Updates of Korean laws and practices regarding TP and relevant taxes including BEPS

Recent years, topics related to BEPS have been actively brought about both in a global standpoint and that of South Korea. South Korean tax authorities (KNTS) have made significant efforts to strengthen the transfer pricing regulations and to consider the practical issues that the taxpayers would bear in the recent amendments of the legislations. The amendments aim to bring the Korean regulations more in line with the BEPS Project, as well as to address taxpayer concerns that were raised after the new filing requirements, and controversial issues related to payment guarantees. Topics discussed include the additional rules and penalty provisions relating to the master file, local file, and country-by-country (CbC) reporting requirements (collectively referred to as the combined report of international transactions or CRIT), deemed interest rate for intercompany loan transactions, controversies in payment guarantees, and the recent Korea-India tax treaty amendment.

This international tax review highlights major changes in the aforementioned tax revision.

Under the legislation amendment, the CbC report has been added to the scope of the CRIT. The CbC report is required for any multinational entity (MNE) with:

1) Sales revenue exceeding KRW 1 trillion ($909 million) per consolidated financial statements for the preceding year, and would be required to be submitted by the ultimate parent company of the MNE. However, if the parent company is located in a foreign country that does not require a CbC report, or does not agree with the exchange of the CbC report, it would be the obligation of the domestic entity to submit the CbC report.

On December 28 2016, South Korea's Ministry of Strategy and Finance (MOSF) released a proposal of details with respect to CbC reporting. The proposal is known in English as proposed presidential enforcement decree of the law for the coordination of international tax affairs, or PED of LCITA.

The proposed enforcement decree would require that there be a reporting entity notification form filed concerning the CbC report. And that, multinational entities (MNEs) operating in Korea would be required to submit a reporting entity notification form in advance, specifying which entity would submit the CbC report to which jurisdiction. While the final CbC report would be due within 12 months of the fiscal year-end, the reporting entity notification form would be required to be submitted within six months of the fiscal year-end (i.e., for the fiscal year ending December 31, the deadline would be June 30 of the following year) by MNEs operating in Korea. The filing is required to be submitted by:

1) Ultimate parent companies located in Korea (outbound) and,

2) Entities or branches located in Korea, which the parent companies reside in foreign countries (inbound).

Under the previous proposals, the master file and local file was required to be submitted by the filing date of the corporate tax return. In the amendment, the required filing deadline for the fiscal year of 2016 would now be within 12 months of the fiscal year-end (i.e., for the fiscal year ending December 31 2016, the deadline is December 31 2017), providing MNEs additional time to prepare the master file and local file.

In consideration of the similarity of the advance pricing agreement (APA) application documents and the content of the local file, the amended regulation states to exempt some MNEs from preparing the local file. This exemption would apply for MNEs that have had relevant transactions covered by an already completed APA and considered to be at an arm's-length price. This exemption would not extend to MNEs that have submitted, but not finalised, an APA.

Previously the law stated that, if any part of the CRIT was not submitted or submitted and/or was falsely described, a penalty in the amount of KRW 30 million ($27,000) would apply. Through the amendment, this penalty provision was revised so that each report would be subject to:

1) A separate penalty of KRW 10 million ($9,000).

For example, if the MNE satisfied the threshold requirement for submitting the master file and local file, but only submitted the local file, the penalty would be KRW 10 million instead of KRW 30 million.

It is required that a detailed statement of cross-border transactions be filed, and the penalty for not submitting one or falsely providing any information in the statement has been KRW 10 million (approximately $9,000). Through the amendment, this penalty provision was revised so that each statement missing for an entity would be subject to:

1) Separate penalty of KRW 5 million ($4,500).

The penalty for both CRIT and a detailed statement of the cross-border transactions could not be more than KRW 100 million (approximately $91,000) in total.

Until recent years, it has been the norm for the KNTS to impose taxes on Korean parent companies for providing payment guarantees to foreign subsidiary(ies) without receiving appropriate arms-length payment guarantee fees. However, there have been controversies with the credit assessment model used by the KNTS, a model developed by KNTS, on whether the model itself was an appropriate calculation methodology at arms length. In October 2015, the court decision interpreted that the methodology developed and used by KNTS was inappropriate for the following reasons:

1) Issues in availability of the data used

2) Issues in usage of domestic corporate bankruptcy rate

3) Disregard of industry-specific and non-financial information

4) Disregard of implied warranties

5) Disregard of locational factors

The court decision has diminished the controversies on the appropriate credit assessment to be used, and lessened the burden and confusion of the taxpayers in regards to the matter. In the practical perspective, Moody's RiskCalcTM is now widely accepted for assessing credit-ratings used for calculating arms-length payment guarantee fees.

In respect to intercompany loan transactions the previous measure stated that the arm's-length interest rate for intercompany loan transactions is an interest rate applicable or deemed as applicable to ordinary monetary transactions between unrelated parties, taking the following matters into consideration: (1) the amount of the obligation; (2) maturity of the obligation; (3) whether the obligation is secured; and (4) the credit rating of the debtor.

