third-party transactions, an adjustment can be made to take this factor into account. Such factors include:
Risk Analysis Framework from the OECD Guidelines
In addition, it is noteworthy that the risk analysis framework described in Chapter 1 of the most recent OECD Guidelines (released in July 2017) was codified into the LCITA in 2019. The purpose of this framework is to accurately delineate a controlled transaction. By incorporating this into Korean domestic law, taxpayers now have more practical and detailed guidance on the comparability adjustments.
Definition of Intangibles in the Context of TP and Applicable TP Methods
The LCITA and its accompanying regulations provide a definition and examples of intangible assets, as well as stipulating factors to be considered when executing transactions involving intangibles with foreign related parties. CUP and PSM are given priority as the most appropriate TP methods of calculating the arm's-length price for such transactions. If these priority methods are difficult to apply, other reasonable methods, such as the “discounted cash flows” method, can be used.
The Concept of Economic Ownership
When calculating the arm's-length price for a transaction involving intangible assets between a resident taxpayer and foreign related parties, regardless of who legally owns the intangible assets, the allocation of excess profits created from the intangibles should be commensurate with the respective value contribution and the level of DEMPE (development, enhancement, maintenance, protection and exploitation) performed by each entity in the value chain. The focus is on the practical use and maintenance of the intangible asset; ie, economic ownership rather than legal ownership. This is consistent with the OECD Guidelines.
Classification of Hard-to-Value Intangibles (HTVI)
Intangible assets that satisfy all of the following requirements are classified as HTVI:
Ex Post Outcomes: Presumptive Evidence
In situations involving the transfer of HTVI or rights in HTVI, an outcome where the actual price exceeds 120% of the price agreed upon by related parties prior to the transaction can create a rebuttable presumption. Specifically, the NTS will be entitled to presume and able to claim that the price agreed in advance did not appropriately take into account reasonably foreseeable developments. Therefore, the presumption will be that the transfer price is unreliable.
Taxpayers can rebut this presumption by producing evidence showing that:
A cost contribution arrangement (CCA) regime was initially codified into the LCITA in 2006, and since then, there have been several revisions to the provision.
The NTS’s Authority to Re-determine the Arm’s-Length Deduction
The NTS has the authority to re-determine the tax base and tax liability of a resident company if:
The NTS will then adjust the resident’s share of the costs, based on the arm’s-length principle.
The NTS is especially likely to wield this authority if there is more than a 20% difference between the benefit that is expected (i) at the time of executing a CCA agreement and (ii) after the joint development.
Methods of Measuring the Expected Benefit
The expected benefit can be calculated by considering one of the following as a proxy for the benefit received.
NTS’s Viewpoint on the CCA
Notwithstanding the enactment of the CCA regime in the LCITA, in practice the tax auditors have often challenged the validity of the CCA and typically deemed the payments made under the CCA as royalties to assess withholding taxes in South Korea. As intangible and the CCA-related provisions have been supplemented during the last several years, it is expected that the NTS will acknowledge the existence and the importance of intangibles and shift its view and perception to better recognise the CCA in practice as well.
Taxpayer’s Right to Make an Affirmative TP Adjustment
Taxpayers can make “self-initiated” TP adjustments, both downward and upward, provided there is a legitimate reason for doing so; eg, if there has been a deviation from an arm’s-length price. One noteworthy point is that this particular taxpayer right was previously contained in the LCITA’s accompanying regulations, but in 2019 was moved into the LCITA, demonstrating the importance of this taxpayer right.
Circumstances that Warrant an Affirmative TP Adjustment
Taxpayers can make this type of adjustment by filing an amended return, if the actual transaction price applied is lower or higher than the arm’s-length price in a cross-border related-party transaction. The deadline for the adjustment, which is consistent with the statute of limitations, is five years for a downward adjustment and seven years for an upward adjustment.
Another circumstance in which the adjustment can be made is when a mutual agreement procedure (MAP) or advance pricing agreement (APA) has been concluded. In this case, an adjustment can be made to harmonise the reported tax base and liability with the MAP or APA; such an adjustment should be made by filing a return within three months of the notice of conclusion of the MAP or APA.
As of January 2021, South Korea has signed 94 tax treaties and 12 “tax information exchange agreements”. South Korea is also one of 141 signatories to the Convention on Mutual Administrative Assistance in Tax Matters.
More TP-specific information exchange with other taxing authorities is facilitated by the Multilateral Competent Authority Agreement, which allows signatories to exchange CbC reporting. South Korea is one of 89 signatories, and it has also separately signed a CbC reporting exchange agreement with the USA, based on the existing tax information sharing agreement with the USA.
