SOUTH KOREA Law and Practice Contributed by: Steve M Kim, Philje Cho, Gijin Hong and Kyu Bin Kang, Lee & Ko
ignated one of the Vietnamese Subsidiaries (herein - after referred to as “YNL”) as the tested party, and selected seven Vietnam-based third-party companies as comparable companies to determine the arm’s length range for the full cost plus mark-up. As a result, the NTS concluded that Company Y had purchased finished products at prices higher than the arm’s length price, thereby shifting income to YNL. Con - sequently, the NTS increased Company Y’s taxable income by KRW 30 billion based on TP and imposed approximately KRW12 billion in corporate income tax (including penalties) accordingly. The Plaintiff (ie, Company Y) appealed this tax assess - ment to the Tax Tribunal. The Tribunal issued a partial reversal, ordering a recalculation of the arm’s length price after excluding one of the comparable compa - nies selected by the NTS. Although the tax assess - ment was partially cancelled following this decision, the Plaintiff filed a lawsuit regarding the remaining portion. The Plaintiff’s arguments were twofold. • When applying the TNMM, the party that performs relatively simple functions and does not own or contribute unique and valuable intangible assets should be selected as the tested party. With respect to the Transactions at Issue, the Plaintiff argued that Company Y performed only limited functions (ie, merely selling products purchased from YNL to the Buyers), and therefore Company Y, rather than YNL, should have been selected as the tested party. • Even if YNL were selected as the tested party, the comparable companies selected by the NTS lacked sufficient comparability with YNL, rendering the assessment unlawful. The lower court (Seoul High Court) rejected both of Company Y’s arguments. First, the court held that the selection of YNL as the tested party was lawful. In the Transactions at Issue, Company Y was the party that entered into supply contracts with the Buyers and externally bore the associated legal risks and respon - sibilities, whereas YNL had no contractual obligations or liabilities vis-à-vis the Buyers. Evidence from the Buyers showed that they regarded YNL merely as one
of Company Y’s overseas manufacturing subsidiaries and entered into the contracts based on their trust in Company Y. Accordingly, Company Y managed the overall execution of the transactions, address - ing issues ranging from supply chain management to post-delivery complaints. On this basis, the court concluded that Company Y could not be viewed as performing simpler functions than YNL. Second, the court found that the NTS’s selection of comparables was lawful. Using the ORBIS database, the NTS selected companies whose primary business involved export-oriented OEM garment manufactur - ing and, to focus on business-to-business transac - tions, excluded companies with selling, general and administrative expenses exceeding 20%. Although the Plaintiff argued that YNL’s woven garments were higher value-added than the comparable companies’ products and pointed to differences in raw material procurement and capacity utilisation (ie, 100%), the court held that these factors did not constitute mate - rial differences sufficient to undermine comparability. Although the lower court’s decision was appealed, the Supreme Court dismissed the appeal, holding that the lower court’s judgment was correct. The implications of this decision are as follows. First, in the context of an OEM business, even where an overseas manufacturing subsidiary undertakes manufacturing activities and performs various ancil - lary functions, it may be difficult to characterise the headquarters as the party performing the least com - plex functions for TP analysis purposes. This is par - ticularly the case where the headquarters develops and maintains customer relationships and exercises overall control and co-ordination of the business through the operation of multiple manufacturing enti - ties. With respect to R&D, which is a key consideration in a functional analysis under the OECD Transfer Pricing Guidelines, Company Y argued that YNL had accu - mulated manufacturing know-how by taking a leading role in certain R&D-related activities (eg, producing apparel samples at YNL’s R&D center in response to Buyers’ requests to communicate directly with the production facility). The court, however, found that
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