The Korean transfer pricing (TP) regulatory regime is set out in the Law for the Co-ordination 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 (MOEF) 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 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 development, keeping pace with similar developments that have taken place in other OECD countries. Broadly, there were five major milestones, which are as follows.

The Origins of the Korean TP Regulatory Regime

The need for a TP regulatory regime first emerged against the backdrop of Korea’s rapid economic growth in the 1980s, and the ensuing increase in the volume of cross-border transactions by multinational businesses. The first TP regulations were introduced in 1988.

Initially, these TP regulations were contained within a provision of the Presidential Enforcement Decree of the Corporate Income Tax Law (CITA), under an article relating to the denial of unfair transactions. This 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 Finance and the NTS introduced standalone TP rules and regulations, to assist with interpretation of the above-mentioned 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 its subordinating regulations – as well as to the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the “OECD Guidelines”). To align 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 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, the cross-border transactions of multinationals became increasingly complex, and it became apparent that 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 address this issue, the Korean government overhauled the TP regime in 2010. The new regime gave the NTS the right to adjust income and tax liability based on the arm’s length principle, abolished the preferential application of the traditional transaction methods, 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 into the Korean TP regime. Consequently, new taxpayer reporting obligations were introduced into the LCITA, including preparing and submitting a “local file”, “master file”, and country-by-country (CbC) reporting. In addition, in line with the core concepts introduced in the pertinent BEPS Actions, the concept and scope of intangible assets were refined, and the arm’s length principle was further refined.

OECD’s Transfer Pricing Guidance on Financial Transactions and the COVID-19 Pandemic Codified Into the Korean TP Regime

The OECD’s recent developments on transfer pricing were partly transposed into the LCITA and its subordinating regulations in 2022. Newly codified intercompany loan pricing methodologies by reference to the OECD’s Transfer Pricing Guidance on Financial Transactions published in October 2020 have reinforced the LCITA’s existing regime, which lacked sophistication, and have provided specific guidance to allow for greater tax certainty. In addition, a cash pool arrangement provision has been created under the subordinating regulations of the LCITA, where it prescribes the definition of a “cash pool arrangement” and how to derive arm’s length remuneration for a cash pool leader and participants. 

In line with the content of the OECD’s Guidance on the Transfer Pricing Implications of the COVID-19 Pandemic published in December 2020, starting from 2022, taxpayers in Korea are allowed to include loss-making companies in their benchmarking analysis, if deemed appropriate, since such provision has been adopted into the subordinating regulations of the LCITA. From this historical background, the modern Korean TP regime has emerged as one that is highly synchronised with the OECD Guidelines. 

Shareholding Test

The basic test of whether the parties to a transaction are related is based on percentage of ownership, as follows:

• a domestic resident owns, directly or indirectly, at least 50% of the voting shares of another foreign company;
• a foreign resident owns, directly or indirectly, at least 50% of the voting shares of a domestic company or a foreign company having a domestic place of business in Korea; or
• a third party, together with their relatives, holding, directly or indirectly, at least 50% of the voting shares of a domestic company or a foreign company having a domestic place of business in Korea, owns, directly or indirectly, at least 50% of another foreign company’s voting shares.

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: 

• the parties have a common interest through an investment in capital, trade in goods or services, grant of a loan, or similar financial provision, and either party has the power to substantially determine the business policy of the other by any of the following means:
1. at least 50% of the executive officers of the one party assumes the position of executive officers of the other party within three years;
2. one party owns at least 50% of the voting shares of the other party through an association or trust;
3. one party borrows at least 50% of the funds from the other party; or
4. one party depends on the intellectual property right provided by the other party for at least 50% of its business activities;
• both parties have a common interest through an investment in capital, trade in goods or services, grant of a loan, or similar financial provision, and a third party has the power to substantially determine the business policies of both transacting parties by any of the following means:
1. a third party owns, directly or indirectly, at least 50% of the voting shares of one party and has the power to substantially determine the business policies of the other party;
2. a third party has the power to substantially determine the business policies of both parties; or
3. one party is an affiliated company of a group within the context of competition law in Korea and another affiliated company of the same group owns, directly or indirectly, at least 50% of the voting shares of the other party.