History of Korean APA Programme
South Korea launched its APA programme in 1995, and its first APA case was concluded with the USA in May 1997. Ever since then, of 726 APA applications (both unilateral and bilateral), 508 cases have been concluded. As is apparent from these statistics, the South Korean APA programme has been very active since its inception, and it is expected that the demand for APAs will gradually increase, as many South Korean companies set up their manufacturing and distribution entities in other parts of the world.
Types of APA
Korean taxpayers can apply for either a unilateral or bilateral APA, depending on the objective of the taxpayers.
Simplified APA for Foreign Invested Companies in Korea
One notable aspect of the Korean APA programme is that the NTS launched a simplified APA for small and medium-sized foreign invested companies in Korea in 2015. This programme was launched in order to reduce the burdens of small and medium-sized foreign invested companies in terms of uncertainties surrounding TP and tax audit. The revenue threshold to qualify as a small and medium-sized foreign invested company is set at KRW50 billion and the programme is applicable only to unilateral APAs. The simplified APA will be processed within one year and once a simplified APA is approved, foreign invested companies can secure TP certainty for the three to five-year period that the APA covers.
Taxpayers can file an APA application to the APA/MAP team, which sits within the International Taxation Bureau of the NTS head office. After filing and completion of negotiation with the counterparty, the commissioner of the NTS has final authority to approve APAs.
As with many other countries, APA and MAP cases are assigned to sub-units within the APA/MAP team of the NTS, based on the counterparty’s jurisdiction. Usually, one sub-unit is responsible for a few different jurisdictions in relation to both APAs and MAPs.
Since APA and MAP cases are assigned within the APA/MAP team based on the country of the counterparty, APAs and MAPs can sometimes be reviewed together, and merged cases tend to result in a speedier process, due to the overlapping circumstances.
Even though in theory there is no law requiring NTS officials on APAs and MAPs to co-operate, in practice there is definitely co-ordination between the NTS teams working on APAs and MAPs.
Technically, there is no limit on which taxpayers or transactions are eligible for an APA, so long as the taxpayer in question is either a Korean legal entity or a branch/permanent establishment of a foreign corporation.
In practice, however, only taxpayers with a material amount of cross-border related-party transactions find APAs useful, in light of the potential tax exposure that could arise from TP-based assessment. There is no rule of thumb as to what constitutes a “material amount”, as there can be substantial variation, depending on the industry and individual companies.
A taxpayer may file an application for an APA to the NTS at any point up to the day before the commencement of the first year of the proposed covered period. For example, if a taxpayer applies for a five-year APA to run from 1 January 2022 to 31 December 2026, then the application must be filed by 31 December 2021.
There is no user fee that a taxpayer is required to pay to the NTS in connection with an APA application.
There is no statutory or other legal limit as to how many prospective years an APA can cover, but in practice, taxpayers generally propose a five-year coverage in their application.
Taxpayers can request in their APA application that their APA takes retroactive effect.
In the case of APA applications filed before 1 January 2021, a rollback provision could allow the APA to cover a period of up to five years immediately preceding the covered period, whereas for a unilateral APA, the limit for a rollback is up to three years.
For APA applications filed after 1 January 2021, a rollback provision for a bilateral APA could allow the APA to cover a period of up to seven years immediately preceding the covered period under the APA, whereas for a unilateral APA, the limit for a rollback is up to five years.
APA and Suspension of Tax Audit
In general, a tax audit is not suspended merely by virtue of the taxpayer under audit filing an APA application. The NTS head office, however, may suspend its audit on transactions during the APA-covered period if the taxpayer appropriately filed an APA on the transactions at issue before receiving pre-notice of a tax audit.
There are three main types of TP-related information that the NTS is entitled to request for submission.
A taxpayer who conducts international transactions with foreign related parties must submit the following information within six months from the end of each fiscal year:
If any part of the international transaction statement is not submitted or is false, a fine of KRW5 million will be imposed on each foreign related party with which the Korean taxpayer had a transaction during the year.
The Combined Report of International Transactions (CRIT)
If a taxpayer is required to submit the CRIT (the threshold is explained in 8.2 Taxpayer Obligations under the OECD Transfer Pricing Guidelines), consisting of a master file, local file and CbC report, the submission must be made within 12 months from the end of each fiscal year. If all or part of the report is not submitted or is false, a fine of KRW30 million is imposed for each report. Additionally, for non-compliant taxpayers, the NTS may request submission of missing reports with a 30-day notice and the failure to comply within such timeframe can trigger interest to start accruing, which could add up to KRW200 million.
Request for the Submission of a TP Report during a Tax Audit and Contemporaneous TP Documentation
The NTS may request certain information relating to the basis of the arm’s-length price calculation for TP purposes – ie, TP documentation – when a taxpayer is audited. If so, the taxpayer must submit it within 60 days of the request. If any part of the requested data is not submitted or is false, a fine of KRW30–70 million may be imposed depending on the level of non-submission. As with the CRIT, the NTS could request to submit missing reports with a 30-day notice, where the failure to comply within such timeframe will trigger the interest to start accruing, which could add up to KRW200 million.
