Recent tax reform to align with the OECD BEPS Action Plan

The 2017 tax reform included the BEPS Action Plan measures, such as Action 2 on neutralising the effects of hybrid mismatch arrangements and Action 4 on limiting base erosion via interest deductions and other financial payments. It also included supplementing Action 13 on re-examining transfer pricing documentation, which had already been discussed in the 2015 tax reform.

The recently introduced tax reforms are the efforts of the Korean government continuously aligning with the OECD BEPS Action Plan, although the law needs to be amended to reflect the full integrity of the OECD initiative.

Details regarding the abovementioned matters and other transfer pricing (TP) regulations in the 2017 tax reform are included in this article.

Since the Law on the Coordination of International Taxation Adjustments (LCITA), which encompasses Korean TP regulations, was introduced in 1995, the LCITA has been updated in line with the revision of the OECD TP guidelines, which in turn are aligned with the global TP standards. Accordingly, Korea introduced a supplement to the transactional profit method and comparability analysis published in its 2012 tax reform following the OECD's release of the revised TP guidelines in 2010. Furthermore, the Korean government has introduced and amended legislation, shown in Table 1, in relation to the OECD BEPS discussion items.

Table 1
OECD BEPS Action Plan	Relevant development in Korea’s regulations
Action 2 Neutralise the effects of hybrid mismatch arrangements	Exclusion of Interest Expenses Incurred in Hybrid Financial Instrument Transactions from Deductible Expenses: LCITA, Article 15-3, newly inserted on December 19 2017. Details included in the next section.
Action 3 Strengthen controlled foreign company rules	Sanctions Against Non-Compliance with the Obligation to Submit Data: LCITA, Article 12, amended on December 19 2017. The obligation to submit information on controlled foreign companies (CFCs) has been strengthened, and a new penalty of up to KRW 100 million ($88,000) of additional tax may be levied for failure to comply.
Action 4 Limit base erosion via interest deductions and other financial payments	Exclusion of Interest Expenses Exceeding Income from Deductible expenses: LCITA, Article 15-2, newly inserted on December 19 2017. Details included in the next section.
Action 5 Counter harmful tax practices more effectively, taking into account transparency and substance	Substance Over Form Principle Concerning International Transactions: LCITA, Article 2-2, amended on January 1 2010. A substance-over-form rule that allows the tax authority to re-characterise a related-party transaction based on its substance in which the tax burden of a company has been unjustly reduced.
Action 6 Prevent treaty abuse	New preamble, including BEPS treaty anti-abuse rule, and adoption of the principal purpose test to deny treaty benefits in inappropriate circumstances (signing of the Multilateral Instrument, June 7 2017).
Action 13 Re-examine transfer pricing documentation	Obligation to Submit Data on International Transactions: LCITA, Article 11, amended on December 19 2017. Implementation of master file, local file, and country-by-country reporting (CbCR) requirements (combined report of international transactions, or CRIT).
	Guidelines, etc for Assessing Administrative Fines: Enforcement of Decree of LCITA, Article 51, amended on February 13 2018. Special provisions on the application of penalty tax: LCITA, Article 13, amended on December 19 2017. Details included in the next section.

As referenced above, the newly implemented laws reflect Actions 2, 4, and 13 of the OECD BEPS Action Plan. The Korean government introduced two new regulations concerning interest expenses under Article 15, which will take effect on January 1 2019:

• Exclusion of Interest Expenses Incurred in Hybrid Financial Instrument Transactions from Deductible Expenses: The payment of interest by a domestic corporation and discount amortisation in relation to a financial instrument (with the nature of both capital and liabilities) transaction with a foreign related party that is not taxed and, as such, is not included in the income of the counter party, in the counter party's jurisdiction, within the appropriate period, will be excluded from the deductible expenses and deemed disposed of as expenditure of income of the domestic company; and

• Exclusion of Interest Expenses Exceeding Income from Deductible Expenses: The limitation of the deduction of net interest expenses in which the amount borrowed from a foreign affiliate exceeds 30% of the adjusted income amount. Any excess amount is excluded from the deductible expenses and deemed disposed of as expenditure of income of the borrowing company.

Moreover, the 2017 tax reform contains a supplement to enforce Action 13 by increasing the penalties for failure to comply with regulations concerning the combined report of international transactions (CRIT), and the 'special provisions on the application of penalty tax' which regulated TP documentation (contemporaneous documentation) before the CRIT was introduced. The amendments are as follows:

• Standards, etc. for the imposition of administrative fines: The existing regulation stipulated that if any part of the CRIT was not submitted or was only partially submitted and/or was falsely described, each report would be subject to a KRW 10 million ($8,900) penalty. The penalty has now been increased to KRW 30 million for each report; and

• Special provisions on the application of penalty tax: In the previous article, when and if the taxpayer maintains and provides data verifying the method for an arm's-length price applied in filing his/her income tax or corporate tax return and is acknowledged as having selected and applied the method for an arm's-length price based on a reasonable determination, the taxpayer was exempted from the penalty for under-reporting under a Korean tax authority assessment following filing of the tax return. In the amended regulation, the local file is regarded as the contemporaneous documentation when the local file is submitted within the deadline.

Not only did the Korean government introduce and amend regulations reflecting the OECD BEPS Action Plan, they also supplemented the ‘Pre-Adjustment of Arm’s-Length Price for National Taxes and Customs Duties’ (LCITA, Article 6–3) and ‘Rectification Claim for Adjustment of Arm’s-Length Transfer Prices for National Taxes and Customs Duties’ (LCITA, Article 10-2). Under the law before the amendments, taxpayers could file for pre-adjustment only if the TP method and the valuation method for customs duties were similar. However, under the newly amended law, taxpayers can now file for pre-adjustment even if the methods applied are not similar. Additionally, when and if there are differences between the import price and the price determined by customs authority, the period during which the taxpayer can file a claim after being made aware of the rectification has been extended from two months to three months.

