THE LAW FOR THE CORDINATION OF INTERNAITONAL TAX AFFAIRS
1. Transfer Pricing Regime
2. Thin Capitalization Rules
3. Anti-Tax Haven Rules
4. Gift Tax on Property Located Outside Korea 
5. Mutual Agreement Procedure (MAP)
6. International Tax Cooperation
1. Transfer Pricing Regime
a. Adjustment of a Transfer Price Based on an Arm's Length Price
The LCITA (Law for the Coordination of International Tax Affairs) authorizes the tax
authorities to adjust the transfer price based on an arm's length price (ALP) and to
determine or recalculate a resident's taxable income when the transfer price of a
Korean company and its foreign counterpart is either below or above an arm's length
price.
(1) Special Relationship
The LCITA and its Decree recognize "special relationship" under the following
circumstances:
(Equity Ownership Test)
- where a foreign company directly or indirectly owns 50% or more of the voting
shares of a Korean company;
- where a Korean company directly or indirectly owns 50% or more of the voting
shares of a foreign company;
- if a corporation (or an individual), which directly or indirectly owns 50% or more
of the voting shares of a foreign company, directly or indirectly holds 50% or more
of the voting shares of a Korean company; and  
(Substantial Control Test)
- if a company's ("Company A") representative director is employed by another
company ("Company B"), if 50% or more of Company A's directors are employed
by Company B, or if a substantial part of Company A's business is dependent
upon Company B's operating funds, intangible property rights, guarantees of
payments, or other transactions, then Company A's business policy will be 
regarded as substantially influenced by Company B.
(2) Computation of Indirect Ownership
If company A owns a 50% stake or more in company B, and B owns a certain
percentage of shares in a third company C, B's equity ratio in C would constitute
the ratio of equity which A indirectly owns in C.
If company A owns less than a 50% stake of company B, and B  owns a certain
percentage of shares in a third company C, then A is considered to own C to the
extent of the ratio computed by multiplying A's equity ratio in B with B's equity ratio
in C.
b. Criteria and Procedure for Transfer Price Adjustments
The LCITA and its Decree define an arm's length price (ALP) as a price that is
established or that can be expected to be established in a normal transaction
between independent enterprises without a special relationship.
The LCITA lists the following methods for determining an ALP: the comparable
uncontrolled price (CUP) method, the resale price method, and the cost-plus
method. Furthermore, the Decree elaborates upon the profit-split method and the
transactional net margin method (TNMM) as methods for determining an ALP based
on profits arising from controlled transactions.
The CUP method evaluates an ALP by comparing the price that an independent
uncontrolled person under the same or similar circumstances in terms of trade
conditions or volume would set for goods identical to those in question.
The resale price method may be applied where a manufacturer sells its products to
a related person and the related person resells the same product to an unrelated
third party without any further processing. Under this method, the adjustment in the
transfer price between related parties may be computed by subtracting an
appropriate mark-up amount from the price that the related reseller charges the
product to unrelated third parties.
The cost plus method, in principle, may be applied where a manufacturer sells his or
her products to the related party and the related party then adds value to the product
by processing it further to sell to unrelated third parties. In such cases, the ALP is
calculated as the price of the refined goods, less the actual costs of further
processing, together with an appropriate mark-up upon such costs.
The profit split method determines an ALP by taking the sum of profits earned by the
related parties and allocating them in proportion to the respective contribution
towards generating the profits realized.
Finally, the TNMM evaluates an ALP by first seeking an independent third company
which is similar to the company at issue in terms of its business operations and the
nature of its business, and then by subjecting such a company to functional and
comparability analyses. The income earned by the third company is then estimated
based upon the following ratios: profits to assets, operating profits to turnovers, and
profits to equity. These estimates will then be used to evaluate and if necessary,
adjust the income and profit of the related parties.
c. Selection of Method for Determining ALP
The Decree states that an ALP should be determined by the most reasonable method
applicable to the situation, whether it be the CUP method, the resale price method,
the cost plus method, or any other method.
The Decree sets out the following criteria for selecting the most reasonable method.
- The level of comparability between the transactions of related parties and those of
independent parties must be high.
- Sufficient data on a comparable independent party must exist.