If the NTS recognises that TP documentation is completed and maintained contemporaneously with a corporate tax return, and if the NTS also considers that the TP method has been carefully selected and applied in a reasonable manner, a taxpayer can receive a 10% under-reporting penalty exemption, if at some point that taxpayer is audited and additional tax is assessed based on TP. When contemporaneous TP documentation is requested by the NTS, a taxpayer must submit it within 30 days.
In order to avoid penalties arising from the NTS’s request for TP-related information, it is very important to comply with the submission deadline, and it is essential to include a reasonable explanation of the TP method applied by the taxpayer. This explanation should be supported by documentation and corroborating data. Moreover, the format of the TP documentation, and database used for benchmarking, should be in line with local practice and the NTS’s expectations, to ensure that it is considered to be substantial and persuasive.
Taxpayers with sales of KRW100 billion or more and KRW50 billion or more in cross-border transactions with their related parties in a given year are required to submit a master file and a local file. As for the CbC report, foreign parent companies with sales of KRW1 trillion on a consolidated basis in the immediately preceding year should submit a CbC report, provided that:
The CRIT consisting of the local file, master file and CbC report should be submitted within 12 months from the end of each fiscal year.
Contemporaneous TP Documentation
For those taxpayers not subject to the CRIT, there is still merit in having TP documentation ready, as the NTS may request it in the course of a tax audit, and if so, it should be submitted within 60 days of the request. Besides, by virtue of preparing contemporaneous TP documentation, taxpayers could benefit from the 10% under-reporting penalty exemption in the event that additional tax is assessed based on TP considerations.
As an OECD member country, the South Korean TP regime is highly synchronised and well aligned with the OECD Guidelines. There may be some minor local tweaks but, by and large, most of the regime is identical to that contained in the OECD Guidelines. This is because the Korean legislature and MOEF closely monitor developments made at the OECD level and adopt them into the Korean TP regime in a timely manner. For example, the updated concepts introduced in BEPS Actions 8–10 and 13 and the ensuing OECD Guidelines released in July 2017 were promptly codified into the Korean TP regime.
The LCITA defines the arm's-length price as “the price that is to be applied or determined to be applied by a resident, a domestic corporation, or a permanent establishment in Korea in its ordinary cross-border transactions with third parties.”
Since the price applied in a related-party transaction is judged to be high or low based on the arm’s-length price, the Korean TP regime has duly adopted the arm's-length principle, and any deviation from this principle – eg, formulary apportionment – is not allowed under any circumstances.
The major impact of the OECD BEPS project on the Korean TP regime was that the obligation to submit the CRIT on cross-border related-party transaction information was stipulated, and the regulations on intangible assets were significantly supplemented. Moreover, due to the BEPS project, the risk analysis framework and a safe harbour provision for low value-adding intra-group services have been also adopted into the Korean TP regime.
If a Korean taxpayer’s sales and cross-border related-party transactions exceed certain thresholds, the taxpayer is required to submit the CRIT, which consists of a local file, master file and CbC report. For detailed thresholds, please refer to 8.2 Taxpayer Obligations under the OECD Transfer Pricing Guidelines.
Please refer to 4.1 Notables Rules and 4.2 Hard-to-Value Intangibles.
Risk Analysis Framework
Please refer to 3.5 Comparability Adjustments.
Low Value-Adding Intra-Group Services
As introduced in Chapter 7 of the OECD Guidelines, the safe harbour mark-up rate of 5% applicable to low value-adding intra-group services has been codified into Korean legislation, and taxpayers who meet a certain threshold requirement are allowed to apply it without having to conduct a separate benchmarking study. The threshold requirement is as follows:
If the cost plus the safe harbour rate of 5% exceeds the lesser of the following, then a taxpayer is not allowed to invoke and apply the safe harbour provision:
The definition of low value-adding services, and examples, are clearly set out in the legislation. Please refer to 11.1 Transfer Pricing Safe Harbours for further information on the low value-adding intra-group services.
In general, the Korean TP regime does not contain clear regulations that restrict the form of business operations to particular types of entity (such as “entrepreneur” and “limited-risk entity”). Nevertheless, it is very common practice to characterise an entity according to some conventional and widely accepted TP categories, such as “entrepreneur”, “entities performing and bearing routine functions and risks”, and “limited risk entities”.
When it comes to a limited risk entity, the NTS may accept a guaranteed return by its parent company, but ever since the OECD Guidelines’ risk analysis framework was adopted into the Korean TP regime, the NTS’s attention is more focused on the issue as to whether there is any discrepancy between the entity purported to be bearing economically significant risks – ie, the contractual arrangements – and the entity that is actually bearing those risks, as evidenced through its dealings and conduct; ie, substance.