Under the legislation amendment, the revised measure is to reflect that a deemed interest rate, as stipulated in the enforcement rules, could be applied by selecting either methods:

1) Arms-length interest rate that has been stated by MOSF, or;

2) Arms-length interest rate that has been calculated.

As a result, a taxpayer could select either approach to apply an arm's-length interest rate, and this treatment would allow taxpayers to diversify the calculation methods available for an arm's-length interest rate.

This change has been effective for an intercompany loan transaction since February 7 2017, the date of enforcement.

Until recent years, taxpayers were not eligible for customs tax refunds for transactions that occur from compensating adjustments via overseas related parties. The previous customs act did not allow for custom tax refunds of the compensating adjustments, which were based on transfer pricing rule. However, the recent customs act amendment includes such compensating adjustment to be reflected to the transaction price of imported goods, leading to the availability of customs refund for the taxpayers if certain conditions under customs act are met. The requirements are listed as follows:

1) A taxpayer with approved APA, etc.

2) Compensating adjustments made pursuant to the arms-length method under LCITA

3) Submission of the preliminary price adjustment application form, before import of goods

The amendment will be in effect for goods imported from July 1 2017, the enforcement date. Filing for tax refunds can be made after approval of the submitted preliminary price adjustment application form by Korea Customs Services.

It has been 30 years since the last effectuation of the Korea-India tax treaty in 1986, in which the new amendments are expected to provide solutions to the double taxation for companies operating in both countries, and further enhance economic cooperation between Korea-India. The subjects that have been newly implemented or amended are:

1) Introduction of mutual agreement procedure (MAP) regulation

2) Revision of taxable categories

3) Deduction in limited tax rate of dividends, interests, and fees

4) Granting partial right of taxation on capital gains to the source country

5) Increase in tax exemption of the source country's shipping income

6) Revision of permanent establishment (PE) definition

7) Revision of taxable basis in independent personal services

8) Exchange of financial information

9) Ineligibility for the application of the tax treaty for transactions with intention of tax avoidance

The new amendment in the Korea-India tax treaty has been made to pursue economic benefits on both countries. Although the intention of the amendment speaks for the betterment, it is nevertheless necessary for Korean companies that are currently or in plan to operate in India to strategise their corporate activities in a comprehensive manner, relative to the new amendment.

Provided below are major topics for LCITA reform proposals currently under review by the MOSF:

• Hard- to-value-intangibles

• Low value-adding intra-group services

• Revision of PE definition

• High bride mismatching

• General anti-abuse rule etc.

Kang Gil Won

Partner KPMG in South Korea GFC 27th Floor, 737 Yeoksam Dong, Gangnam-gu, Seoul 135-984 Tel: +82 2 2112 0907 gilwonkang@kr.kpmg.com Gil Won is the global transfer pricing services leader of KPMG in South Korea. He has an excellent reputation within the profession and has close relationships with the Korean tax authorities. Before joining KPMG, Gil Won led the outbound transfer pricing practice at Kim & Chang, Korea's largest law firm and helped establish its Chinese tax practice. He concluded the first Korean-Chinese APA and the first APA related to intra-group service transactions in Korea. Gil Won was a member of the competent authority team of Korea's National Tax Service and handled various negotiations with G8 nations. He continues to hold seminars for the Korean government and Korean multinational companies on transfer pricing issues. During 2013, Gil Won was appointed as one of the world's leading transfer pricing advisers in Euromoney's guide.

Baek Seung Mok (William)

Partner KPMG in South Korea GFC 27th Floor, 737 Yeoksam Dong, Gangnam-gu, Seoul 135-984 Tel: +82 2 2112 0982 sbaek@kr.kpmg.com Seung Mok is the global transfer pricing services partner of KPMG in South Korea. He has in-depth knowledge and various field experience in tax consulting focusing on international tax and transfer pricing matters. Seung Mok has been working in KPMG since 2002 and specialises in transfer pricing documentation/planning, tax audit defences, appeals, APA/MAP and designing and implementation of tax-optimised transfer pricing systems for multinational clients mostly investing in China, Vietnam, India, Mexico, EU and the US. He is a member of South Korea CPA/CTA and takes care of KPMG key multinational clients including SK Hynix, Hanwha, Kolon etc. Recently he has held lots of seminars for Korean multinational companies on transfer pricing matters including BEPS action plans and has provided the clients with various TP services.

Sang Hoon Kim

Partner KPMG in South Korea GFC 27th Floor, 737 Yeoksam Dong, Gangnam-gu, Seoul 135-984 Tel: +82 2 2112 7939 skim32@kr.kpmg.com Sang-Hoon is a transfer pricing partner. With over 20 years of work experience at the NTS, Sang-Hoon handled the MAP and APA approvals with various countries. Sang-Hoon managed international investigation, analyses on foreign companies, and funds-related projects. Sang-Hoon conducted management of revenue during his time in District Tax Offices of the NTS. As a tax examiner, he was also involved in various tax audits involving transfer pricing, beneficial interest, permanent establishments, thin capitalisation, and offshore tax evasion issues.