T RANSFER P RICING IN K OREA

1. TRANSFER PRICINGIN KOREA November, 2005 Presenter : Songdong Kim The NATIONAL TAX SERVICE KOREA

2. Table of Contents • Transfer Pricing in Korea • Cases

3. Transfer Pricing in Korea 1. Brief Overview of Regulation • Contained in the Law for the Coordination of International Tax Affairs (“LCITA”, effective January 1996) • Consistent with OECD guidelines and based on the arm’s length standard • Specifies the transfer pricing methods • Contains provisions for set-offs, advance pricing approval and mutual agreement through competent authority

4. Transfer Pricing in Korea (cont’d) 2. Transfer Pricing Method • Transactional methods preferred over profitability-based methods • No preference between transactional methods and between profitability-based methods

5. Transfer Pricing in Korea (cont’d) 3. Documentation Requirement • Primary Documentation • Declaration of Transfer Pricing Method • Summary of International Intercompany Transactions • Summary of Foreign Affiliate Income Statements • Must be submitted along with filing of tax return • Secondary Documentation • Other Documents Supporting Transfer Pricing Policies including: contracts, product price lists, statement of manufacturing cost, schedule of individual controlled and uncontrolled transactions, documents relating to the supply of services and other transactions, organizational charts, etc. • Should be provided to NTS within 60 days of request • One-time 60 day extension is available • Failure to submit may result in penalties of up to KRW 30 million (US$25K) for each instance of non-compliance as well as the inability to submit documents at a later date.

6. Transfer Pricing in Korea (cont’d) 4. Current Environment • Since the introduction of the LCITA, transfer pricing has become the single most important international tax issue facing multinational companies doing business in Korea • NTS has declared that the enforcement of transfer pricing compliance is their highest priority • Introduced onerous transfer pricing documentation requirements • Conducting transfer pricing audits on a routine basis • Training field examiners to enhance the ability to conduct transfer pricing audits • Increase the administrative resources toward transfer pricing

7. Transfer Pricing in Korea (cont’d) 5. TP Administration in Korea (TP Audit) • NTS or the regional tax office selects companies to be audited after analyzing submitted documents • Characteristics of TP Audit • Inevitable double taxation  MAP or Korean Tax Appeal Procedure • External adjustment  Huge income adjustment amount, secondary disposition (disposition of income) • Analysis of vast amount of data over an extend period of time • Mutual agreement on the adjustment instead of fine tuning • Problems with TP audit • Taxpayer: Assessment on results  difficult to establish stable business strategy  Excess tax duty and double taxation • Tax Administration: Limited resources (manpower, time), burden of proof, need to reach agreement with taxpayer • Solutions for solving TP issues is an APA  Guarantee predictability and establish stable business strategy (taxpayer)

8. Case (1) Resale Price Method Case □ Case Summary <Foreign Parent Company> <Korean Subsidiary> A Co. (Parent) A' Co. (Subsidiary) Indirect Sales Resale Contact customers Price Negotiation After Service Direct Sales (Off-shore Sales) B (End user)

9. Case (1) Resale Price Method Case □ Transaction Type    1) Resale : A‘ Co. acquires title to goods and resells the goods through the local distribution network  → A‘ Co. performs main functions such as advertising and assumes major risks such as inventory risk, etc.    2) Sales Support : A‘ Co. provides domestic sales support for ACo.     → A Co. performs main functions and assumes major risks □ Questions 1) Appropriate TPM andComparables Selection Approach? 2) Applicability of financial statement profit ratio? 3) Deemed PE issue? 4) Marketing Intangible issue?

10. Case (2) Service Provision Case □ Case Summary <Foreign Parent Company> <Korean Subsidiary> Management Service A Co. (Parent) A' Co. (Subsidiary) Compensation (at cost)

11. Case (2) Service Provision Case □ Transaction Type : Intra-group Services   ○ Type of Service : Management Service (accounting, legal, etc)   ○ Fee Calculation : Allocation of parent company’s service related expenses without mark-up □ Questions  1) How to prove that service was actually provided? (See attached: NTS Tongchik 4-0-2)  2) Appropriate calculation method of service fee?     - Determining allocable expenses (direct, indirect)     - Determining allocation basis     - Determining related companies subject to allocation  3) Is APA applicable?

12. Case <Attached: Basic Comprehensive Regulations (Effective ‘04.6.15)> (Would be upgraded as a provision of Presidential Decree, coming year) 4-0…2【Deductibility of Management Services Fees Remitted to a Foreign Parent Company】 ① Previously, a foreign parent company and its Korean subsidiary were regarded as separate entities, accordingly, head office expenses allocated to the subsidiary were unlikely to be regarded as tax-deductible expenses. However, under the newly issues Basic Comprehensive Regulations, the fees remitted for essential services will be recognized as deductible expenses where all of the following conditions are met: 1.Substantiating evidence of actual services performed is available; and 2.Service fees are directly related to the generation of the subsidiary’s income; and 3.Service fees are charged at a rate that would normally apply to a transaction between third parties. ② However, where the foreign related party (parent company) is a shareholder of a Korean domestic company, the following services performed will not be regarded as essential services. 1. Preparation of financial statements according to foreign accounting principles where the parent company is located 2. Activities regarding parent company’s reporting obligations 3. Audit or supervisory activities