As Korea's economy opened up rapidly in the 1990s, the need to participate in a wide range of international co-operation systems emerged. Accordingly, Korea joined the OECD in December 1996.
In July 1995, the OECD announced the TP Guidelines for multinational corporations and tax administrations, and at the end of 1995, when Korea was pursuing OECD membership, it proactively reflected the OECD Guidelines through domestic legislation. Subsequent revisions to the OECD Guidelines – ie, in 2010 and 2017 – have been duly reflected in the Korean TP regime.
As an OECD member country, Korea’s TP regime is based on the OECD Guidelines, and except in respect to the definition of related parties, Korea has generally not adopted the principles from the UN Practical Manual on TP.
There are two main types of transactions where TP safe harbour rules may apply:
Low Value-Adding Intra-Group Services
If an intercompany service transaction within a multinational group is of a supportive and “back office” nature, rather than relating to the core business activities of the taxpayer, then this is deemed to be a “low value-adding intra-group service”. In this case, a 5% mark-up can be applied, without the need to conduct a separate benchmarking analysis.
In order for an intra-group service to be deemed as a low value-adding service, a unique and valuable intangible asset should not be used or created, and the service provider should not bear, manage or control any significant risk in the course of rendering the service.
The legislation provides the following as examples of services that do not constitute low value-adding intra-group services:
Intercompany Loan Transactions
When a taxpayer conducts a financial transaction with a foreign related party, the arm’s-length interest rate can be calculated in two ways, as follows:
In the latter case, the regulation stipulates that the interest rate for an overdraft, which is 4.6%, is deemed as a safe harbour rate when a Korean taxpayer lends funds to its foreign related parties. Conversely, if a Korean taxpayer borrows funds from its foreign related parties, the 12-month US dollar LIBOR rate plus 150 basis points is deemed as a safe harbour rate.
Under the Korean TP regime, the concept of savings arising from operating in Korea is not specifically addressed. However, as Korea follows the OECD Guidelines, it would be difficult for either the NTS or taxpayers to argue for the existence of such savings, and it is highly likely that such savings could be seen as part of a local market feature, which does not warrant any comparability adjustments, provided that reliable local market comparables can be identified.
Moreover, there has been no prominent case in which the location saving concept was disputed.
There are no unique TP rules or practices in Korea.
In the Korean TP regime, there is some co-ordination between transfer pricing and customs valuation, as follows.
TP Review Committee
The NTS is legally required to establish a TP Review Committee (TPRC) within each regional tax office to review proposed TP adjustments prior to the completion of a tax audit. The TPRC is designed to ensure that taxpayers are treated fairly and consistently in regard to TP assessments. The TPRC is responsible for reviewing proposed adjustments that are:
Review of Accuracy of Tax Imposition (RATI)
Once a tax audit has been completed, the tax auditor will provide a notice to the taxpayer of its findings and the proposed amount of additional tax that will be assessed. This notice is known as a pre-tax assessment notice (PTAN). Time limits are important, since the taxpayer has 30 days to appeal to an administrative body within the NTS to review the legal basis of the proposed tax assessment. This process is referred to as a request for a RATI.
Once filed, the tax auditor’s right to issue a formal tax assessment notice (TAN), which crystalises the taxpayer’s obligation, is suspended until the RATI procedure is completed. The RATI is reviewed by a panel of reviewers comprised both of NTS officials as well as outside experts such as professors, accountants, licensed tax representatives, and attorneys who have good standing with the NTS. However, a senior official of the NTS has the final say in all decisions and sometimes conducts several hearings, in the event that this senior official disagrees with the decisions reached by the panel.
The RATI procedure is informal and taxpayers are often provided with an opportunity to appear before the panel or submit additional documents, in support of their position that some or all of the proposed tax assessment is unjustified. The RATI process typically takes several months to complete.
If the taxpayer prevails, the RATI panel will issue a written decision that the proposed tax assessment should be cancelled and the tax audit shall close.
Timing of the Disputed Tax Payment
If a taxpayer decides not to file a request for a RATI within 30 days of the issuance of a PTAN, or if the taxpayer receives an unfavourable decision in the RATI, the tax auditor will issue a formal TAN.
The issuance of a TAN formalises the taxpayer’s obligation to pay the amount shown on the TAN (ie, the deficiency plus interest and penalty). Such an obligation must be settled (by payment or other arrangements such as posting a bond or obtaining a guarantee) within 30 days of receipt.
If the taxpayer’s obligation is not settled, additional interest can accrue, and depending on the facts and circumstances, the tax authority can seek to attach or freeze a taxpayer’s assets and bank accounts.