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:

• comparable uncontrolled price method (CUP);
• resale price method (RPM);
• cost-plus method (CPM);
• transactional net margin method (TNMM); 
• profit split method (PSM); and
• other reasonable methods.

The last category in 3.1 Transfer Pricing Methods, “other reasonable methods”, should be applied only when none of the first five TP methods can 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 the 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 among 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 respect only, there is a limited hierarchy of methods.

It is possible for 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: 

• types and characteristics of goods or services; 
• functions of business activities; 
• risks associated with transactions; 
• assets used; 
• contractual terms and conditions; 
• economic conditions; and 
• business strategies.

Risk Analysis Framework From the OECD Guidelines

In addition, it is noteworthy that the risk analysis framework first introduced in Chapter 1 of the OECD Guidelines released in July 2017 was codified into the LCITA in 2019. The purpose of this framework is to identify and assess economically significant risks assumed by taxpayers and their foreign related parties by virtue of accurately delineating controlled transactions. 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 subordinating 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 for 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 flow” 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; that is, 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 the following requirements are classified as HTVI:

• when there is no comparable transaction between third parties at the time of the transaction involving intangible assets; and
• the intangible assets are under development, and they are expected to take a long time to be used commercially; or there is a high degree of uncertainty about the economic benefits expected from the intangible assets at the time of the transaction (this could be due to the level of innovation involved, or other similar unforeseen factors). 

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:

• they appropriately took into account the relevant factors when reaching their pricing arrangement; and
• the difference in the actual outcome was due to unforeseeable developments.

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:

• a resident business enters into a CCA with a foreign-related party, in order to jointly develop or acquire intangible assets; and
• the resident’s actual share of costs is higher or lower than an arm’s length share.

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 a 20% or more difference between the benefit that is expected (i) at the time of executing the 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:

• costs saved; or
• an increase in any of the following items due to the use of intangible assets:
1. sales;
2. operating profit; or
3. usage, production or sales volume.

NTS’s Viewpoint on the CCA

Despite the enactment of the CCA regime in the LCITA, in practice, 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 Korea. As intangibles and CCA-related provisions have been supplemented during recent 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. 

The 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, such as, if there has been a deviation from an arm’s length price. One noteworthy point is that this particular taxpayer’s right was previously contained in the LCITA’s subordinating regulations, but in 2019 was moved into the LCITA, demonstrating the importance of this taxpayer’s right. 

Circumstances That Warrant an Affirmative TP Adjustment

Taxpayers can make this type of adjustment by incorporating it as part of the tax return or filing a separate 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 the end of December 2023, South Korea has signed 95 tax treaties (up from 94 last year due to a recently sealed tax treaty with Taiwan) and 12 “tax information exchange agreements”. South Korea is also one of 147 signatories to the Convention on Mutual Administrative Assistance in Tax Matters.

The exchange of more TP-specific information with other taxing authorities is facilitated by the Multilateral Competent Authority Agreement, which allows signatories to exchange CbC reporting. South Korea is one of 100 signatories, and it has also separately signed a CbC reporting exchange agreement with the USA, based on the existing tax information exchange agreement with the USA. 

History of the Korean APA Programme

Korea launched its APA programme in 1995, and its first APA case was concluded with the USA in May 1997. Since then, of 912 APA applications (both unilateral and bilateral), 666 cases had been concluded as at 31 December 2022. As is apparent from these statistics, the Korean APA programme has been very active since its inception, and it is expected that the demand for APAs will gradually increase, as many Korean companies set up their manufacturing and distribution entities in other parts of the world. 

Types of APAs

Korean taxpayers can apply for a unilateral or bilateral APA, depending on the objective of the taxpayers and availability of MAP provision (ie, a bilateral APA) per pertinent tax treaty. However, it is noteworthy that even though the NTS still accepts unilateral APA applications due to the shorter processing time, etc, unilateral APAs are somewhat less favoured due to their limitation as a double tax prevention measure, unless taxpayers have a particular reason to pursue a unilateral APA. 

