Appropriate interest rates in transactions among relatedparties

Date: June 11, 2021

I. Introduction

Where related parties lend and borrow money,deemed interests are calculated based on weighted average borrowing rates ofinterest or interest rates of overdrawn account. This post will sketch out theguidelines 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 is1.5 percent 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 borrowmoney for 2 percent of interest rate, is this transaction deemed a wrongfulbusiness transaction?

III. Conclusion

Where it isimpracticable to apply the lessee's incremental borrowing rate of interest andthere exists a ground prescribed by Ordinance of Ministry of Economy andFinance: The interest rate prevailing in the market on overdraft shall applyonly to relevant loans or borrowings

IV. Related Laws and Regulations

Article 88 (Typesof 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 asinvestments in kind at a price higher than the market price or the assets areover-depreciated;

6.  Where money, other assets or services arelent or provided gratuitously or at an interest rate, tariff, or rent lowerthan the market price: Provided, That this shall not apply to any of thefollowing cases:

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

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

Article 89 (Scopeof Market Price)

(3)  In lending or borrowing money referred to inArticle 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 Financeshall be the rate prevailing in the market, notwithstanding paragraphs (1) and(2): Provided, That in any of the following cases, the interest rate prevailingin the market on overdraft (hereinafter referred to as "interest rate onoverdraft") prescribed by Ordinance of the Ministry of Economy and Financeaccording to the classification in each subparagraph shall apply:

1.  Where it is impracticable to apply thelessee's incremental borrowing rate of interest and there exists a groundprescribed by Ordinance of Ministry of Economy and Finance: The interest rateprevailing in the market on overdraft shall apply only to relevant loans orborrowings;

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

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

Article 52(Repudiation of Wrongful Calculation)

(1)  Where the head of the tax office havingjurisdiction over the place of tax payment or the commissioner of the competentregional tax office deems that the tax burden of a domestic corporation hasbeen unjustly reduced through the wrongful calculation of the amount of incomeof the domestic corporation in transactions with a related party prescribed byPresidential Decree (hereinafter referred to as "related party"),he/she may calculate the amount of income for each business year of thedomestic corporation regardless of the wrongful calculation of the amount of incomeof such domestic corporation (hereinafter referred to as "wrongfulcalculation").

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

(3)  A domestic corporation shall submit adetailed statement on the particulars of transactions with each related partyfor 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 ofmarket prices, and other matters shall be prescribed by Presidential Decree.

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