Appeal to Administrative Bodies of the Government
Time limits are also important for the TAN, because the taxpayer has 90 days after receipt to appeal to one of three administrative bodies of the government, namely the Tax Tribunal, the Board of Audit and Inspection (BOAI) or the NTS’s office of appeals. In the vast majority of cases, taxpayers appeal to the Tax Tribunal as it is considered more independent than the BOAI or the NTS. Another important reason to file an administrative appeal is that under the Korean tax dispute system, the taxpayer must file the appeal and wait at least 90 days before they can file a petition to the court.
The Tax Tribunal is established under the office of the prime minister and is administered by officials generally seconded from the MOEF and the NTS. Like the RATI panel, the adjudicators of the Tax Tribunal are comprised of NTS officials and outside experts, and like the RATI panel, a senior official at the NTS has the final say in all decisions. Tax Tribunal proceedings are less formal than court proceedings but more formal than RATI proceedings.
Similar to court proceedings, the taxpayer and the tax authority are expected to submit briefs with technical arguments and applicable evidence. The taxpayer will also be given a formal opportunity to speak and plead before the adjudicators, although recently some of these hearings have been held by videoconference.
A typical Tax Tribunal proceeding involving a foreign entity, or a Korean entity with foreign investment, or involving an international tax issue, may last six months, although a large or complex TP case can last a year or more. During the proceedings, it is also possible that the adjudicators may order a re-investigation, which is effectively a re-audit of the taxpayer. However, such a re-investigation is essentially a desk tax audit, which involves the reviewing of files prepared by the tax auditor, rather than undertaking another field examination at the taxpayer’s premises.
Once a written decision has been issued and received by the taxpayer, the statute of limitations for filing a petition to the court is 90 days. In addition, as noted above, so long as the appeal has been filed with the Tax Tribunal for at least 90 days, the taxpayer has the option to file a petition to the District Court without waiting for a decision from the adjudicators.
Both the plaintiff and the defendant have the right to appeal decisions of the District Courts that are wholly or partially unfavourable, and, in practice, the losing party is virtually certain to appeal a District Court’s decision to the High Court that has competent jurisdiction. For example, a plaintiff appealing the decision of the Seoul Court for Administrative Matters can appeal to the Seoul High Court for Administrative Matters. The appeal period is two weeks from receipt of the written decision (unless extended due to a national holiday) and must be strictly adhered to.
Under the Korean judicial appeal system, all decisions of the High Court can be appealed to the Supreme Court within two weeks from receipt of a written decision by the appealing party. At all stages of tax litigation, the right of appeal is automatic, without having to seek permission, either from the original court or from the appeal court.
However, unlike the District Court or the High Court, the Supreme Court does not have original jurisdiction and its role is limited to reviewing the technical accuracy of the legal analysis that formed the basis for the decisions rendered by the High Court. Moreover, after reviewing legal issues raised in the petition for appeal, the Supreme Court can decide to dismiss the petition without considering the merits of the appeal, on the basis that the same issue has already been decided several times by the Supreme Court or simply lacks technical merit.
Generally, this initial review process takes about four months, and if the appellant’s petition has not been dismissed, it is an indication that the Supreme Court will undertake a substantive review of the case, and it may take up to two or even three years before a decision is rendered.
Korea is not a common law country that follows the doctrine of precedent (or “stare decisis”). Instead, Korea has adopted the continental legal system. Hence, although, in practice, Supreme Court decisions are followed by lower courts, Supreme Court decisions do not create law in the form of legally binding precedents, as would be the case in a common law system.
Accordingly, although Supreme Court decisions are influential, the NTS is not obliged to follow them and sometimes differs from the Supreme Court in its interpretation of the law. However, the NTS will generally acquiesce after several consistent and uniform Supreme Court decisions have been issued.
Moreover, in practice, tax auditors are generally reluctant to progress cases to the court level unless there is some particular reason to do so, and prefer to negotiate and settle at a tax audit level. Hence, a majority of disputed cases involving TP issues are resolved at a tax audit level, and this results in relatively fewer TP court cases compared to common law countries.
One of the high-profile TP court rulings involved a quantitative model developed and used by the NTS in making TP assessments. Specifically, this model was used for transactions involving financial guarantee fees paid to Korean companies by their foreign subsidiaries. Under this model, any deficiencies in financial guarantee fees received by those Korean companies were additionally included as taxable income and corresponding taxes were assessed in Korea. A number of Korean companies filed administrative appeals to the Tax Tribunal and judicial litigation to the administrative courts.
As a result, the lower court rendering a decision stating that the TP method using this NTS model cannot be considered to correspond to a reasonable TP method specified in the legislation (Seoul Administrative Court 2014 Guhap 54387, Incheon District Court 2014 Guhap 30712, etc).
After these decisions, the NTS developed an alternative claim that led to the successful argument that the Moody's RiskCalc credit rating model was one of the “other reasonable methods” specified in the legislation (Seoul Administrative Court 2014 Guhap 73968, Seoul Administrative Court 2015 Guhap 64480, Daegu District Court 2014 Guhap 21181).