A starting point for processing APAs in Korea is to file an application for a pre-filing meeting with the NTS officers at the APA/MAP office, which sits within the International Taxation Bureau of the NTS Head Office. After successfully completing a pre-filing meeting and receiving a go-ahead sign from the APA/MAP office, taxpayers become eligible to file an official APA application to the APA/MAP office. Once an APA application is filed and the negotiation with the competent authority of the other contracting state is completed, the commissioner of the NTS has the 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 APAs and MAPs. 

Since APA and MAP cases are assigned within the APA/MAP office 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 working on APAs and MAPs to co-operate, in practice, there is definitely co-ordination between these NTS teams.

Technically, there is no restriction on which taxpayers or transactions are eligible for an APA, as long as the taxpayer in question is 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 2025 to 31 December 2029, then the application must be filed by 31 December 2024. However, in order to file the application in time, the preparation for the APA should proceed at least six months before in light of the time required to complete a pre-filing meeting and secure a go-ahead sign from the NTS. 

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 five-year coverage in their application.

Roll-Back Provision

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 roll-back 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 roll-back is up to three years. 

For APA applications filed after 1 January 2021, a roll-back 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 roll-back 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.

TP-Related Forms

A taxpayer that is not subject to the regulations in the Combined Report of International Transactions (CRIT), which is described in the following section, but which still conducts international transactions with foreign related parties must submit the following information within six months from the end of each fiscal year: 

• an international transaction statement for each foreign related party (submission is waived if the transaction amount does not reach a certain threshold);
• a summary income statement of each foreign related party that has cross-border transactions with a Korean taxpayer (submission is waived if the transaction amount does not reach a certain threshold); and
• a form stating the TP method selected and reasons for each related-party transaction – there are separate forms for tangible property transactions, intangible property transactions, service transactions and CCAs (but submission is waived if the transaction amount does not reach a certain threshold).

If any part of the international transaction statement is not submitted or is false, a fine of KRW5 million may be imposed on each foreign related party with which the Korean taxpayer had a transaction during the year.

The Combined Report of International Transactions

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 such report. Additionally, for non-compliant taxpayers, the NTS may request the submission of missing reports with 30 days’ notice, and failure to comply within such timeframe can trigger interest, which could add up to KRW200 million.

Given the foregoing burden of penalties for non-compliant taxpayers, starting from 2022, taxpayers will be able to benefit from reduced penalties if taxpayers voluntarily take a pre-emptive measure (ie, submission of missing reports or rectifying false information) and the rate of reduction varies from 30% to 90% depending on how soon such measure is taken. 

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 can request the submission of missing reports with a 30-day notice period, where failure to comply within such timeframe can trigger interest, 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, which could be sometimes quite subjective and contentious, 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. 

Threshold Requirements

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: 

• there is no CbC report submission requirement in their home country; and
• their home country has not executed a CbC report exchange treaty with Korea. 

Submission Deadline

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 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 similar to that contained in the OECD Guidelines. This is because the Korean legislature and the MOEF closely monitor developments at the OECD level and adopt them into the Korean TP regime in a timely manner. For example, the updated core transfer pricing concepts introduced in BEPS Actions 8–10 and 13 and transfer pricing guidance on financial transactions as well as the Guidance on the Transfer Pricing Implications of the COVID-19 Pandemic were promptly incorporated 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. 

As part of the arm’s length principle, the NTS needs to fully understand the key details of the international transaction, including the commercial or financial relations between the resident and the foreign related party, as well as important terms and conditions. The NTS will then determine if the transaction makes sense from a commercial standpoint (ie, commercial rationality) when compared with similar transactions between unrelated parties. If it’s determined that the transaction is not commercially rational and difficult to compute an arm’s length price, the NTS may consider such transaction as if it had not occurred, or apply an arm’s length method by re-characterising it as a new transaction in a rational manner.

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. 

The CRIT

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. 

Intangible Assets

See 4.1 Notable Rules and 4.2 Hard-to-Value Intangibles. 

Risk Analysis Framework

See 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 that 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:

• 5% of the taxpayer’s sales; or
• 15% of the taxpayer’s operating expenses.

The definition of low value-adding services, and examples, are clearly set out in the legislation. See 11.1 Transfer Pricing Safe Harbours for further information on low value-adding intra-group services.

