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ransfer pricing is currently one of the biggest taxation concerns for companies engaged in cross-border inter-company transactions. Transfer pricing audits conducted by the tax authorities usually result in large tax adjustments that range from a few million to several tens of millions of dollars. This may be detrimental to the financial performance of a company.

  Recent Developments in Transfer Pricing Regulations
  The Law on the Coordination of International Tax Affair (¡°LCITA,¡± effective Jan. 1st 1996) was established in Korea as a formal regulation that independently governs transfer-pricing issues in Korea. Like most countries in which transfer pricing rules and regulations are established, LCITA espouses its principles based on the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrators (¡°OECD Guideline¡± hereinafter).
  Thus, LCITA adheres to arm¡¯s length principles, in large part, similar to those adopted by OECD member countries as well as non-member countries that closely follow the OECD Guideline.
  The National Tax Service (¡°NTS¡±) recently began to conduct more detailed and active monitoring of transfer pricing by domestic companies after it took steps to increase its knowledge of transfer pricing and strengthened its resolve to bolster tax revenues from this area.
  The NTS has held several conferences to inform taxpayers of its intention to reinforce investigation of international transactions and to promote the Advance Pricing Agreement (¡°APA¡±) program to taxpayers.

  In the diagram below, by charging its Korean subsidiary $1,000 for products in a controlled transaction (Transaction A), the parent company will be generating a taxable income $200 higher than if it sold the same goods directly to an unrelated party for $800. On the other hand, by selling the same products to an unrelated party in an uncontrolled, market determined transaction (Transaction B) the taxable income of the subsidiary will be reduced by $200.

  This results in an infringement on the Korean government¡¯s right to impose a tax and consequently, the government will make adjustments on the transfer price of the subsidiary in order to secure $200 of taxable income.
  Therefore, the transfer pricing regulation is a system to re-calculate taxable income that should have been attributed to a taxpayer. The regulations impose the resulting amount of tax in such cases where applying a higher or lower price than the arm¡¯s length price reduces the taxable income of the taxpayer.

  Transfer pricing regulation applies where
International transactions
Related parties, and
An arm¡¯s length price is involved.
  Each of these conditions is examined below in detail.

  International Transactions
  The transfer pricing regulation is only applied in cases of international transactions. In cases where transactions are conducted between domestic affiliates, the regulation for unfair transactions under the Corporate Income Tax Law shall be applied.

  Related Parties
  The scope of related parties prescribed in the LCITA is classified as to related parties under
A Formal Criterion and
A Substantial Criterion
  The key principles regarding the scope of related parties are as follows.

Refer to Paragraph 1, Article 2 of the LCITA/Article 2 of Presidential Enforcement Decree (PED) under the LCITA

  Arm¡¯s length price
  The term ¡°arm¡¯s length price¡± means a price that is applied, or determined as being applied in the same or similar transaction (comparable uncontrolled transaction) between one trade party and an unrelated trade party. (Refer to Item 10, Paragraph 1, Article 2 of the LCITA).

  Transfer Pricing Method
  An arm¡¯s length price should be calculated/tested by the most reasonable method listed in the LCITA given the circumstances surrounding the transaction. The LCITA presents four transfer pricing methods:
Comparable uncontrolled price method
Resale price method
¡°Cost plus¡± method, and
¡°Other reasonable methods¡±

  According to Paragraph 1, Article 5 of the LCITA, application of other reasonable methods shall be limited to cases where the arm¡¯s length price may not be computed by the comparable uncontrolled price method, the resale price method, or the cost plus method. The Presidential Enforcement Decree under the LCITA (Article 4) lists the profit split method, the transaction net margin method and other applicable methods as other reasonable methods.
  Transfer Pricing Methods Prescribed in the LCITA

By Lee Heui-Tae (htlee@samil.com)
Director, Transfer Pricing Team,
Samil Accounting Corporation
+ 82-2-3781-9083