Ultimately, the NTS closed the case through conciliation with a large number of taxpayers, but some taxpayers continued to pursue lawsuits and received decisions from the Supreme Court, to the effect that while the NTS model cannot be considered as a reasonable TP method, the TP method using the Moody's RiskCalc model is one of the “other reasonable methods” specified in the legislation (Supreme Court 2017 Du73983), except for the case where foreign subsidiaries subject to the credit evaluation are new entities that do not have enough historical financial records to use the Moody’s RiskCalc model.
The implication of this court ruling at the Supreme Court is that taxpayers are not required to stick to the guarantee fee calculated by the NTS, which is readily available on the NTS portal, but they have an option to calculate arm’s-length guarantee fees by applying commonly accepted methodologies such as yield curve or loss given default approach, with credit evaluation conducted through Moody’s or other major credit rating agencies’ credit rating methodologies.
A Korean resident or corporation intending to make outbound payments to any recipient – in a controlled or uncontrolled transaction – in excess of USD50,000 per transaction must submit documents to a foreign exchange bank, proving the reason and amount of the payment.
However, the converse does not apply: foreign funds remitted to Korea by a non-resident or foreign corporation are not subject to this regulation.
15.1 Restrictions on Outbound Payments Relating to Uncontrolled Transactions applies to payments made both to related parties and to third parties.
Upon the request of a taxpayer, the MOEF or NTS can request that the competent authorities of another jurisdiction should initiate a mutual agreement procedure where:
Every year, the NTS publishes an APA Annual Report, which details the APA's processing procedures and various statistics, and also provides a description and history of the APA. The latest one available is the 2019 version published in October 2020.
Taxation with Asymmetry of Information
There is an NTS internal administrative order that states that when a taxpayer requests information necessary for the exercise of their rights during a tax audit, the NTS should provide the information in a timely manner. This means that the taxpayer has the right to review and dispute any evidence gathered by the NTS in support of its tax assessment. For this reason, it is difficult for the NTS to assess taxes through information that is not made available to taxpayers.
Secret Comparables in Limited Circumstances
In a bid to reduce the number of taxpayers that are non-compliant with BEPS Action 13, the MOEF recently changed the existing regulations to allow the NTS to determine arm’s-length prices and make assessments based on secret comparable data in cases where the local file, master file or CbC reporting is incomplete or absent.
In the past, taxpayers have challenged the NTS’s use of secret comparable data because of the asymmetry of information and the unavailability of the data to the public.
However, as the LCITA now allows tax authorities to use secret comparable data to assess non-compliant taxpayers, the NTS can legitimately and more aggressively assess taxpayers’ TP when there is non-compliance.
There are no separate regulations or guidance for COVID-19 under the current TP regime. However, since the Korean TP regime is based on the OECD Guidelines, Korea is expected to respond to issues caused by COVID-19 by referring to the “Guidance on the Transfer Pricing Implications of the COVID-19 Pandemic” published by the OECD in December 2020.
The NTS has offered an extension for the deadline for corporate tax returns and VAT returns by three months and one month, respectively, for companies affected by COVID-19. There are certain requirements that must be satisfied in order to benefit from these extensions. Qualifying taxpayers should apply for an extension by mail, in person at their local tax office, or online.
The NTS is providing administrative support to reduce the burden on companies affected by COVID-19, such as postponing scheduled tax audits, as well as stalling tax audits that have already started. An exception to this is where the statutory limitation period is due to expire imminently.
The OECD's base erosion and profit shifting (BEPS) project has had a significant impact on international taxation and on the actions of tax authorities and multinational corporations around the world. Since its inception in 2015, the OECD BEPS Deliverables have been continuously supplemented, and Korea is an especially active country when it comes to adopting OECD guidelines into its domestic tax laws. Amidst this backdrop, the recent OECD proposals and subsequent revisions to Korean transfer pricing regulations reflect broader trends within the OECD BEPS project. This chapter will discuss some of the salient points arising from these revisions, which raise important implications for multinational companies operating in Korea.
Transfer Pricing Regulations for TP Documentation
Under BEPS Action 13, there is a three-tier documentation requirement, whereby a master file, a local file and country-by-country (CbC) reporting (collectively referred to as “BEPS documentation”) must be submitted by taxpayers. This requirement had already been introduced in Korea, and Korea has now adopted a stricter submission deadline for the BEPS documentation. In most countries, taxpayers should prepare and retain the master file and local file within a time limit requested by that country’s tax authorities. However, BEPS documentation in Korea must be filed within 12 months from the end of the fiscal year.
There are several key points that taxpayers must consider, in terms of their transfer pricing management, with respect to this strict timeline for submission of the BEPS documentation.
