SOUTH KOREA Law and Practice Contributed by: Steve M Kim, Philje Cho, Gijin Hong and Kyu Bin Kang, Lee & Ko
Both the first and second-instance courts (Seoul Administrative Court, 17 February 2021, Case No 2019Guhap82554, and Seoul High Court, 7 July 2023, Case No 2021Nu37641) ruled in favour of Company O for the following reasons. • The most appropriate transfer pricing method in this case was the PSM. • However, in calculating the arm’s length price under the PSM: (a) the operating expenses of the relevant group affiliates were unjustifiably exclud - ed (ie, not deducted) when calculating the combined net profit subject to profit split between Company O and the relevant group affiliates, resulting in an overstate - ment of the profit; and (b) the profit allocation weight assigned to the group affiliates was underestimated, failing to accurately reflect their relative contribution to the overall profit. Based on these findings, the courts cancelled the tax assessment. This case also involved a dispute over the bur - den of proof. The tax authorities argued that, due to Company O’s failure to provide sufficient doc - umentation during the tax audit, they were una - ble to deduct the affiliates’ operating costs when calculating the profit subject to split. However, both the first and second-instance courts ruled that the burden of proof regarding the legality of the tax assessment rests with the tax authorities, ultimately ruling in favour of Company O. Nevertheless, there is academic opinion sug - gesting that, in the case of intercompany service transactions involving the indirect charge meth - od applied in this case, it would be practically impossible for the tax authorities to determine the arm’s length price without the taxpayer’s
submission of extensive documentation. This has led to the suggestion of a shift in the bur - den of proof. As this case is currently pending before the Supreme Court (Supreme Court Case No 2023Du50707), the outcome of the final judg - ment should be closely monitored. Company P Company P is a Korean corporation established for the purpose of manufacturing and selling polypropylene products, with a 50% ownership stake held by a Korean chemical company and the other 50% by Company A, which belongs to a multinational petrochemical group. Company P has subsidiary companies, C1 and C2, located in China, as well as T in Thailand. Company P sold the polypropylene products produced in Korea to C1, C2 and T (hereinafter referred to as “the transaction in question” ). The tax authorities selected the Cost Plus Meth - od (CPM) to determine the arm’s length price for the transaction in question. For this purpose, the tax authorities chose transactions between Company P and unrelated third parties as inter - nally comparable transactions to calculate arm’s length gross profit of Company P. Based on the income adjustment amount calculated there - from, the tax authorities assessed additional corporate income tax on Company P. In the first instance, the Seoul Administrative Court (Seoul Administrative Court, 17 February 2021, Case No 2019Guhap82554) ruled as fol - lows. Regarding the transactions between Company P and C1, as well as Company P and C2, the court found that, in the Chinese market, there could be a significant variation in cost-plus rates based on sales volume, manifested by the dif- ferent margins charged by Company P to differ -
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