NationalSymbols of the Republic of Korea
International Taxation
Transfer Pricing
A. Adjustment of a Transfer Price Based on an Arm's Length Price
The LCITA (Law for the Coordination of International Tax Affairs) authorizes the tax authorities to adjust the transfer
price based on an arm's length price (ALP) and to determine or recalculate a resident's taxable income when the
transfer price of a Korean company and its foreign counterpart is either below or above an arm's length price.


(1) Special Relationship
The LCITA and its Decree recognize "special relationship" under the following circumstances:
(Equity Ownership Test)
- Where a foreign company directly or indirectly owns 50% or more of the voting shares of a Korean company; or
- Where a Korean company directly or indirectly owns 50% or more of the voting shares of a foreign company; or
- If a corporation (or an individual), which directly or indirectly owns 50% or more of the voting shares of a
foreign company, directly or indirectly holds 50% or more of the voting shares of a Korean company; or
(Substantial Control Test)
- If one transaction party (¡°Company A¡±) substantially controls the business policy of the other transaction
party (¡°Company B¡±) or vice versa and at the same time they share the same interest; or
- If the same third party substantially controls the business policy of both Company A and Company B and at the same time both transaction parties share the same interest.
(2) Computation of Indirect Ownership
If company A owns a 50% stake or more in company B, and B owns a certain percentage of shares in a third company C, B's equity ratio in C would constitute the ratio of equity which A indirectly owns in C. If company A owns less than a 50% stake of company B, and B owns a certain percentage of shares in a third company C, then A is considered to own C to the extent of the ratio computed by multiplying A's equity ratio in B by B's equity ratio in C.


B. Criteria and Procedure for Transfer Price Adjustment
The LCITA and its Decree define an arm's length price (ALP) as a price that is established or that can be expected to be established in a normal transaction between independent enterprises without a "special relationship."

The LCITA lists the following methods for determining an ALP: the comparable uncontrolled price (CUP) method, the resale price method, and the cost plus method. Furthermore, the Decree elaborates upon the profit-split method and the transactional net margin method (TNMM) as methods for determining an ALP based on profits arising from controlled transactions.

The CUP method evaluates an ALP by comparing the price that an independent uncontrolled person under the same or similar circumstances. In terms of trade conditions or volume would be set for goods identical to those in question.

The resale price method may be applied where a manufacturer sells its products to a related person and the related person resells the same product to an unrelated third party without any further processing. Under this method, the adjustment in the transfer price between related parties may be computed by subtracting an appropriate mark-up amount from the price that the related reseller charges the product to unrelated third parties. The cost plus method, in principle, may be applied where a manufacturer sells his or her products to the related party and the related party then adds value to the product by processing it further to sell to unrelated third parties. In such cases, the ALP is calculated as the price of the refined goods, less the actual costs of further processing, together with an appropriate mark-up upon such costs.

The profit split method determines an ALP by taking the sum of profits earned by the related parties and allocating them in proportion to the respective contribution towards generating the profits realized.

Finally, the TNMM evaluates an ALP by first seeking an independent third company which is similar to the company at issue in terms of its business operations and the nature of its business, and then by subjecting such a company to functional and comparability analyses. The income earned by the third company is then estimated based upon the following ratios: profits to assets, operating profits to turnovers, and profits to equity. These estimates will then be used to evaluate and if necessary, adjust the income and profit of the related parties.


C. Selection of Method for Determining ALP
The Decree states that an ALP should be determined by the most reasonable method applicable to the situation, whether it be the CUP method, the resale price method, the cost plus method, or any other method.

The Decree sets out the following criteria for selecting the most reasonable method.
- The level of comparability between the transactions of related parties and those of independent parties must be high.
- Sufficient data on a comparable independent party must exist.
- The economic assumptions made in comparing the related parties' transactions with those of independent parties must reflect the actual economic situation of the parties.

The degree of comparability can be evaluated on the following factors:
- Functions performed and risks assumed, as reflected in conditions and transactions;
- Types as well as characteristics of the goods or services involved; and
- Economic environment of the market and the degree of change in market conditions.

If the inter-company price established by a Korean company and its foreign related party differs from an ALP, the Korean company shall pay the corporate income tax based upon the income it would have reported under an ALP.

