Taxing authority and tax law
Tax authority: National Tax Service (NTS)
Tax law: The Law for Coordination of International Tax Affairs (LCITA)
Relevant regulations and rulings
- Presidential Enforcement Decree (PED)
- The Ministerial Decree and Interpretations
OECD guidelines treatment
The LCITA has priority over the OECD guidelines. The NTS recognizes the OECD guidelines, but the OECD guidelines have no legally binding effect. Hence, if a taxpayer’s argument is based on the OECD guidelines only and not the LCITA, in practice, the NTS or regional tax offices may not accept it.
Due to the recent changes to the OECD guidelines, there are currently proposed changes to the LCITA which are pending legislation approval.
Priorities/pricing methods
The South Korean transfer pricing regulations prescribe the following transfer pricing methods: CUP Method, Resale Price Method, Cost Plus Method, Profit Split Method, TNMM, and other reasonable methods. Among the aforementioned transfer pricing methods, the taxpayer is to select the most appropriate method based on the availability and reliability of data. According to the current language of the LCITA, the transaction-based methods (i.e., CUP Method, Resale Price Method and Cost Plus Method, with no internal priority amongst these three methods), have priority over the profit-based methods ( i.e., Profit Split Method and TNMM, with no internal priority between these two methods). There is currently pending legislation to replace this priority of transaction-based methods with a “best method” type rule. Other reasonable methods may be selected if none of the five specific methods can be applied.
Transfer pricing penalties
There are two types of penalties associated with a transfer pricing adjustment: an underreporting penalty and an underpayment penalty.
- The underreporting penalty is approximately 10% of the additional taxes resulting from a transfer pricing adjustment.
- The underpayment penalty, which is an interest payment in nature, is calculated as 0.03% of the additional taxes on a transfer pricing adjustment per day (10.95% per annum) on the cumulative days. The counting of cumulative days of the underpayment starts from the day after the statutory tax filing due date, which comes three months after the fiscal year-end, and ends on the date that a payment for the tax assessment is made.
There is also a penalty of up to KRW30m for failure to provide the documentation requested by the NTS within the due date. There is pending legislation to increase the amount of this penalty to KRW100m, with the amount of the penalty to be based on the importance of the documentation requested. In general, the documents are to be submitted within 60 days of the date of request. However, the taxpayer may be granted a one-time extension for 60 days if the reasonable circumstances specified in the LCITA exist. See below for further details regarding contemporaneous TP documentation.
Penalty relief
Under Article 13 of the LCITA, if the taxpayer has prepared and maintained contemporaneous TP documentation for the TP methods applied to the cross-border intercompany transactions reported in the corporate income tax return and such documentation supports the reasonableness of the TP methods reported, the penalty for underreporting will be waived in the case where a TP adjustment is made.
PED Article 23 of the LCITA provides guidelines on the contents of the contemporaneous TP documentation. In general, contemporaneous TP documentation should include information on the taxpayer’s business (including functions performed and factors that can affect pricing for intercompany transactions with related parties), details on cross-border intercompany transactions, an explanation of the TP method selected and reasons for not selecting other TP methods prescribed in the regulations, and details on the comparable company or transaction data used. The guideline also stipulates that the comparable data used should be representative and should not have been chosen to favor the taxpayer’s position (i.e., no “cherry-picking”). In the case where a taxpayer applies a TP method different from that agreed upon in an APA or selected by auditors in a tax audit, the taxpayer needs to justify the use of the different TP method.
Also, under the LCITA Article 13 and PED Article 23, the underreporting penalty is waived if the mutual agreement procedure (MAP) result confirms that a taxpayer is not guilty of negligence; i.e., a taxpayer must:
- Select and report the most appropriate transfer pricing method specified in the LCITA
- Actually apply the selected method
- Maintain supporting documentation
Documentation requirements
At the time of filing the corporate income tax return, a taxpayer is required to submit certain transfer pricing reporting forms. Under the contemporaneous TP documentation rules, in order to receive the benefit of the relief from the underreporting penalty, taxpayers are required to prepare and maintain TP documentation by the due date of the filing of the annual corporate income tax returns. Such contemporaneous TP documentation must be submitted to the NTS within 30 days of the request. Documents are generally required to be submitted in Korean.
Documentation deadlines
A taxpayer must submit documents and information within 60 days upon request of the NTS. A onetime 60-day extension may be granted if reasonable circumstances specified in the LCITA exist. Contemporaneous TP documentation should be submitted to the NTS within 30 days of the request. The tax authorities may also request that a taxpayer submit certain information, including a TP study, at the time of a tax audit. In that case, the taxpayer may be given a shorter notice to submit (e.g., a 10-day notice).
Statute of limitations on transfer pricing assessments
The statute of limitations on transfer pricing adjustments is generally five years. It extends to 10 years in case of a fraud or other wrongful act and to 7 years if a taxpayer does not submit the tax filing on the due date.
Return disclosures/related-party disclosures
The LCITA requires a taxpayer to submit the following transfer pricing reporting forms when filing the annual corporate income tax return:
- A form stating the transfer pricing method selected and the reason for the selection of the method for each intercompany transaction. There are different forms for different types of transactions, (e.g., tangible property transactions, intangible property transactions, service transactions, cost-sharing arrangements).
- A summary of cross-border intercompany transactions with foreign related parties.
- Summary income statements of foreign related parties having cross-border intercompany transactions with the South Korean entity.
Audit risk/transfer pricing scrutiny
The risk of transfer pricing issues being reviewed during a tax audit is high. The NTS, as a matter of policy, requests for transfer pricing documentation, and such requests can be made separately from a tax audit. The NTS closely monitors companies whose profitability suddenly drops or companies whose profits fluctuate substantially over a number of years, and they are likely to be subject to tax audits. Also, companies paying large royalties abroad or receiving large management service fee charges or cost allocations from overseas related parties will likely be subject to scrutiny by the NTS.
APA opportunity
Unilateral, bilateral and multilateral APAs are available under the LCITA. In order to encourage the application of APAs, the NTS does not require an application fee, and documents submitted to the NTS with regard to an APA are to be held confidential in accordance with the LCITA. In addition, the APA officials of the NTS are making efforts to shorten the APA processing period. The NTS releases Annual Reports on APAs which include information such as statistics on the type of APAs being concluded, the countries that are counterparties to APAs, time taken to process APA cases, and other related information.
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