SOUTH KOREA Trends and Developments Contributed by: Dong Shin Lee, Wankyu Jeon, Sung Hyun Ryu and Young Woong Park, Yoon & Yang LLC
ing substantial comparability are core requirements for the legality of taxation when calculating arm’s length prices under Article 8 of the Law for Coordina - tion of International Taxes Affairs (LCITA). The ruling indicates, that when tax authorities calculate arm’s length prices, the tax authorities must demonstrate that they examined and, where necessary, adjusted for differences in functional analysis, risk assumption, and economic conditions between the comparable entities and the tested party. Moreover, this decision is expected to contribute to the protection of taxpayers’ rights by clearly reaffirm - ing that the burden of proof for the legality of denial of unfair calculation and transfer pricing adjustments lies with the tax authorities. From a practical stand - point, this judgment highlights the importance of pre - cisely analysing the scale and nature of transactions with related parties, preemptively validating the eco - nomic rationale underpinning transfer pricing policies and establishing a defense strategy that rigorously requires the tax authorities to satisfy their evidentiary burden during tax audits. Whether it is appropriate to select comparable companies without reasonable adjustments for significant differences in handled products, transaction stages, and functions when applying the Transactional Net Margin Method to product export transactions with foreign related parties (Supreme Court Decision 2024du64901 dated 13 March 2025) Summary of the decision The Supreme Court upheld the lower court’s decision that the corporate income tax assessment imposed by the tax authorities, based on Articles 7 and 8 of the LCITA, was unlawful concerning the transfer pricing applied by a domestic corporation exporting bedding cleaners and other products to its foreign related party in Japan. In this case, the tax authorities proceeded on the premise that the Japanese local entity per - formed only simple sales functions and calculated the arm’s length price based on the operating margins of arbitrarily selected comparable companies using the Transactional Net Margin Method (TNMM). Both the trial and appellate courts, however, the determined that significant differences existed between the Jap - anese local entity and the comparable companies
selected by the tax authorities in terms of the charac - teristics of handled products, transaction stages, core functions performed, and risks assumed. Specifically, the court determined that the tax authori - ties did not sufficiently implement reasonable adjust - ments to eliminate these differences during the calcu - lation of the arm’s length price, and the adjustments solely for working capital were insufficient to secure comparability. On that basis, the court concluded that the the arm’s length price calculation, which formed the basis of the tax assessment, did not meet the requirements for a reasonable calculation method stipulated in Article 8 of the Enforcement Decree of the LCITA. The Supreme Court ultimately dismissed all appeals holding that there were no grounds for further review, including any material error of laws. Implications This decision is significant in that it reaffirms the need for a rigorous and disciplined approach to the selec - tion of comparable companies and the conduct of a substantive comparability analysis when assessing must the legality of the arm’s length price calculation method in transfer pricing adjustments. This ruling makes it clear that tax authorities should not rely on the practice of mechanically extracting comparable companies using commercial databases during trans - fer pricing tax audits. Instead, they must precisely analyse the impact on profit margins caused by dif - ferences in product types, business activity functions, transaction conditions, and economic circumstances between the transaction under review and the compa - rable transactions and implement appropriate adjust - ments where such differences are material. In particular, where the categories of handled prod - ucts differ or where key value drivers that materially affect net profitability are not aligned, it is difficult to sustain the legal defensibility of an arm’s length price absent an examination of those underlying economic differences. Simple numerical adjustments figures will not suffice unless accompanied by a reasoned analy - sis addressing the intrinsic distinctions in functions, assets, risks, and market positioning. In conclusion, this ruling suggests that future dis - putes over similar transfer pricing transactions should
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