1. Taxation of Intra-group Services in Korea Yoon OH

2. Table of Contents Arm’s Length Rules  The Transfer Pricing Taxation Rule  The Unfair Transaction Adjustment Provision Inbound Service Provision  Expense Deduction by the Recipient  Income Taxation on the Provider Outbound Service Provision  I ncome Taxation on the Provider  Credit guarantee fee 2

3. Arm’s Length Rules The Transfer Pricing Taxation Rule(“TPTR”) in Korea  The TPTR has been stipulated in the ITCA(“International Tax Coordination Act”) since 1996, which is a separate law governing international tax issues.  ITCA Art. 4 [Adjustment of Taxation by an Arm’s Length Price] In the case where a resident(which hereafter includes a domestic corporation or a domestic place of business of a nonresident or a foreign corporation) enters into an international transaction with a related party overseas at a price unreasonably higher or lower than the arm’s length price, the tax authorities may determine or adjust the resident’s taxable base and tax amount based on the arm’s length price.  The TPTR in Korea generally follows the OECD TP Guidelines. 3

4. Arm’s Length Rules The Unfair Transaction Adjustment Provision  The TPTR in the ITCA is a variation of the UTAP(“Unfair Transaction Adjustment Provision”).  The UTAP is applied to transactions amongst related parties while the TPTR is applied to international transactions between a resident and a non-resident. The UTAP is stipulated in the Corporate Tax Act(“CTA”) and the Income Tax Act(“ITA”). Art. 52 Para. 1 of the CTA provides that where a corporation has improperly reduced its taxable income through transactions with related parties, the tax authorities may recast the transaction to achieve appropriate tax results.  The ITCA clearly prescribes that the TPTR overrides the UTAP(ITCA Art. 3). The business purpose defense is not allowed for the TPTR while it is allowed for the UTAP. An objective 3 rd Party Comparability Analysis prevails. 4

5. Inbound Service Provision Expense Deduction by the Recipient  Issue Does management service fee paid satisfy the requirement of expense deduction under the tax laws? Rules under the CTA  allow deduction of expenses only if they are either ‘generally accepted as ordinary’ or ‘associated directly with the revenue’ (CTA Art. 19 Para. 2). Arm’s length rule under the ITCA  Is it a fee for a service actually provided?  Would a 3 rd party have chosen to receive the service provided by the related party?  Is the fee paid reasonable?  Would a 3 rd party have paid such a fee? 5

6. Inbound Service Provision Expense Deduction by the Recipient  Tax Administration before Rockwell Automation Korea Case in 2002 Any expenses had to be substantiated by the documents of services actually rendered in direct relationship with each payment in order to satisfy the requirement of ‘associated directly with the revenue’. Only Direct Charge Method had been accepted. 6

7. Inbound Service Provision Expense Deduction by the Recipient  Supreme Court Decision for the Rockwell Automation Korea Case in 2002 Fact  Cost of human resources activities : allocation of (cost + 5% markup) by the # of employees  Cost of purchase and sales management : allocation of (cost + 5% markup) by the net sales Decision  The company received such services as personnel management, market analysis and sales management from Hong Kong Asia-Pacific Regional Headquarter and the services are reasonably associated with its income accrual and therefore the payments are deductible. Indirect Charge Method(Cost Allocation Method) was accepted. 7

8. Inbound Service Provision Expense Deduction by the Recipient  ITCA Basic Ruling(“ITCABR”) Art. 4-0…2 in 2002 Following the decision made in 2002, the National Tax Service(“NTS”) in cooperation with the Ministry of Strategy and Finance(“MOSF”) released a basic ruling that stated the management service fee may be deductible if it meets the following conditions(ITCABR Art. 4-0…2).  The provision of a specific service has to be proved with evidences,  The service provided has to be either ‘generally accepted as ordinary’ or ‘associated directly with the revenue’ Refer to CTA Art. 19(2), and  The payment should be at arm’s length. 8

9. Inbound Service Provision Expense Deduction by the Recipient  ITCA Presidential Decree(“ITCAPD”) Art. 6-2 Para. 2 The ITCAPD has accommodated the above basic ruling in a quite different fashion in its 2006 revision. The management service fee may be deductible if it meets the following conditions.  There should be a prior arrangement for the provision of service, and the service has to be provided according to the arrangement,  There should be ‘expected benefits’ from the service rendered,  The payment should be at arm’s length, and  Pertinent documents have to be presented.  The second condition seems to prove that the government accepts the indirect charge method. Tax Tribunal Decision 2005Seo985, 2006.08.14 9

10. Inbound Service Provision Expense Deduction by the Recipient  The Concept of “Low Value-adding Intra-group Services” in the BEPS Final Report Action 8-10 Elective and simplified method is proposed in the Report for the compliance purpose.  Accounting and auditing, Processing and management of accounts receivables, and Human resources activities, etc.  Some indicator of the expected benefits may serve as an allocation key. The Korean government might well follow the new approach in the above.  The concepts of “expected benefit” and “prior arrangement” in the ITCAPD  Documentation Issues!(re Action 13 Report)  Cost Pool, Benefit Pool  CbC Report? 10

11. Inbound Service Provision Income Taxation on the Provider  Withholding tax on services fees Income from management service, is it business profit or royalty income? Business profit  Under a tax treaty, business profit is not taxed in a source country unless it is attributable to a PE.  Without a tax treaty, 3% of tax is withheld from the payment. Royalty Income  if assessed by a rate of the sales amount: Tax Authority’s Position  Service PE? (re BEPS Action 7) The United Nations Committee of Experts has been considering the taxation of services for several years and in 2013 endorsed the addition of a new article to the UN Model dealing with fees for technical services. Any special movement for the introduction of the concept of service PE is not to be found in Korea as of now. 11

12. Outbound Service Provision Income Taxation on the Provider  Is the fee for the service rendered properly collected from the overseas related party? Would a 3 rd party have recognized such a provision as having rendered a service? Would a 3 rd party have chosen to render the service for such a fee? 12

13. Outbound Service Provision Credit guarantee fee  Case Fact Pattern  A Korean parent company provided a credit guarantee for its foreign subsidiary.  It collected a relatively small fee for such a service. Issue  Arm’s length fee Law  No specific provision other than the general arm’s length rule(Comparability criterion) stipulated at the time of the transaction in case  No taxation case under the UTAP was to be found for the domestic transactions by the tax authority  No financial merit for such a taxation from the standpoint of the government 13

14. Outbound Service Provision Credit guarantee fee  Case Assessment by the tax authority  The National Tax Service developed a formula model for the calculation of the arm’s length fee in 2012.  The NTS sent the letter of recommendation of filing tax return amended according to the formula model.  Tax authorities sent the deficiency notice and assessed taxes for the years before 2013 within the statute of limitation against the parent companies in Korea, which did not accept the recommendation. Lower Courts have upheld the arguments made by the parent companies.  The formula model does not conform to the CUP methodology.  It has been developed against the proper comparability analysis.  2014 Guidance on Transfer Pricing Aspects of Intangibles Para.1.99  Benefit incidental to group membership may not be viewed as a service provided. 14

15. Outbound Service Provision Credit guarantee fee  The cases are pending in the Higher Courts  Current Law In February 2013, the ITCA Ministerial Decree was revised to reflect the formula model of the NTS. The parent companies are filing tax return for the taxable years after 2013 following the formula model in the ITCAMD, the details of which are basically the same with what was developed by the NTS in 2012. Does the ITCAMD revision legitimize the formula model? 15

16. Thank you! 16