- The economic assumptions made in comparing the related parties' transactions
with those of independent parties must reflect the actual economic situation of the
parties.
The degree of comparability can be evaluated on the following factors:
- functions performed and risks assumed, as reflected in conditions and
transactions;
- types as well as characteristics of the goods or services  involved; and
- economic environment of the market and the degree of  change in market
conditions.
If the inter-company price established by a Korean company and its foreign related
party differs from an ALP, the Korean company shall pay the corporate income tax
based upon the income it would have reported under an ALP.
If there is a transaction between unrelated parties identical or similar to the
transactions between the related parties at issue, the CUP method will be selected
over any other method.
Among the methods of determining an ALP, traditional transaction methods (i.e., the
CUP method, the resale price method, and the cost-plus method) have priority over
transactional profit methods such as the profit split method or the transactional net
margin method. The latter methods are intended to be used only if the traditional
methods are inapplicable.
If an international transaction made between unrelated parties cannot be treated as
an arm's-length transaction because of the possibility of price manipulation, such
transaction may not be used as a comparable one.
The tax authorities may use an arm's length range determined by two or more
uncontrolled transactions to adjust the taxable income of taxpayers. Such tax
adjustment must be made based upon reasonable values computed from the 
transactions examined.
d. Reporting Methods for an ALP Determination
The method used and the reason for adopting that particular one for an ALP
determination must be disclosed to the tax authorities by a taxpayer in a report
submitted along with his annual tax return.
If the inter-company price used by a Korean company and its foreign counterpart
differs from the transfer price determined under the proper method for determining an
ALP, then the taxpayer must adjust such inter-company price.
e. Advance Pricing Arrangement (APA) System
If a taxpayer wishes to obtain an APA for transactions with its foreign related parties,
then he or she should submit an application for an APA to the National Tax Service
(NTS) by the end of the first fiscal year concerned. Both the NTS and the taxpayer
are bound by the method agreed upon in the APA.
Once the NTS approves the application of a certain method for determining an ALP,
the approved method is applicable for as long as the taxpayer desires.
An applicant for an APA may withdraw his application for an APA or change the
contents of such an application.
Any data submitted with the application for an APA will be used to only determine
whether or not to grant an APA. If an application for an APA is refused or withdrawn,
such data will be returned to the applicant in order to safeguard the confidentiality
right of the taxpayer.
In the case where an APA is obtained, a taxpayer is required to file an annual report
which shows the inter-company price which was determined by the method agreed
upon under the APA within six months of the annual tax return submission due date.
A taxpayer who applies for an APA may request that the NTS invoke a Mutual
Agreement Procedure (MAP) with the competent authorities of the country in which its
related foreign party is a resident under the relevant tax treaty (Bilateral APA). 
However, the NTS may grant an APA without undergoing a MAP for the taxpayer's
convenience.
Having obtained an APA, a taxpayer may file an amended tax return that reflects the
change from its prior inter-company price with a related party and the price
determined under the APA.
f. Secondary Adjustment
If the tax authorities adjust the transfer price between a Korean company and its
foreign related party based upon an ALP, or if they increase the taxable income of the
Korean company, an amount equal to the additional taxable income will be treated as
dividends, contribution of paid-in capital, etc., unless the foreign party returns an
amount equivalent to the amount of adjustment to the Korean company.
If a foreign related party owns 50% or more of the voting shares of a Korean
company, an amount equal to the additional taxable income will be treated as
dividends paid out to the related party. If a Korean company owns 50% or more of the
voting shares of a foreign related party, an amount equal to the additional taxable
income will be treated as the Korean company's contribution to the foreign related
party as paid-in capital.
A Korean company will be deemed to have loaned an amount equivalent to the
additional taxable income to the foreign related company as of the last day of the
taxable year in which the inter-company transactions took place. The Korean
company is to include the deemed interest on the loan as taxable income.
g. Corresponding Adjustment
The LCITA and its enforcement decree state that if a foreign government, on the basis
of an ALP, increases the taxable income of a foreign company which is an
associated enterprise to its Korean Counterpart, the Korean government will
correspondingly reduce the taxable income of that Korean company if the two
governments have agreed upon an ALP applicable to the case through a Mutual
Agreement Procedure (MAP). In such a case, a taxpayer may apply for a downward 
adjustment in his taxable income by filing a notification of the MAP results with the tax
authorities.
