Taxissue on the contract with overseas affiliate party
Written by Yun,Myeong Seon
Translated by Park, Eun Kyung
Ⅰ “A” ( we will call it “ company “) willpay USD 120,000 to the “Hongkong B” ( we will call it Hongkong B) quarterly forthe service fee according to the service contract. We will see tax issue forthis contract.
Ⅱ Fact and Notion
1. Providing service method ( Existence and nonexistence of human and material)
hongkong B will provide consulting service by email,phone call and other documents.
hongkong B will not send employee to companyand will not use any space as office in Korea.
2. Relationship on tax between company andhongkong B : Overseas affiliate party (note1)
Company and hongkong B have same holdingcompany located in certain island. HongkongB is regarded as overseas special affiliate party.
3. Basis of service fee calculation (note2. )
Normal price should be fixed in the transactionwith overseas special affiliated party.
Priceshould be fixed by most rational method among below 3 (note 3, note 4)
① Comparable third party’s price : amount fixed in the transactionbetween company and none special affiliated party.
② Cost plus pricing: production cost + common profit amount
③ Transaction net proft: amount based on “ transaction net profit” in the similar transact withnone special affiliate party.
(2) Documents to submit to the tax authority.
Reportwith method of normal price calculation for service.
Ⅲ Tax issue: tax report discrepancy byprovided service contents.
1.Common service provided from third party.
Ifprovided law, accounting, tax. Asset management consulting service from honking B are common service which can beprovided by other third party,
Theconsulting service fee is regarded as “business income”.
(1)The price within normal price
① Withholding tax within normal price
-noneduty for withholding tax
- Inthe case of business income, Korean government tax on business income only tothe overseas company which has place of business in Korea and provide serviceby it.
Honking B doesn’t have place of business inKorea. Therefore Korean government doesn’t tax to the Hongkong B. (note 5)
②Accepting as expense in the corporate tax calculation
-Theamount paid for service fee can be accepted as expense (title of account:payment commission)
-Requireddocuments : contracts and verified documents as providing service schedule,service operation sheet, breakdown of payment. (note 6)
(2) Price over normal price
① Withholding tax in payment
-noduty for withholding tax
-Inthe case of business income, Korean government tax on business income only tothe overseas company which has place of business in Korea and provide serviceby it.
Honking B doesn’t have place of business inKorea. Therefore Korean government doesn’t tax to the Hongkong B.
②Accepting as expense in the corporate tax calculation.
Theprice over normal price can not be accepted as expense ( reject on wrongfulcalculation).
2. Special and specific service which can notbe provided from third party.
Law, accounting, tax, asset managementconsulting service provided by Hongkong B are special service which can not beprovided by third party.
Therefore use of know-how, technique transfer,intellectual property, trademark rights, industrial property right, value andpayment for them are regarded as loyalty.
(1) Price within normal price
① withholding tax in payment.
-havingduty for withholding tax
-taxrate for loyalty income : 10%(including local income tax) (note7)
②Accepting as expense in the corporatetax calculation
-Paidservice fee can be accepted as expense.(title of account: payment commission).
-Requireddocuments : contracts and verified documents as providing service schedule,service operation sheet, breakdown of payment.
(2) Price over normal price.
① Withholding tax in payment
-havingduty for withholding tax
-taxrate 10% (including local tax) for loyalty.
②Accepting as expense in the corporate tax calculation
Itcan not be accepted as expense because it is over normal price (note8)
1. type of income
This transaction occurs between company and HongkongB (overseas affiliate party) providing special and specific service.
This service can be shown know how, technicaltransfer, intellectual property, trademark rights, industrial right propertyright, brand value which can not be provided by other third party.
Therefore it looks loyalty income but it can bedifferent by contents of service.
2. Factors should be suggested clearly in thecontract.
(1)Scope of Service
(2) Clear standardof calculation for the service fee.
Norman price shouldbe calculated according to the Adjustment of International Taxes Act and samelaw decree in the transaction.
Normal price willbe accepted with condition as follows;
① It should be meet certain standard.
For example · multiply sales amount orbusiness profits by certain rate.
·Add certain rate of profit tothe time, expense for supplying service.
Standard shouldbe clear and fixed in calculation as above example
② It should be applied toconsistently.
Calculationshould be applied consistently over 2 taxation period.
③ It should be recognized in view of practice of same type ofbusiness and a socially accepted idea.
Undergoing tax investigation, officer from taxoffice will examine carefully on the transaction price between company andaffiliate party(Hongkong B).
We recommend you calculate the price accordingto the related law.
3. Preparing documents
To be accepted as expense for consulting fee,you should have contracts, providing service schedule, service operation sheet,and breakdown of payment basis of fixing price.
Ⅵ. Related Law.
