This month we present Part I of a two-part series on Korea’s amended Presidential Decree under the Law for Coordination of International Tax Affairs and other relevant tax laws. Following is context for and the main points of the amendment. Next month, we’ll look at other important tax regulation changes providing foreign investors with advantageous effects.
Guaranty Fees
• Background
The National Tax Service (NTS) has imposed a substantial amount of tax assessments against Korean multinational enterprises on grounds that the level of guaranty fees charged by the Korea parent company to their foreign subsidiaries was not sufficient to meet the arm’s length principle stipulated in the Law for Coordination of International Tax Affairs (LCITA). A substantial number of cases were appealed by the taxpayer and are still pending at the Tax Tribunal.
In the process, it has come to the attention of both the Ministry of Strategy and Finance (MOSF) and taxpayers that there is no clear statutory guideline for determining the arm’s length guaranty fee, creating vast uncertainties. In an effort to reduce further confusion between the NTS and taxpayers, the MOSF has enacted new rules setting forth the standards of determining arm’s length guaranty fees in the Presidential Decree under the LCITA (PD-LCITA).
• Main points of the amendment
The newly amended Article 6-3 of the PDLCITA stipulates a set of methods for determining arm’s length price, specifically applicable to guaranty fees. The methods stipulated are (i) benefit approach (i.e., benefits derived in the form of the reduced cost of raising capital), (ii) cost approach (i.e., an expected loss to the guarantor), and (iii) cost-benefit approach (i.e., a reasonable compromise between (i) and (ii)). PD-LCITA delegates the details of these approaches to the Ministerial Decree of LCITA (MD-LCITA), which was also amended and became effective on February 23. MDLCITA specifies detailed factors that include not only traditional financial factors (such as interest differentials and credit rating), but also non-financial factors (such as geographical region, industry, level of technology and market position). Article 6-3 of the PD-LCITA also provides for a safe harbor, whereby fees determined by methods meeting certain requirements would be deemed arm’s length. The amendment is applicable to payment guarantees given after the effective date of the MD-LCITA.
• Implication for foreign-invested firms
Although the amendment was motivated by the need to address the ambiguity concerning guaranty fees for Korean multinationals, the same principle also applies equally to foreign multinational enterprises having affiliates in Korea. This may provide a tax-saving opportunity for foreign multinationals with Korean operations. The charge of payment guaranty fees to the Korean affiliates usually subjects them to very strict documentation requirements, which, in the absence of a specific statutory guideline on what constitutes arm’s length guaranty fees, could be overbearing. The amendment could substantially ameliorate the burden by its clear stipulation of arm’s length guaranty fees and adoption of a safe harbor. As part of the tax-saving consideration, however, potential additional costs emanating from the charge of guaranty fees (such as withholding tax and proxy VAT) should be carefully weighed against the benefits to be gained. That is because guaranty fees to be paid to a foreign parent company may need to be withheld by an affiliated company in Korea in accordance with Korean income tax law as well as Korean tax treaties. Further, if the payer of guaranty fees is a VAT-exempted entity, such as financial institutions, it should collect proxy VAT from the provider of the guaranty (i.e., foreign parent company in most cases) and pay it to NTS.
By Kyung Geun Lee
Tax Partner, Yulchon LLC
Ph.D. in Economics
Source : Invest Korea