On 8 October 2021, the OECD/G20 Inclusive Framework on BEPS reached a final agreement on the two-pillar approach to address the tax challenges arising from the digitalisation of the economy. After the agreement, the MOEF announced its intention to codify the two-pillar approach, and execute and implement the multilateral agreement in 2023 as one of the signatories. In January 2022, the MOEF publicly put out a tender for research services on the codification plan for Pillars One and Two respectively.

However, as the development of Pillar One at the OECD level has been dragged on for quite some time and there are still many obstacles to overcome before reaching an implementation stage, it is highly likely that Korea’s transposition of Pillar One into its own law will also be delayed. 

On the other hand, there has been significant progress with Pillar Two at the level of both the OECD and Korea. Korea is known to be the first country to codify the main elements of Pillar Two into its own international tax regime – ie, the LCITA. It announced a proposed tax law change for 2023, incorporating Pillar Two provisions in July 2022, and later in December 2022, it was officially enacted and codified into a separate part of the LCITA, making Korea one of the early adopters of Pillar Two. In July 2023, as part of the tax law changes for 2024, more extensive Pillar Two provisions incorporating OECD commentaries and administrative guidance on Pillar Two were proposed, and were officially enacted in December 2023. Particularly, as part of the tax law changes for 2024, the implementation of Undertaxed Payments Rule (UTPR) has been officially postponed from 2023 to 2024 in order to keep pace with other major countries. In January 2024, more specific and detailed regulation on Pillar Two was introduced by the MOEF as a part of the Presidential Enforcement Decrees of the LCITA and such promulgation solidified the legal framework for the implementation of Pillar Two. Pillar Two becomes effective for the fiscal years beginning on or after 1 January 2024, with the first information return due within 18 months from the end of the first effective fiscal year – ie, 30 June 2026.

In general, the Korean TP regime, just like the OECD Guidelines, does not contain clear regulations that restrict the form of business operations to particular types of entities (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”. 

With regard to a limited-risk entity, the NTS may accept a guaranteed return by its parent company, but since the OECD Guidelines’ Risk Analysis Framework was adopted into the Korean TP regime, the NTS’s attention has been more focused on 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 Guidelines were issued, 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 – in 2010, 2017 and 2022 – have mostly been reflected in the Korean TP regime. 

As an OECD member country, Korea has based its TP regime on the OECD Guidelines, and except with respect to the definition of related parties, Korea has generally not adopted the principles from the UN Practical Manual on Transfer Pricing.

There are two main types of transactions where TP safe harbour rules may apply: 

• low value-adding intra-group service transactions; and 
• intercompany loan transactions.

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:

• research and development;
• exploration, extraction and processing of natural resources;
• manufacturing;
• sales and marketing; and
• finance, insurance and reinsurance. 

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:

• by considering comparability factors such as the amount of the debt, maturity of the debt, existence of a guarantee, creditworthiness of the debtor and other factors; or
• by using the “safe harbour” interest rate prescribed in the LCITA.

In the latter case, the regulations stipulate 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, Risk Free Rates (RFR) for respective currencies, which are enumerated in the subordinating regulation of the LCITA, such as SOFR for USD and KOFR for KRW, plus 150 basis points is deemed as a safe harbour rate. In the case where a certain currency is not enumerated in the regulation, SOFR will be used as the base rate pursuant to the regulation. 

Starting in 2022, as referred to in 9.1 Alignment and Differences, key points from the OECD Transfer Pricing Guidance on Financial Transactions have been codified into the subordinating regulations of the LCITA and the updated regulations supplement the aforementioned high-level regulations on intercompany loan pricing, with more detailed methodologies set out below: 

• utilisation of financial derivative instruments such as credit default swaps by taking into account the comparability factors listed above; and
• utilisation of economic modelling by adding a number of premiums related to various aspects of a loan – such as, default risk, liquidity risk, expected inflation and maturity – to a risk-free interest 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 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.