Firstly, taxpayers cannot modify the contents of the BEPS documentation once submitted. For instance, it would be difficult to change the transfer pricing method, selected for the initial BEPS documentation, when preparing the BEPS documentation for a subsequent fiscal year. The Korean tax authority (the National Tax Service, or NTS) may compare and analyse the BEPS documentation submitted by taxpayers for multiple years; any inconsistency between the submissions may lead to a transfer pricing assessment. With this in mind, it is essential that taxpayers manage their transfer pricing issues with a high degree of caution and precision.
Secondly, the NTS has within its possession the transfer pricing analysis data included in the BEPS documentation, submitted by numerous multinational corporations every year. Accordingly, the NTS can use this data to select new targets for transfer pricing investigations, and may refer to the BEPS documentation submitted by other similar companies when conducting transfer pricing investigations. Furthermore, it is also worth noting that the recent revisions to the transfer pricing regulations allow the NTS to utilise the BEPS documentation more proactively for transfer pricing investigation purposes, as described below.
Unifying the information and communication network for the submission of the master file and local file
Previously, taxpayers were able to submit the master file and local file electronically through an e-file portal site, as well as in hard copy. However, the revised rules only allow e-files to be submitted. The purpose of this revision is to allow the NTS to co-ordinate and manage all BEPS documentation in a more integrated manner.
Increased penalty for failure to report international transaction information
The penalty for failure to appropriately report international transaction information has been increased. If the BEPS documentation is not submitted by the deadline, and in the absence of any taxpayer request for an extension, the penalty was originally KRW10 million per report. As of FY 2018, however, the maximum penalty was increased to KRW30 million per report. Additionally, for non-compliant taxpayers, the NTS can request missing reports to be submitted, or any inaccurate information to be rectified, within 30 days. After the 30-day period has passed, interest will start to accrue, to a maximum of KRW200 million.
The establishment of a legal basis for the NTS to make tax assessments based on its own estimates, when a taxpayer fails to submit information on cross-border transactions
Under a provision newly introduced into Korean law, the NTS is now able to make a transfer pricing adjustment based on transfer pricing data it possesses (ie, BEPS documentation submitted by other similar companies), when a taxpayer fails to submit transfer pricing-related information, after being requested to do so. After this revision, therefore, the NTS can now use the transfer pricing data in its possession more efficiently. For this reason, it is recommended that multinational corporations prepare their transfer pricing documentation in a timely manner, in order to keep their transfer pricing risk in Korea at a manageable level.
Managing Transfer Pricing Risks in Relation to Intangible Assets
In the past, transfer pricing investigations in Korea mainly focused on tangible property such as goods and products. However, there has recently been a rapid increase in the number of investigations and tax assessments relating to intangible assets and service transactions. This can be seen both through the recent revisions to Korean law and also by considering the higher number of active investigations in this area. Most of these revisions to the laws and regulations surrounding intangible assets were made in order to implement the OECD BEPS Deliverables into domestic legislation.
The remuneration principle based on “DEMPE” functions (development, enhancement, maintenance, protection and exploitation)
A provision has been newly introduced to the effect that the DEMPE functions must be considered when evaluating the transfer price of intangible assets. According to the revised regulations, when determining an arm's-length price for transactions involving intangibles, it is necessary to consider whether or not there has been a reasonable allocation of cost to each controlled entity. However, when performing this analysis, it is necessary to consider the economic benefits derived from the use of the intangible assets, rather than legal ownership.
Specifying the transfer pricing method for transactions involving intangible assets
The newly revised regulations also specify that the comparable uncontrolled price method (“CUP Method”) and the profit-split method (“PS Method”) are the preferred transfer pricing methods, which should be used to determine the arm’s-length price for transactions involving intangibles. Moreover, the DEMPE analysis should also be considered when applying the transfer pricing method, and this may increase the likelihood of applying the PS Method in a transfer pricing analysis of transactions involving intangibles.
These legal developments pertaining to intangibles shows the NTS's interest in, and strong willingness to investigate, intangible asset transactions. In fact, a number of aggressive assessments related to intangible asset transactions have been imposed in recent transfer pricing investigations. Since there have been many cases where the NTS’s approach has been aggressive and controversial, the number of cases leading to tax appeals has rapidly increased as well. The description below illustrates how the revised regulations related to intangible assets are applied in practice.
Foreign-invested companies located in Korea operate their business by obtaining the right to use intangibles from their parent company. Korean subsidiaries generally pay royalties to the parent company in exchange for the right to use intangible assets. The most traditional method applied to a royalty transaction is the CUP Method, which benchmarks the royalties derived from transactions of similar intangibles. Another method that many companies have applied is the transactional net margin method (TNMM). With this method, the arm’s-length price of a royalty transaction is measured by comparing the operating margin of the Korean subsidiary, after deducting the amount of royalty paid to the parent company, with the operating margin of comparable companies.
