INSIGHT: Key Amendments to South Korean Transfer Pricing Regulations in 2020

South Korea enacted the 2020 tax reform bill on December 31, 2019. Under the 2020 bill, the Law for the Coordination of International Tax Affairs (LCITA) and its Presidential Enforcement Decree (PD of LCITA)—South Korea’s transfer pricing (TP) regulations—have been amended.

The 2020 amendments aim to provide increased clarity on and enhancement of the effectiveness of compliance for taxpayers, and also more effective procedures and measures for tax authorities to examine taxpayers’ TP policies. Tax audits have been and are becoming more rigorous, and considering the new rules, a more proactive and strategic approach will be required for documentation to support TP policies.

Key amendments can be classified broadly into three categories:

• filing and retention;
• tax audits;
• mutual agreement procedure (MAP).

Unless otherwise specified, the amendments will become effective for fiscal years beginning on or after January 1, 2020.

Filing and Retention

Amendments to TP Disclosures and Exemptions

The LCITA requires taxpayers to submit the following TP disclosure forms when the corporate income tax return is filed:

• form stating the TP method selected and the reasoning for selecting the method for each related party transaction (there are different forms for tangible property transactions, intangible property transactions, service transactions and cost sharing arrangements)—minimum revenue threshold exemption applies;
• summary of cross-border transactions with foreign-related parties;
• summary of income statements of foreign-related parties that have cross-border transactions with the Korean entity—minimum revenue threshold exemption applies.

Taxpayers are also required to file the master file and local file in South Korea, within 12 months from the fiscal year-end date, if the South Korean taxpayer’s revenue exceeds 100 billion South Korean won ($81.65 million) and the cross-border related party transaction exceeds 50 billion South Korean won. Minimum exemption is contingent on the taxpayer filing the master file and local file by the set due date. Therefore taxpayers must, in parallel, notify the tax authority of their intention to exempt filing the TP method selection form and summary of cross-border transactions.

While the above amended rules provide taxpayers with some relief from filing requirements, it is worth noting that similar information would need to be prepared for the TP forms for local file purposes. In any case, taxpayers that are on the borderline revenue threshold for master file and local file filings would need to prepare the forms to determine their compliance responsibilities, helping to ensure they are ready to submit if and when required.

The amended rules also remove the option for taxpayers to submit hard copies of the master and local files—only online submission is possible, via the South Korean tax authority’s electronic filing system.

Retention of Documentation

South Korea applies the best method rule in applying the TP methodology, and the rules for determining the arm’s length price for intangible assets stipulate the use of the comparable uncontrolled price method and profit split method first. This is followed by the use of the discounted cash flow valuation methodology as part of the other reasonable methods if all other methods cannot be applied.

The rules have not previously provided details on document retention; however, the new amended rules set this out for intangible transactions, relating specifically to the valuation report for transfer of intangible assets. This amendment strengthens the tax authority’s position to collect information from taxpayers on valuations performed, given this is often requested in tax audits when reviewing valuations.

Five Percent Markup to Low Value-Adding Intra-Group Services

Another amendment relates to the application of 5% markup to low value-adding intra-group services. While South Korean TP regulations are closely aligned with the Organization for Economic Co-operation and Development Transfer Pricing Guidelines, the LCITA did not stipulate the application of 5% markup on low value-adding intra-group services. The new amendments now include this application and include requirements on what constitutes a low value-adding intra-group service that the 5% markup could apply to, in addition to the required documentation supporting such low value-adding services.

Based on the amended rules, low value-adding services are considered support services such as:

• accounting, audit, legal and HR services that are not the core business activities of the group;
• where unique and valuable intangible assets are not used or created as part of the service provision and the service provider does not assume or manage significant risks;
• there shall not be a similar service transaction with third parties.

Special consideration should be given to whether the services are classified as low value-adding intra-group services where a separate benchmarking analysis to support the markup is not required (i.e., application of safe harbor rule of 5%), or whether they constitute a service that is not low value-adding but based on benchmarking analysis a 5% markup has been applied.

Nevertheless, notwithstanding the type of services, the taxpayer should retain documents supporting the substance and benefit of the services provided for deductibility purposes.