  
h. Sanctions imposed for Failure to Comply with the Data Request
Under the LCITA, the tax authorities are empowered to request from a taxpayer the
data required for an adjustment of the inter-company price. If a taxpayer fails to
submit the requested data within 60 days without any justification, the tax authorities 
may grant an extension of 60 days. The taxpayer may appeal within 30 days of the
penalty imposition date.
The tax authorities may request the following data from a taxpayer:
- a copy of the sales contract between the Korean company and its foreign
counterpart;
- a price list of the products at issue;
- a schedule of the manufacturing cost of the products;
- an organizational chart of the company with a description of the functions of each
department;
- the inter-company price policy; and
 - the equity relationship of the group.
2. Thin Capitalization Rules
a. Outline of Thin Capitalization Rule
A multinational enterprise (MNE) may adopt a tax avoidance mechanism under which
the contribution of paid-in capital to its subsidiary in Korea is decreased, while
increasing its loans to the subsidiary as much as possible. This may result in the
minimization of the taxable income of the subsidiary through the increase in interest
expense deduction of the subsidiary. Under such an arrangement, non-deductible
dividend payments are replaced with deductible interest payments.
To cope with such an arrangement, the LCITA and its enforcement decree contain
thin capitalization rules; whereby if a Korean company borrows from its controlling
shareholders overseas (CSO), an amount greater than three times its equity (six
times in case of financial institutions) interest payable on the excess portion of the
borrowing, computed as shown below, will not be deductible in computing taxable
income.
For purposes of the thin capitalization rules, money borrowed from a CSO includes
amounts borrowed from an unrelated third party based upon the CSO's guarantee.
         
The following is the formula for computing non-deductible interest:
¡¡ Non-deductible interest = Interest and discount payable to CSO * B/A
¡¡ A : Debt borrowed from the CSO or guaranteed by the CSO; ¡¡
¡¡ B : A - [Paid-in capital contributed by the CSO * 3 (or 6 in the case of a
¡¡ financial institution)]. ¡¡
b. Debt Under an Arm's Length Situation
Although the ratio of debt owed to a CSO to equity exceeds 3:1, as long as the
conditions and the amount of debt owed to a CSO are reasonable compared to the
debt from an independent third party, such debt from the CSO will be excluded from
the scope of the debt subject to thin capitalization rules. As a result, interest on such
debt will be deductible.
Anti-thin capitalization that originated from the arm's length principle  is adopted from
Article 9(1) of the OECD Model Tax Convention. Thus, if given requirements are
satisfied, the debt-equity ratio prevailing in the industry (rather than a 3:1 or 6:1 ratio)
will be applied.
   
3. Anti-Tax Haven Rules
a. Outline of Anti-Tax Haven Rules
Under the LCITA and its enforcement decree, if a Korean company invests in a
company located in a tax haven, which unreasonably has reserved profits in the
controlled foreign company, the profits reserved therein shall be treated as dividends
paid out to that Korean company, despite the fact that the reserved profits are not
actually distributed.
Korean companies subject to anti-tax haven rules are companies directly or
indirectly owning 50% or more of the shares in a foreign company, or those
substantially controlling the business policy of the foreign company and owning at
least 20% or more of the voting shares.
Anti-tax haven rules are intended to regulate a company that has made overseas
investments of an abnormal nature. Thus, these anti-tax haven rules apply to those
Korean companies that have invested in a company incorporated in a foreign country
with an average effective tax rate of 15% or less on taxable income for the past three
years (previously it was one year).
However, if a company incorporated in such a tax haven country actively engages in
business operations through an office, shop, or a factory, then anti-tax haven rules
will not apply.
 
b. Scope of Actually Accrued Income
If an average effective tax rate imposed for the past three years by a foreign country
is 15% or less of the actually accrued income of a company incorporated therein, the
country will be classified as a tax haven.
The term "actually accrued income" refers to the net income before tax calculated
based on the generally accepted accounting principle (GAAP) of the host country. If
the host country's GAAP is significantly different from that of Korea, the actually
accrued income will be computed pursuant to the Korean GAAP.
c. Scope of a Tax Haven 
According to the LCITA and its Decree, a country that meets any of the following
conditions is regarded as a tax haven.