Note 1) Adjustment of International Taxes Act.article 2-1-8-(2)
Arelationship between both parties to a transaction where a third party ownsdirectly or indirectly at least 50 percent of their respective voting stocks.
Note 2) Adjustment of International Taxes Act.article 4-1
(1) Where the price ofan international transaction in which either party to the transaction is aforeign related party is lower or higher than the arm’s length price, the taxauthority may determine or rectify the tax base and tax amount of a resident(including a domestic corporation and a domestic place of business; hereafterthe same shall apply in this Chapter) based on the arm’s length price:Provided, That where the same method of computing the arm’s length price amongthe methods prescribed in Article 5 applies to computation of the arm’s lengthprice for at least two taxable years, and the tax base and tax amount for someof such taxable years are determined or rectified based on the arm’s lengthprice so computed, the tax base and tax amount for the remaining taxable yearsshall also be determined or rectified based on the same arm’s length price.
Note 3) Adjustment of International Taxes Act.article 5
Methods of Computing Arm’s length Prices.
1.Comparable uncontrolled price method: A method that, in an internationaltransaction between a resident and a foreign related party, regards as thearm’s length price, a trade price between independent unrelated parties incomparable transactions.
2.Cost plus method: A method that, in an international transaction between aresident and a foreign related party, regards as the arm’s length price, theprice computed by adding the amount considered as the normal profit of theseller of an asset or the provider of services to the cost incurred in thecourse of producing and selling the asset or of providing the services.
3.Transactional net margin method: A method that, in an international transactionbetween a resident and a foreign related party, regards as the arm’s lengthprice, a trade price calculated on the basis of an ordinary transactional netmargin realized in comparable transactions between a resident and a unrelatedparty.
Note 4) Adjustment of International Taxes ActDecree . article 6-2
Arm's Length Price for Service Transactions
(1) Where the price fora transaction of service (referring to business management, financial advising,payment guarantee, computing or technical support, or any other servicetransaction deemed necessary for the business concerned; hereafter the sameshall apply in this Article) between a resident and a foreign related party isthe one for the transaction of service that meets all the followingrequirements, such a price shall be deemed the arm's length price andrecognizable as a loss:
1.The service provider shall make an agreement in advance and actually providesuch service in accordance with the agreement;
2.The person who has been provided with such service shall expect additionalprofits or a reduction in expenses;
3.The price for the service provided shall be computed in accordance with Article5 of the Act and Articles 4 through 6 of this Decree. In such cases, it shallbe computed in accordance with the following guidelines, when the cost plusmethod under Article 5 (1) 3 of the Act or the net trade profit ratio to salescost and sales expenses under Article 4 (2) 1 (c) of this Decree is applied:
(a)The cost incurred shall include all expenses incurred directly or indirectly inproviding the service;
(b)Where the service provider requests a third party to perform all or part of theservice vicariously pays the price therefor in a lump sum, and then claims suchexpenses to the person to whom the service is provided, the service providershall add an ordinary profit to the cost incurred from the activities that theservice provider performs on his/her own in connection with the service:Provided, That the foregoing shall not apply, if deemed reasonable in light ofthe substance of the service, status of the transaction, and customarypractices;
4.There shall be documents prepared and preserved for proving the facts set forthin subparagraphs 1 through 3.
Note 5) Korea-Hongkong treaty. article 7
The profits of an enterprise of aContracting Party shall be taxable only in that Party unless the enterprisecarries on business in the other Contracting Party through a permanentestablishment situated therein. If the enterprise carries on business as aforesaid,the profits of the enterprise may be taxed in the other Party, but only so muchof them as is attributable to that permanentestablishment.
Note 6) Adjustment of International Taxes Actenforcement rule 4-0-2
Accepting as Deductible Expense for ConsultingFee.
To be accepted as expense there need documentsas providing service schedule, service operation sheet, breakdown of payment. A
Above documents are needed to verify thatconsulting is occurred.
Note 7) Korea-Hongkong treaty. article 12
1. Royalties arising in a Contracting Party and paid to aresident of the other Contracting Party may be taxed in that otherParty.
2. However, such royalties may also be taxed in theContracting Party in which they arise and according to the laws of that Party,but if the beneficial owner of the royalties is a resident of the otherContracting Party, the tax so charged shall not exceed 10 per cent of the grossamount of the royalties. The competent authorities of the Contracting Partiesshall by mutual agreement settle the mode of application of thislimitation.
3. The term "royalties” as used in thisArticle means payments of any kind received as a consideration for the use of,or the right to use, any copyright of literary, artistic or scientific workincluding cinematograph films, or films or tapes used for radio or televisionbroadcasting, any patent, trade mark, design or model, plan, secret formula orprocess, or for information concerning industrial, commercial or scientificexperience.
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