• When there is an upward adjustment on a dutiable value by the Korea Customs Service (KCS) for customs purposes, the taxpayer is entitled to file a downward amended return for TP purposes, within three months of receiving the customs duty assessment letter. However, there is an important precondition: such a claim for downward adjustment will only be accepted when the recalculation of customs value by the KCS is consistent with the relevant arm’s length TP methods under the Korean TP regime.
• When a taxpayer applies for a unilateral APA to cover the method of calculating the arm’s length price, it can simultaneously apply for an advance customs valuation arrangement, in order to obtain a pre-alignment between the arm’s-length price and the dutiable value. Upon receipt of the application, the NTS and the KCS will co-operate on the method of calculating the arm’s length price and dutiable value, and the range of the pre-adjusted price.

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 with regard to TP assessments. The TPRC is responsible for reviewing proposed adjustments that are: 

• in excess of KRW5 billion (KRW10 billion in case of Seoul Regional Tax Office); or 
• disputed by a taxpayer.

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, particularly where the 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 will 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 arrangement, 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 the 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 it 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 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. 

As in 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.

Judicial Litigation

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, as 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 few TP court cases compared to common law countries. 

Court Ruling Related to the Integrated Analysis of Individual Transactions

The case

Current Article 15 of the Presidential Enforcement Decree of the LCITA stipulates that when applying the arm’s length pricing method, if each individual transaction is closely linked or consecutively conducted, it is not reasonable to calculate the price, profit, or net profit of each transaction separately, and the individual transactions may be assessed on an aggregate basis. Article 8 of the Ordinance of the LCITA lists the instances where individual transactions can be assessed on an aggregate basis as follows:

• the product line is closely linked, or they have the same product line;
• the transaction is to provide know-how and supply key components to a manufacturing company;
• the transaction is a circumvention using a related party;
• the sale of one product is directly related to the sale of another product, such as printers and toner, coffee makers and coffee capsules, and so on; and
• it is reasonable to assess the individual transactions on an aggregate basis in light of the substance and practice of the transaction.

Taxpayers and the NTS often dispute whether individual transactions should be aggregated in tax audits, and there have been cases involving this issue that were decided by the Seoul Administrative Court and the Seoul High Court in 2022 and 2023.

The taxpayer is a domestic corporation wholly owned by a Swiss-based luxury watch manufacturer (the “Parent Company”) that exclusively imports and sells the Parent Company’s luxury branch watches (the “Watches at Issue”). The taxpayer sells the Watches at Issue and provides warranty repair and overhaul services (the “Services at Issue”) free of charge to its customers, regardless of which distributor or country they purchased the Watches at Issue from, as part of the Parent Company’s policy to increase the value of its luxury watches worldwide. As the taxpayer did not receive any compensation from its Parent Company for the expenses incurred in providing the Services at Issue, the NTS calculated the arm’s length price of the Services at Issue and the amount of transferred income for the 2013-2017 taxable years. This amount was included in the taxpayer’s profits and treated as a deemed dividend since the adjusted income has not been repatriated to the taxpayer.

In June 2019, the taxpayer appealed to the Tax Tribunal after disagreeing with the NTS’ assessment of arm’s length pricing for the Services at Issue. Despite the Tax Tribunal ordering the NTS to re-investigate and determine the arm’s length price, the NTS changed the arm’s length method used for the Services at Issue from the Cost-Plus Method (CPM) to the Transactional Net Margin Method (TNMM) to re-assess the arm’s length price. However, the re-assessed amount under the TNMM exceeded the original assessed amount and, thus, the NTS decided to stick to its original assessment based on the principle of prohibition of disadvantageous alteration. This is an unusual case because the result of reinvestigation by the NTS came out more negatively for the taxpayer than the original assessment. As the Tax Tribunal’s re-investigation decision became meaningless in effect, the taxpayer filed a lawsuit with the Seoul Administrative Court.

The taxpayer argued that the assessments were unlawful since the Services at Issue and the transactions involving the taxpayer’s import and sale of the Watches at Issue from the Parent Company were not only closely linked, but also continuous. Thus, the taxpayer argued it is unreasonable to segregate and independently calculate the arm’s length price. Furthermore, the taxpayer highlighted that a third-party distributor of the Watches at Issue operated an authorised service centre and provided identical services without charging back the associated expenses to the Parent Company. However, NTS maintained that the transfer pricing adjustment was justified because transfer pricing is evaluated on an individual transaction basis. Given that the taxpayer rendered Services at Issue for watches it did not directly sell, the NTS argued that it was untenable to assume that the consideration received by the taxpayer for importing and selling the Watches at Issue encompassed compensation for the services provided. Thus, the NTS maintained that their adjustment should be justifiable.

