Tax issues on service transactions between foreign related parties

Date: Apr 14, 2020

I. Introduction

A domestic corporation A (hereinafter referred to as ‘A') is actually managed by its sister corporation B in Hong Kong (hereinafter referred to as ‘B'). A is looking for ways to send its earned surpluses to B. A is considering signing a contract with B for business advisory and paying USD120, 000 every month for the advisory service. This post will look into tax issues and risks this transaction carry.

II. Considerations and Tax Computation

① Types of service (personal service vs physical service)

B provides A with advisory service through email, phone calls, and documents. Bdoes not send its workers to A and does not have any office in Korea.

② What is relationship between A and B under the Korean tax law?

A and B are sister companies having the same parent corporation.  A makes a foreign related party to B.

③ Computation of service fees

Transaction prices between foreign related parties should be based on the arm's lengthprice.

★ Methods of Computing Arm's LengthPrices

1.  Comparable uncontrolled price method: A method that, in an international transaction between a resident and a foreign related party, regards as the arm's length price, a trade price between independent unrelated parties in comparable transactions;

2.  Resale price method: Where a resident and a foreign related party trade in an asset and the purchaser of the asset, being a party to such transaction, subsequently resells it to an unrelated party, a method that regards as the arm's length price, the amount computed by deducting the amount considered as the normal profit of the purchaser from the resaleprice;

3.  Cost plus method: A method that, in an international transaction between a resident and a foreign related party,regards as the arm's length price, the price computed by adding the amount considered as the normal profit of the seller of an asset or the provider of services to the cost incurred in the course of producing and selling the assetor of providing the services;

III. Tax Issues based on the types of services

1. If the legal, financial, tax and asset management services offered by B are ordinary services that could alsobe provided by a third party the payment for the service should be regarded as business income.

(1) Payment not exceeding arm's length price

① Pay withholding tax when payment is made

- No obligation to pay withholding tax

- The business income paid to Bis not subject to withholding taxation because B does not have a domestic placeof business.

② Inclusion ofdeductible expenses in corporation tax

- The fee paid to B is subject to deductible expense

- Documents such as contracts or evidential documents should be submitted

(2) Payment exceeding arm's length price

① Pay withholding tax when payment is made

- No obligation to pay withholding tax

- The business income paid to B is not subject to withholding taxation because B does not have a domestic place of business.

② Inclusion of deductible expenses in corporation tax

- Prices exceeding arm's length price are not deemed as expenses.

2. If the legal, financial, tax and asset management services offered by B are special services that cannot be provided by a third party company and allow others to use know-hows, skill instruction,copy rights, trademark rights, industrial property rights.

(1) Payment not exceeding arm'slength price

① Pay withholding taxwhen payment is made

- have obligation to pay withholding tax

- Tax rate for royalty income:10%

② Inclusion of deductible expenses in corporation tax

- The fee paid to B is subjectto deductible expense

- Documents such as contractsor evidential documents should be submitted

(2) Payment exceeding arm'slength price

① Pay withholding tax when payment is made

- have obligation to pay withholding tax

- Tax rate for royalty income:10%

② Inclusion of deductible expenses in corporation tax

- Prices exceeding arm's lengthprice are not deemed as expenses.

Learn more about Korean tax system by visiting our website

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