Although Korean tax rules have no formal connection to the OECD guidelines, Korea has been diligently changing TP rules and administrative practice to align with the OECD guidelines. For example, the LCITA was amended in 2012 in accordance with the revisions made in the OECD guidelines published in 2010. Furthermore, Korea presented the 2017 tax reform in line with the 2017 OECD guidelines, which followed the final report on the OECD BEPS Action Plan published in October 2015. However, Actions 8, 9, and 10 are yet to be fully reflected in the LCITA.

As summarised in Table 2, Korea has followed the OECD guidelines when they were revised, but recent changes to the OECD guidelines have not yet been fully implemented in the LCITA. For example, the 2017 revised OECD guidelines include a section on analysing risk and necessary conditions for the assumption of risk, such as control of the risk and financial capacity and low value-adding intra group services, etc., but the LCITA has not yet introduced such concepts. Considering that recent TP audits in Korea involving management service fees have been under intense scrutiny by the tax authorities and the tendency for sufficient evidential documentation being required to prove the substantiality of the costs incurred by service providers, implementing low value-adding services in the LCITA would make it easier for multinational enterprises (MNEs) in Korea to analyse what documentation was required.

Table 2
OECD BEPS Action Plan	Relevant Korean regulations
Action 8: Intangibles	The Considerations for the Transfer Pricing Method for Intangibles: Enforcement Decree LCITA, Article 6, paragraph 2.
Action 9: Risks and capital	Selection of Transfer Pricing Method and “Supplement, etc. to the Transfer Pricing Method: Enforcement Decree of LCITA, Article 5, 6. Stipulates the comparability analysis that includes the risks accompanying trade.
Action 10: Other high-risk transactions	Arm's-length price for service transactions: Enforcement Decree of LCITA , Article 6-2. Stipulates the type of services transaction and the relevant criteria, which include the preparation of relevant documentation, such as a contract, organisation charts, and so on, for the deductibility of the service fees, which are paid by the Korea-based company to foreign related parties in other jurisdictions.

To its great credit, Korea has created the BEPS Support Centre. The centre was founded on March 2 2016 by the Ministry of Strategy and Finance, the Korean Institute of Public Finance, the Korean Chamber of Commerce and Industry, along with non-governmental experts. Gil-Won in KPMG in Korea was invited as one of those non-governmental experts, and has been participating as a core member of the centre. The BEPS Support Centre is aware of taxpayers' difficulties, especially as regards intangible transactions, in determining and verifying to the tax authorities that their TP outcomes are in line with value creation. Korea is proactively discussing how to reflect Actions 8 to 10 in the LCITA. Since Korea has always adopted any revisions to the OECD guidelines, it is expected that relevant regulations in relation to Actions 8 to 10 will be implemented shortly.

Korea has been examining its TP arrangements in line with revised OECD guidelines, but there is still some work to do in terms of formalising their legal status. It is unlikely that Korea would consider reflecting the changes in the OECD guidelines with immediate effect, yet more aggressive actions are expected in the near future.

Gil-Won Kang

Partner KPMG in Korea 27F. Gangnam Finance Centre, 737 Yeoksam Dong, Gangnam-gu, Seoul, 135-984 +82 2 2112 0907 gilwonkang@kr.kpmg.com Gil-Won Kang is a lead partner in KPMG Korea’s transfer pricing (TP) practice. Gil-Won has handled various transfer pricing projects, such as tax audit defence, TP documentation, advance pricing agreements (APA), and mutual agreement procedures (MAP). As a core member of the competent authority (CA) team of the National Tax Service, he handled various negotiations, and actively participated in CA meetings.

Sang-Hoon Kim

Partner KPMG in Korea 27F. Gangnam Finance Centre, 737 Yeoksam Dong, Gangnam-gu, Seoul, 135-984 +82 2 2112 7939 skim32@kr.kpmg.com Sang-Hoon Kim has more than 20 years of work experience at the National Tax Service, during which time he handled the mutual agreement procedure (MAP) and advance pricing agreement (APA) approvals of various countries. Sang-Hoon managed international investigations, analyses of foreign companies, and funds-related projects. He was involved in the management of revenue during his time at the district tax offices of the NTS. As a tax examiner, he was also involved in various tax audits involving transfer pricing (TP), beneficial interest, permanent establishments, thin capitalisation, and offshore tax evasion issues.

Seung-Mok (William) Baek

Partner KPMG in Korea 27F. Gangnam Finance Centre, 737 Yeoksam Dong, Gangnam-gu, Seoul, 135-984 +82 2 2112 0982 sbaek@kr.kpmg.com Seung-Mok (William) Baek has in-depth knowledge and varied field experience in tax consulting, focusing on international tax and transfer pricing (TP) matters. Seung-Mok has been working at KPMG in Korea since 2002 and specialises in TP documentation/planning, tax audit defence, appeals, advance pricing agreements (APA)/mutual agreement procedures (MAP), and the designing and implementation of tax-optimised TP systems for multinational clients mostly investing in China, Vietnam, India, Mexico, the EU and the US. He is a member of the South Korea CPA/CTA, and advises some of KPMG's key multinational clients, including SK Hynix, Hanwha, Kolon, etc.