The Seoul Administrative Court, a court of first instance, held that luxury watches constitute durable goods intended for long-term use, necessitating regular repair and maintenance, often involving intricate technical expertise. Furthermore, the court emphasised that the provision of dependable repair and ancillary services significantly enhances the value of such products. The court also asserted that the elevated selling price of luxury watches inherently encompasses the assurance and worth associated with reliable and convenient product management services. The court agreed with the taxpayer’s arguments, finding that the import sales of the Watches at Issue and the Services at Issue were inherently linked to each other in substance and practice. Furthermore, the court determined that so long as the increase in sales of the Watches at Issue within the domestic market is translated to a tangible benefit upon the taxpayer, the taxpayer’s exclusive right to distribute the Watches at Issue in Korea and its guaranteed profits therefrom should be construed as the taxpayer being properly compensated for the Services at Issue by the Parent Company (2020Guhap80806 dated 20 May 2022).

The NTS appealed to the Seoul High Court, which rejected the appeal citing entirely different reasons from the first instance ruling. The Seoul High Court reasoned that, according to the Presidential Enforcement Decree of LCITA, the arm’s length price is typically calculated separately for each transaction. It was evident that the taxpayer’s import sales transactions and the Services at Issue were not covered by specific items 1 through 4 of the Presidential Enforcement decree. Additionally, the court noted the lack of objective evidence to support that the taxpayer was assured exclusive import sales of the Watches at Issue as a precondition for providing the Services at Issue. The court also observed that the terms, contents, or sales volume of the contracts did not vary based on whether the Services at Issue were provided. Furthermore, the court found that the taxpayer’s presented business reasons and the circumstances of the case were not sufficient to demonstrate that the importation and sale of the Watches at Issue and the Services at Issue were sufficiently linked or directly correlated. Despite the taxpayer’s arguments, the court deemed it appropriate to evaluate these components separately for transfer pricing purposes. However, the Seoul High Court ultimately ruled in favour of the taxpayer, asserting that the NTS’s selected comparables lacked adequate comparability to the Services at Issue. Since the NTS did not appeal this decision to the Supreme Court, the decision was upheld at the second trial (2022Nu47935 dated 14 June 2023).

It would have been more implicative had the case reached the Supreme Court for a final decision. However, it is significant to highlight the central issue; that is, whether to aggregate individual transactions that seem to be linked in business practice. The differing conclusions between the first and second trials underscore the complexity and importance of this issue in transfer pricing analysis. Despite the specificity of the Presidential Enforcement Decree outlining items 1 through 4 and incorporating a catch-all provision under item 5, the Seoul High Court’s interpretation differed from the initial ruling. The Seoul High Court’s finding regarding the lack of objective evidence to establish a close linkage between two transactions for aggregation has an implication for taxpayers in the sense that taxpayers should present a legitimate argument supported by objective and concrete evidence in order to make a case for why an aggregated approach is more appropriate than a segregated analysis for their specific situations and circumstances. 

Restrictions on outbound payments relating to uncontrolled transactions apply to payments made both to related parties and to third parties.

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.

Upon the request of a taxpayer, the MOEF or the NTS can request that the competent authorities of another jurisdiction should initiate a MAP where:

• there is a tax treaty between Korea and the other jurisdiction;
• the other jurisdiction has made a TP adjustment in a related-party transaction;
• the related-party transaction is between a Korean resident and a resident of that other jurisdiction; and
• from the taxpayer’s perspective, a corresponding adjustment is required to avoid double taxation.

Every year, the NTS publishes an APA Annual Report, which details the APA processing procedures and various statistics, and provides a description and history of the APA. The latest one available is the 2022 version published in December 2023.

Taxation With Asymmetry of Information

There is an NTS internal administrative order which states that when a taxpayer requests information necessary for the exercise of its 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 non-public comparable data in cases where the local file, master file or CbC report 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 the 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.