If there is a transaction between unrelated parties identical or similar to the transactions between the related parties at issue, the CUP method will be selected over any other method.

Among the methods of determining an ALP, traditional transaction methods (i.e., the CUP method, the resale price method, and the cost-plus method) have priority over transactional profit methods such as the profit split method or the transactional net margin method. The latter methods are intended to be used only if the traditional methods are inapplicable.

If an international transaction made between unrelated parties cannot be treated as an arm's-length transaction because of the possibility of price manipulation, such transaction may not be used as a comparable one.

The tax authorities may use an arm's length range determined by two or more uncontrolled transactions to adjust the taxable income of taxpayers. Such tax adjustment must be made based upon reasonable values computed from the transactions examined.


D. Reporting Methods for an ALP Determination
If a taxpayer wishes to obtain an APA for transactions with its foreign related parties, then he or she should submit an application for an APA to the National Tax Service (NTS) by the end of the first fiscal year concerned (Unilateral APA).

Once the NTS approves the application of a certain method for determining an ALP, both the NTS and the taxpayer are bound by the method agreed upon in the APA. The roll-back of a unilateral APA to the prior 3 years is permitted (Unilateral APAs had previously applied on a progressive basis only).

An applicant for an APA may withdraw his application for an APA or change the particulars of such an application.

Any data submitted with the application for an APA will be used to only determine whether or not to grant an APA. If an application for an APA is refused or withdrawn, such data will be returned to the applicant in order to safeguard the confidentiality right of the taxpayer.

In case where an APA is obtained, a taxpayer is required to file an annual report which shows the inter-company price which was determined by the method agreed upon under the APA within six months of the annual tax return submission due date.

A taxpayer who applies for an APA may request that the NTS invoke a Mutual Agreement Procedure (MAP) with the competent authorities of the country in which its related foreign party is a resident under the relevant tax treaty (Bilateral APA). However, the NTS may grant an APA without undergoing a MAP for the taxpayer's convenience.

Having obtained an APA, a taxpayer may file an amended tax return that reflects the change from its prior inter-company price with a related party and the price determined under the APA.


F. Secondary Adjustment
If the tax authorities adjust the transfer price between a Korean company and its foreign related party based upon an ALP or they increase the taxable income of the Korean company, and if the foreign party has not returned an amount equal to the additional taxable income to the Korean company, the tax authorities will give the foreign related party the 90-day period during which it may return to the Korean company the amount plus interest accrued up to the point of the return. If the foreign related party fails to do so within the period, the amount equivalent to the additional taxable income will be mostly treated as dividends even if the foreign party is a related company of the Korean company other than a shareholder.


G. Corresponding Adjustment
The LCITA and its Enforcement Decree states that if a foreign government, on the basis of an ALP, increases the taxable income of a foreign company which is an associated enterprise to its Korean counterpart, the Korean government will correspondingly reduce the taxable income of that Korean company if the two governments have agreed upon an ALP applicable to the case through a Mutual Agreement Procedure (MAP). In such a case, a taxpayer may apply for a downward adjustment in his taxable income by filing a notification of the MAP results with the tax authorities.


H. Adjustment with regard to a Cost Sharing Agreement (CSA)
International standards used to verify appropriateness of cost sharing between a resident and its foreign related party have been reflected in domestic tax law.

Under the new provision, in case where a resident agrees to jointly develop intangible property with its foreign related party and to share costs/expenses incurred in relation to such development with the foreign related party, the tax base of the resident may be adjusted based on ALP (The shared costs based on the ALP are tax deductible).


I. Sanctions imposed for Failure to Comply with the Data Request
Under the LCITA, the tax authorities are empowered to request from a taxpayer the data required for an adjustment of the inter-company price. If a taxpayer fails to submit the requested data within 60 days without any justification, the tax authorities may grant an extension of 60 days. The taxpayer may appeal within 30 days of the penalty imposition date.

The tax authorities may request the following data from a taxpayer:

- A copy of the sales contract between the Korean company and its foreign counterpart;

- A price list of the products at issue;

- A schedule of the manufacturing cost of the products;

- An organizational chart of the company with a description of the functions of each department;

- The inter-company price policy; and

- The equity relationship of the group.
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