Appropriate interest rates in transactions among relatedparties

Date: June 26, 2020

I. Introduction

Where related parties lend and borrow money,deemed interests are calculated based on weighted average borrowing rates of  interest or interest rates of overdrawn account. This post will sketch out the guidelines in deciding the interest rates in the transactions.

II. Case Study

1) The largest shareholder of corporation A isalso the largest shareholder of corporation B. Therefore, corporation A and Bis related parties to each other.

2) Corporation A's interest rate of loans is 1.5percent and interest income rate is 20.percent.

3) Corporation B's interest rate of loans is2.75 percent and there's no interest income rate.

4) Where corporation A and B lend and borrow money for 2 percent of interest rate, is this transaction deemed a wrongful business transaction?

III. Conclusion

Where it is impracticable to apply the lessee's incremental borrowing rate of interest and there exists a ground prescribed by Ordinance of Ministry of Economy and Finance: The interest rate prevailing in the market on overdraft shall apply only to relevant loans or borrowings.

IV. Related Laws and Regulations

Article 88 (Types of Wrongful Calculations)

(1)  "Where ... the tax burden of a domesticcorporation has been unjustly reduced" in Article 52 (1) of the Act meansany of the following cases:

1.  Where assets are purchased or received as investments in kind at a price higher than the market price or the assets are over-depreciated;

6.  Where money, other assets or services are lent or provided gratuitously or at an interest rate, tariff, or rent lower than the market price: Provided, That this shall not apply to any of the following cases:

(a)  Where money is paid to the exercise or grant of stock options, etc. referred to in the subparagraph 19-2 of Article 19 with the exception of its items;

(b)  Where company houses (including rental company houses prescribed by Ordinance of the Ministry of Economy and Finance)are provided to executive officers (including executive officers who are minority stockholders, etc.) and employees, other than stockholders,contributors, etc.;

Article 89 (Scope of Market Price)

(3)  In lending or borrowing money referred to in Article 88 (1) 6 and 7, the lessee's incremental borrowing rate of interest(hereinafter referred to as "lessee's incremental borrowing rate ofinterest") prescribed by Ordinance of the Ministry of Economy and Finance shallbe the rate prevailing in the market, notwithstanding paragraphs (1) and (2):Provided, That in any of the following cases, the interest rate prevailing in the market on overdraft (hereinafter referred to as "interest rate onoverdraft") prescribed by Ordinance of the Ministry of Economy and Finance according to the classification in each subparagraph shall apply:

1.  Where it is impracticable to apply the lessee's incremental borrowing rate of interest and there exists a ground prescribed by Ordinance of Ministry of Economy and Finance: The interest rate prevailing in the market on overdraft shall apply only to relevant loans or borrowings;

1-2.  Where there are loans, the maturity period of which exceeds five years, and other cases prescribed by Ordinance of Ministryof Economy and Finance: The interest rate prevailing in the market on overdraft shall apply only to relevant loans or borrowings;

2.  Where the relevant corporation chooses the interest rate prevailing in the market on overdraft, as prescribed by Ordinance of the Ministry of Economy and Finance, upon filing a report under Article 60 of the Act: The interest rate prevailing in the market on overdraft shall apply to the business year for which interest rate prevailing in the market on overdraft is chosen and two consecutive business years thereafter.

Article 52(Repudiation of Wrongful Calculation)

(1)  Where the head of the tax office having jurisdiction over the place of tax payment or the commissioner of the competent regional tax office deems that the tax burden of a domestic corporation has been unjustly reduced through the wrongful calculation of the amount of income of the domestic corporation in transactions with a related party prescribed by Presidential Decree (hereinafter referred to as "related party"),he/she may calculate the amount of income for each business year of the domestic corporation regardless of the wrongful calculation of the amount of income of such domestic corporation (hereinafter referred to as "wrongful calculation").

(2)  In applying paragraph (1), the standards for determination shall be sound social norms, generally-accepted trade practices,and the prices applied or acknowledged to be applied to arm's length transactions between persons, other than related parties (including premium rates, interest rates, rents, exchange rates, and other corresponding rates;hereafter referred to as "market price" in this Article).

(3)  A domestic corporation shall submit a detailed statement on the particulars of transactions with each related party for each business year to the head of the tax office having jurisdiction overthe place of tax payment, as prescribed by Presidential Decree.

(4)  In applying paragraphs (1) through (3),matters necessary for the types of wrongful calculation, the assessment of market prices, and other matters shall be prescribed by Presidential Decree.

 

 

 

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