-  a country which does not impose a corporate income tax or which allows a tax
¡¡ exemption of 50% or more of actually accrued income ¡¡
-  a country whose average effective tax for the past three years is 15% or less of
¡¡ actually accrued income (i.e., net income before corporate income tax computed
¡¡ based on GAAP) of a company incorporated therein ¡¡
For this purpose, if the company has paid foreign taxes, such foreign taxes will  be
deemed to have been paid to the resident state.
Effective tax rate = (Tax paid to resident country £« Foreign taxes paid)  ¡¡
¡¡ ¡¡    / Net income before corporate income tax. ¡¡
d. Computation of the Reserved Income to be distributed
The reserved income that can be distributed is computed by subtracting the items
listed below from the adjusted amount of earned-surplus. The earned-surplus is
represented on the income statements prepared in accordance with the GAAP of the
resident state of the foreign company subject to the anti-tax haven system:
- distribution of earned-surplus based upon an appropriation of retained earnings,
- bonuses, severance pay, and other types of outlays paid based on the
appropriation of retained earnings, 
- reserves to be retained under the law of the resident state, and
- reserves remaining after the distribution of the earned-surplus for the year, which
was subject to tax in the previous taxable years.
 
If the resident state's GAAP is significantly different from the Korean GAAP, the
earned-surplus shall be computed pursuant to the Korean GAAP.
4. Gift Tax on Property Located Outside Korea 
Under the current Inheritance and Gift Tax Law (IGTL), a gift tax is imposed only if 1)
the donee is domiciled in Korea or 2) the donated property is located in Korea.
Accordingly, if a Korean individual donates a property located offshore to a donee
domiciled offshore, a Korean gift tax cannot be levied.  In this case, moreover, if the
foreign country in which the donee is domiciled does not impose a gift tax, then
double non-taxation will occur.  Korea, which is now a member of the OECD, intends
to adopt the "taxation of donor" principle of the OECD Model Double Taxation
Convention on Estates and Inheritances and on Gifts.
Under the LCITA and its enforcement decree, if a person domiciled in Korea donates
offshore property to a person who is domiciled in a foreign country where a donee is
not subject to a gift tax, the donor will be subject to the Korean gift tax.
5. Mutual Agreement Procedure (MAP)
If a Korean resident requests that his case be resolved by recourse to the competent
authorities under an applicable tax treaty, the Minister of Finance and Economy or the
Commissioner of the National Tax Service shall invoke the mutual agreement procedures
(MAP). The MAP will be invoked in the following cases:
- where it is necessary for Korea to consult with a foreign competent authorities with
respect to the application and interpretation of the tax treaty;
- where a Korean resident is subject to taxation in a foreign country contrary to the tax
treaty concerned; or
- where it becomes necessary for the competent authorities of the two countries to
adjust the taxable income of a taxpayer.
Once the MAP is invoked, the taxpayer will be allowed to postpone the filing of an appeal
until the MAP is completed. Furthermore, if the MAP is invoked under an applicable tax
treaty, the collection of national and local taxes will be postponed on a reciprocal basis
until the MAP is completed.
6. International Tax Cooperation
The LCITA and its enforcement decree accept the general principle that income
classification under a Korean tax treaty takes priority over that of the domestic tax law.
Under the LCITA and its enforcement decree, the Korean tax authority may request the
tax authority of a treaty partner to collect the Korean taxes, subject to any limitations
provided for in the treaty. Similarly, if the treaty partner requests the Korean tax authority
to cooperate in collecting its taxes from a Korean resident, the Korean tax authority may
collect the treaty partner's tax in accordance with the procedure for the collection of
national taxes provided in the National Tax Collection Law.
The Korean tax authority may exchange tax information with foreign countries with which
Korea has entered into tax treaties, subject to the  provisions and limitations of the tax
treaties.
If necessary, the Korean tax authority is permitted to 1) simultaneously conduct a tax
audit with foreign tax authorities concerned, under the convention for cooperation in tax
administration with that foreign country or 2) dispatch Korean tax officials to the
concerned foreign country to conduct a direct tax audit of the company in that country.