Korea, Republic of
The consolidated corporate tax filing system can be adopted for a domestic corporation in cases where two or more wholly-owned subsidiaries exist. A taxpayer may elect the consolidated filing scheme upon approval from the tax authorities, but it cannot be revoked for at least five years after the election of the consolidated tax filing.
The LCITA authorises the tax authorities to adjust the transfer price based on an arm’s-length price and to determine or recalculate the taxable income of a domestic company (including PE of a foreign company) when the transfer price for the transaction between the domestic company and its foreign related party is either below or above an arm's-length price.
The LCITA lists the following methods for determining an arm's-length price: the comparable uncontrolled price (CUP) method, the resale price method, the cost-plus method, the profit-split method, the transactional net margin method, and other reasonable methods. Other reasonable methods can be used only if it is unfeasible to apply one of the aforementioned methods.
The method used and the reason for adopting that particular one for an arm's-length price determination must be disclosed to the tax authorities by a taxpayer in a report submitted along with the taxpayer's annual tax return.
To address consistency with international standards on transfer pricing rules, the tax reform for 2019 introduces a new rule to clarify and establish the principles for determining the arm’s-length prices of the transactions involving intangibles and addressing an appropriate remuneration for the functions performed, such as development, enhancement, maintenance, protection, and exploitation of intangibles. The principles of determining the arm’s-length price in a cross-border intangible transaction and addressing an appropriate remuneration in the transaction provide that the comparable uncontrolled price (CUP) method, profit split method, valuation method (discounted future cash flows) would take precedence over other transfer pricing methods; and the companies performing the functions and assuming the relevant risks regarding the development, enhancement, maintenance, protection, and exploitation of intangibles should get appropriate remuneration for the contributions they made.
Transfer pricing documentation requirement
In line with the Organisation for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting (BEPS) Action 13, the LCITA includes a reporting requirement for multinational companies in Korea to submit a consolidated report (including local file and master file) on their cross-border, related-party transactions, affecting not only Korean corporations but also foreign corporations having a PE in Korea that meet all of the following conditions: (i) annual gross sales of an individual entity exceeding KRW 100 billion and (ii) international related-party transactions exceeding KRW 50 billion per year. Required information to be submitted for reporting includes organisation, business, intangible assets, related-party transactions, etc. relating to the group and the local entity. Failure to comply with the reporting requirement will result in a penalty and, effective from the fiscal year beginning on or after 1 January 2020, eventually lead to the assessment of an estimated tax. A penalty of up to KRW 100 million is imposed for failing to submit the documentation or for submitting incorrect information. With effect from 1 January 2020, a penalty of up to KRW 200 million may be imposed every 30 days after the first penalty assessment was imposed until the documentation is submitted, depending on the lateness of the submission.
The LCITA introduces the requirement to submit country-by-country (CbC) reporting following the implementation of the transfer pricing rules requiring multinationals in Korea to submit local files and master files on their cross-border transactions. The CbC report must be filed within 12 months after the end of the ultimate parents’ income tax year.
In cases where a Korean company borrows from its foreign-controlling shareholder and the debt-to-equity ratio exceeds 2:1 (6:1 in case of financial institutions), a portion of interest payable on the excess borrowing is characterised as dividends subject to Korean WHT (reduced rate if a tax treaty applies) while being treated as non-deductible in computing taxable income.
In line with the OECD’s recommendation on the limitation of interest deductions (BEPS Action 4), the new rule shall restrict interest deduction on top of the existing thin capitalisation rule. Deduction of net interest (i.e. the amount of interest expense paid to overseas related parties minus the interest income received from overseas related parties) claimed by a domestic company for international transactions will be limited to 30% of the adjusted taxable income (i.e. taxable income before depreciation and net interest expenses) of the domestic company. This will be implemented from the fiscal year beginning on or after 1 January 2019.
Controlled foreign corporations (CFCs)
Under the Korean CFC rule, when a Korean national directly or indirectly owns at least 10% in a foreign corporation and the foreign company’s average effective income tax rate for the three most recent consecutive years is 17.5% or less (the level of 70% of the top marginal CIT rate of 25% at present from the tax year beginning on or after 1 January 2022), the undistributed earnings of the CFC shall be deemed to be paid as a dividend to the Korean national and subject to tax in Korea.
For more information on the CFC rule, see Foreign income in the Income determination section.
Deduction limit on hybrid financial instruments
In a commitment to implement the hybrid mismatch rules recommended by the OECD (BEPS Action 2), a new rule shall limit expense deductions for hybrid mismatch arrangements. Hybrid financial instruments include financial instruments that have debt or equity positions at the same time but are treated as a debt in one country but treated as an equity in the other country (e.g. participating bonds). In principle, expense deduction will be denied for the amount of payment that is not taxed in a counterpart jurisdiction.
Under the provision of the CITL, the tax authorities may recalculate the corporation’s taxable income when CIT is unreasonably reduced due to transactions with related parties. Generally, if the discrepancy between the transaction price and fair market value exceeds 5% of the fair market value or KRW 300 million, the transaction will be subject to this provision.