Tax Audits

Tax Authorities’ Use of Other Sources of Information for Assessment

TP is one of the most challenged areas during tax audits in South Korea. One notable area of difficulty for tax authorities is in the case of non-submission of requested information. The amended rules stipulate the tax authority may reasonably determine the arm’s length price based on information obtained from taxpayers engaged in similar business or other information obtainable by the tax authorities.

The rules also include “justifiable reasons” for late or non-submission:

1. fire, natural disaster, theft or other similar issues;
2. difficulty submitting due to significant business crisis faced by taxpayer;
3. related documents have been confiscated by a competent authority;
4. fiscal year-end of the overseas related party with the information has not ended;
5. gathering the information requires a considerable amount of time, rendering the deadline impossible to meet;
6. other reasons similar to the above.

The fifth reason above has been one of the most widely used for requesting a further extension for submitting the requested information. In such cases, the tax audit is ordinarily suspended until information is gathered and resumes thereafter. Based on the amended rules, the tax authority would be able to assess the arm’s length nature based on other sources of information.

If the taxpayer decides to appeal the tax assessment or apply for a MAP, the LCITA stipulates that the tax or competent authority can choose not to use the new information submitted during the extended timeframe: this information has been interpreted as requested during an audit, but not submitted.

Given these changes, detailed preparation and timely submission, with sufficient supporting documentation, is increasingly important.

Changes to Rules on Penalties for Non-Submission

Another factor to consider is the penalties for non-submission of requested information without justifiable reason. Current penalties for non-submission range between 5 million and 70 million South Korean won, up to a cap of 100 million South Korean won, depending on the information specifics.

Based on the amended rules, the tax authority may request the penalized taxpayer to submit the requested information or correct the false information within 30 days. If the taxpayer does not comply, an additional penalty may be imposed, up to 200 million South Korean won. The same penalty amount first imposed can also be imposed for every 30 days of non-submission.

Mutual Agreement Procedure

In the case of an additional tax assessment as a result of a tax audit, the taxpayer may choose domestic appeal procedures or decide to apply for the MAP. The MAP can be one effective measure to resolve double taxation issues.

The amended rules provide three developments relating to MAPs in South Korea:

• calculation of interest for deferment of tax collection or postponement of disposition in arrears;
• procedures on execution of the MAP result and submission of taxpayer position;
• timeline on the return of the income adjustment amount under the MAP.

Calculation of Interest

Once the tax audit is concluded and the taxpayer decides to appeal the additional tax assessment, the taxpayer may apply for deferral of tax collection or postponement of disposition before filing the appeal procedures. However, interest on the tax assessment continues to accrue during the appeal process. The taxpayer is subject to tax payment deferral interest (9.125% per annum) if payment is deferred by the taxpayer for the duration of the appeal proceedings.

It is therefore in the taxpayer’s best interests to first pay the additional taxes and penalties before proceeding with the appeal, to avoid accruing further interest.

Where the tax payment is deferred by the taxpayer, the new rules stipulate the national taxes refund interest rate (2.1% per annum) to be applied for the deferment period after two years for MAPs. While this reduces the interest after the two years, it should be considered in the context that the targeted average period in South Korea for resolving MAP cases received on or after January 1, 2016 is 24 months.

Execution of MAP Result

In the past, when the taxpayer takes both routes of appeal (to court and MAP), if the court ruling differed from the result concluded by the MAP, the MAP would be deemed not to have proceeded in the first place (i.e., nullified). The amendment deletes such clause to strengthen the effectiveness of the MAP and to deter unnecessary court appeals. Furthermore, the taxpayer may put forward its position on the MAP to the tax authority until the conclusion of the MAP.

Return Timeline

For MAPs that are concluded, the TP income adjustment resulting from the MAP shall be returned within 90 days from the next day following the MAP conclusion date.

Planning Points

Considering the amendments to the South Korean TP regulations, it is critical that taxpayers:

• pay close attention to the revised compliance requirements relating to filing of TP-related forms and documentation;
• address new supporting document retention rules for intangible and service transactions;
• become even more prepared to support their TP policy for tax audits, considering the increase in penalties and enhanced policy for tax assessment of the South Korean tax authorities.

Jason Yun is a Partner leading the Asia-Pacific Transfer Pricing Desk at Ernst & Young LLP, based in London.

He can be contacted at jason.yun@uk.ey.com

Disclaimer: The views reflected in this article are the views of the author and do not necessarily reflect the views of the global EY organization or its member firms.

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