| Transfer Pricing Investigation by Korea NTS (national tax service) | |||||||||
| 1) Current Movement of the Tax Office | |||||||||
| Recently, the tax office is eager to collect tax from foreign companies. Due to continued | |||||||||
| depression in Korean economy, local companies are not so profitable to pay tax any more. | |||||||||
| Therefore, they may divert their concern to foreign companies operating in Korea. | |||||||||
| The assessment of tax due to "Transfer Pricing : TP" is active nowadays. | |||||||||
| Basically, TP means an arbitrary pricing between related companies in different countries in | |||||||||
| a bid to reduce profit in the high-tax-rate country. As you know, this is devised to reduce the | |||||||||
| aggregate tax worldwide of the multinational companies. | |||||||||
| 2) Real case of TP investigation | |||||||||
| One of our clients is now under tax audit due to TP. | |||||||||
| It is a 100% wholly owned subsidiary of a multinational company. The Head Office currently is | |||||||||
| holding subsidiaries, branch offices or even agents all over the globe and mainly engages | |||||||||
| in supplying academic periodicals, books and Database to a lot of libraries of universities, | |||||||||
| research institutes and the governments. | |||||||||
| The subsidiary in question has 10 or more employees and is assisting the libraries order | |||||||||
| new peroiodicals, books and database. They sometimes provide information on new | |||||||||
| materials and install some computer facilities needed to access a certain database. All the | |||||||||
| people working in the procurement division of libraries, institute and government do not | |||||||||
| speak/write good English, so they act as a bridge between head office and the user. | |||||||||
| Based on the service agreement between head office, 105% cost plus markup system is | |||||||||
| used by the subsidiary for computing revenue. | |||||||||
| This summer (June), tax office commenced tax audit to this subsidiary. They requested a | |||||||||
| heap of information and material to the subsidiary including income statement of the Head | |||||||||
| office segregated by country which can illustrate the revenue and expense belonging to a | |||||||||
| specific country, e.g. Korea. Upon this request, subsidiary submitted the information to the | |||||||||
| tax office upon Head office's approval and preparation. | |||||||||
| According to the income statement segragated by country, the revenue incurred from Korean | |||||||||
| market was 50 million USD and the bottomline was 4.5 million USD after tax effect for a single | |||||||||
| year of 2005. The 5-year (2001 ~ 2005) aggregate figure is almost four(4) fold of that of 2005. | |||||||||
| However, the operating expense of the subsidiary was just 1 billion Korean Won for 2005, so | |||||||||
| the profit was just 50 million Korean Won. The subsidiary has paid a tax less than 20 million | |||||||||
| Korean Won for 2005. Total taxes paid for the last 5 years (2001 ~ 2005) is less than 70 | |||||||||
| million Korean Won. | |||||||||
| Tax office insists that this tax amount is really small compared to the operation volume in | |||||||||
| Korea. They want to adopt PSM (Profit Sharing Method) which is prescribed in the Article 5 of | |||||||||
| the "Law for Cordination of International Tax Affairs", asserting that the profit in the IS of Head | |||||||||
| office was derived from the combined effort of both Head Office and the subsidiary together, | |||||||||
| so it should be devided based on relative contribution ratio. And they exhibited to us the | |||||||||
| computation formula. | |||||||||
| We understand that the computation of "relative contribution ratio" done by the tax office was | |||||||||
| not fair. They used only the expense, number of persons and other financial factors to derive | |||||||||
| the ratio, so as a result of this, the ratio of the subsidiary is high and the tax assessment due | |||||||||
| to this computation is also very high. | |||||||||
| In consideration of the above situation, we cannot rule out the possibility that the 105% cost | |||||||||
| plus markup system used by other companies in Korea may face a challenge from the tax | |||||||||
| office in someday. Preparation against that challenge is recommended. | |||||||||