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					TRANSFER PRICING IN KOREA




    November, 2005

    Presenter : Songdong Kim
                The NATIONAL TAX SERVICE
                KOREA
Table of Contents

   Transfer Pricing in Korea
   Cases




                                2
 Transfer Pricing in Korea
1. Brief Overview of Regulation
   Contained in the Law for the Coordination of International Tax Affairs
    (“LCITA”, effective January 1996)
   Consistent with OECD guidelines and based on the arm’s length standard
   Specifies the transfer pricing methods
   Contains provisions for set-offs, advance pricing approval and mutual
    agreement through competent authority




                                                                             3
 Transfer Pricing in Korea (cont’d)
2. Transfer Pricing Method

                                        Comparable Uncontrolled Price (CUP) Method
    Traditional Transactional Methods   Resale Price Method (RPM)
                                        Cost Plus Method (CPM)

                                        Profit Split Method (PSM)
    Profitability-Based Methods
                                        Transactional Net Margin Method (TNMM)


    Other Methods Deemed Reasonable




   Transactional methods preferred over profitability-based methods
   No preference between transactional methods and between profitability-based
    methods




                                                                                     4
 Transfer Pricing in Korea (cont’d)
3. Documentation Requirement
   Primary Documentation
       Declaration of Transfer Pricing Method
       Summary of International Intercompany Transactions
       Summary of Foreign Affiliate Income Statements
       Must be submitted along with filing of tax return

   Secondary Documentation
       Other Documents Supporting Transfer Pricing Policies including: contracts, product price lists,
        statement of manufacturing cost, schedule of individual controlled and uncontrolled
        transactions, documents relating to the supply of services and other transactions,
        organizational charts, etc.
     Should be provided to NTS within 60 days of request
     One-time 60 day extension is available
     Failure to submit may result in penalties of up to KRW 30 million (US$25K) for each instance
        of non-compliance as well as the inability to submit documents at a later date.




                                                                                                          5
 Transfer Pricing in Korea (cont’d)
4. Current Environment
   Since the introduction of the LCITA, transfer pricing has become the single
    most important international tax issue facing multinational companies doing
    business in Korea

   NTS has declared that the enforcement of transfer pricing compliance is
    their highest priority
       Introduced onerous transfer pricing documentation requirements

       Conducting transfer pricing audits on a routine basis

       Training field examiners to enhance the ability to conduct transfer pricing audits

       Increase the administrative resources toward transfer pricing




                                                                                             6
 Transfer Pricing in Korea (cont’d)
5. TP Administration in Korea (TP Audit)
   NTS or the regional tax office selects companies to be audited after analyzing
    submitted documents
   Characteristics of TP Audit
       Inevitable double taxation  MAP or Korean Tax Appeal Procedure
       External adjustment  Huge income adjustment amount, secondary disposition (disposition
        of income)
       Analysis of vast amount of data over an extend period of time
       Mutual agreement on the adjustment instead of fine tuning
   Problems with TP audit
       Taxpayer: Assessment on results  difficult to establish stable business strategy
                                          Excess tax duty and double taxation
       Tax Administration: Limited resources (manpower, time), burden of proof, need to reach
        agreement with taxpayer
   Solutions for solving TP issues is an APA
     Guarantee predictability and establish stable business strategy (taxpayer)



                                                                                                  7
 Case
(1) Resale Price Method Case

□ Case Summary


 <Foreign Parent Company>                      <Korean Subsidiary>

            A Co.             Indirect Sales          A' Co.          Resale
           (Parent)                                (Subsidiary)

                                                          Contact customers
                                                          Price Negotiation
                        Direct Sales                      After Service

                      (Off-shore Sales)
                                                       B
                                                   (End user)



                                                                               8
  Case
(1) Resale Price Method Case

□ Transaction Type
  1) Resale : A‘ Co. acquires title to goods and resells the goods through the local distribution network
              → A‘ Co. performs main functions such as advertising and assumes major risks such as
                inventory risk, etc.
  2) Sales Support : A‘ Co. provides domestic sales support for A Co.
                → A Co. performs main functions and assumes major risks



□ Questions
1) Appropriate TPM and Comparables Selection Approach?
2) Applicability of financial statement profit ratio?
3) Deemed PE issue?
4) Marketing Intangible issue?




                                                                                                            9
 Case
(2) Service Provision Case

□ Case Summary




     <Foreign Parent Company>               <Korean Subsidiary>
                             Management
                               Service
                  A Co.                            A' Co.
                 (Parent)                       (Subsidiary)
                             Compensation
                               (at cost)




                                                                  10
 Case
(2) Service Provision Case

□ Transaction Type : Intra-group Services
 ○ Type of Service : Management Service (accounting, legal, etc)
 ○ Fee Calculation : Allocation of parent company’s service related expenses without mark-up


□ Questions
1) How to prove that service was actually provided? (See attached: NTS Tongchik 4-0-2)


2) Appropriate calculation method of service fee?
  - Determining allocable expenses (direct, indirect)
  - Determining allocation basis
  - Determining related companies subject to allocation
3) Is APA applicable?




                                                                                               11
 Case
<Attached: Basic Comprehensive Regulations (Effective ‘04.6.15)>
                (Would be upgraded as a provision of Presidential Decree, coming year)


4-0…2【Deductibility of Management Services Fees Remitted to a Foreign Parent Company】

① Previously, a foreign parent company and its Korean subsidiary were regarded as separate entities,
   accordingly, head office expenses allocated to the subsidiary were unlikely to be regarded as tax-
   deductible expenses. However, under the newly issues Basic Comprehensive Regulations, the fees
   remitted for essential services will be recognized as deductible expenses where all of the following
   conditions are met:
 1.Substantiating evidence of actual services performed is available; and
 2.Service fees are directly related to the generation of the subsidiary’s income; and
 3.Service fees are charged at a rate that would normally apply to a transaction between third parties.


② However, where the foreign related party (parent company) is a shareholder of a Korean domestic
   company, the following services performed will not be regarded as essential services.
 1. Preparation of financial statements according to foreign accounting principles where the parent
   company is located
 2. Activities regarding parent company’s reporting obligations
 3. Audit or supervisory activities


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