The CUP Method is a transfer pricing method that can be applied preferentially to transactions involving intangible assets, even under the revised transfer pricing regulations. However, where the CUP Method is used, this is easily susceptible to challenge from the NTS, due to the lack of publicly available information on potential comparable data required for the application of the CUP Method. According to the revised transfer pricing regulations, the TNMM is not a method that must be applied on a preferential basis. The NTS may attempt to tax intangible assets through the PS Method, which is prescribed as one of the preferential methods in the revised transfer pricing regulations.
As stated above, taxpayers are now also required to consider the DEMPE functions and the relative value of each controlled entity's contribution to the combined operating profit or loss when determining an arm's-length price of intangible asset transactions. This is consistent with the PS Method, in which the excess economic returns from the exploitation of intangible assets are allocated to each of the subsidiary and parent company, by reference to the relative value of their contribution to the combined operating profit or loss. If the subsidiary performs the DEMPE functions for intercompany transactions to a greater extent than the parent company, the equivalent operating profit or loss will additionally be attributed to the subsidiary.
In transfer pricing investigations, a fierce debate can arise between taxpayers and investigation officers over the DEMPE functions and the relative value of each controlled taxpayer's contribution to the combined operating profit or loss. The investigating officers will try to find evidence to claim that the Korean subsidiary is performing a part, if not all, of the DEMPE functions. Upon investigation, if it is apparent that the DEMPE functions carried out by the Korean subsidiary have contributed to the combined operating profit or loss, then the corresponding additional profit or loss will be attributed to the Korean subsidiary.
The extent to which the DEMPE functions contribute to the creation of intangible assets is also debatable. General activities that appear as routine functions from the point of view of taxpayers can be treated as important DEMPE activities from the NTS’s perspective. For example, marketing and sales functions are routinely performed by subsidiaries in the process of selling branded products in Korea. But the NTS can interpret these functions as important DEMPE activities that contribute to the brand value. Similarly, process improvement activities and/or engineering activities of manufacturing subsidiaries can also be treated as DEMPE activities.
Given these developments, subsidiaries in Korea that conduct DEMPE activities ought to consider whether or not the transfer pricing methods traditionally applied in the past (ie, the TNMM or CUP Method) remain a safe transfer pricing method for their transactions involving intangibles in Korea. Even if subsidiaries in Korea have achieved routine margins and/or even if royalties paid are within an arm’s-length range, there is the risk of suffering a tax assessment when the PS Method is used. In addition, transfer pricing policies should be reconsidered, in light of the aforementioned revisions to the law and investigation trends.
Updates to APAs and MAPs
APA – increased maximum retroactive period
Through a recent amendment to the law, the permissible period of retroactive application of an advance pricing agreement (APA) has been extended. Upon receipt of a taxpayer’s application, the NTS may approve that a method applies retroactively up to a maximum of seven years immediately preceding the proposed period of the APA (the previous limit being five years). In a unilateral APA case, the new maximum retroactive period is five years (previously three years). This extension of the period of retroactive application of the APA is expected to increase the protection of taxpayers' rights. Since the statute of limitation period on international transactions is seven years, the extended period of rollback could be interpreted as an effort by the Korean government to address concerns about the loss of taxpayer rights.
MAP – final court rulings
There was also a revision to the law related to mutual agreement procedures (MAPs). In the past, it was impossible for MAPs to continue if a final decision was issued by a court during the course of the MAP. However, these requirements have been relaxed. Now, even if there is a final court ruling, it is still possible to continue with a MAP for the purpose of obtaining a corresponding adjustment in the other contracting state. This revision is expected to strengthen the rights of taxpayers.
APA and MAP – conclusion
Tax assessments in Korea based on transfer pricing are on the rise, and the interpretation and application of the rules of taxation is becoming ever more complex and controversial. Accordingly, disputes between taxpayers and the NTS over transfer pricing issues are inevitably increasing. In this situation, many taxpayers are considering the APA, as a pre-emptive transfer pricing risk management tool (as well as filing a MAP), to deal with difficult transfer pricing disputes.
Of course, the COVID-19 pandemic has resulted in the suspension and delay of inter-country MAP meetings. However, new ways of working, including holding virtual meetings, should be sought. The Korean government is continuing to improve and update the Korean transfer pricing regime, and strengthen the effectiveness of the MAP, in line with OECD principles. It is also noteworthy that recent legal revisions newly inserted an arbitration provision in the context of MAPs.
Although an arbitration provision is currently not included in Korean tax treaties, this amendment has been made pre-emptively, in anticipation of an arbitration provision also being added to tax treaties in the near future.
It is apparent, therefore, that the Korean government is improving the MAP system in line with OECD recommendations, and taxpayers should be watchful for further similar developments.