[1] In a case where the foreign specially related person and the transfer price appear to be different from the reasonably calculated arm's length price based on the data secured by the tax authority's best effort, the burden of proving that the transaction price between independent business operators who are likely to be compared may exist in a reliable figure and constitute a range of arm's length price, and that the transfer price with the relevant overseas specially related person cannot be deemed to lack economic rationality due to the lack of economic rationality (=taxpayer)

[2] In a case where the tax authority selects a comparable company that performs a transaction that is similar to the transaction conditions in question and reasonably calculates the arm's length price based on the data secured by best effort when applying the transactional net profit ratio method, whether the arm's length price may be deemed to have been determined solely on the ground that the tax authority did not make a separate adjustment based on the difference between the transaction items or the comparable company and

[1] According to Articles 11 and 13 of the former Adjustment of International Taxes Act (amended by Act No. 6779 of Dec. 18, 2002), and Articles 7 and 23 of the former Enforcement Decree of the Adjustment of International Taxes Act (amended by Presidential Decree No. 18628 of Dec. 31, 2004), a taxpayer who engages in international trade with a foreign specially related party bears the duty to submit specifications of international trade, to select the most reasonable arm's length price calculation method and to submit data necessary for the final return of the tax base and tax amount, and to keep and keep the arm's length price calculation method. Therefore, in a case where the transfer price with a foreign specially related party can be reasonably different from the arm's length price calculated based on the data secured by the tax authority's best effort, the tax authority does not have to consider the above scope of arm's length price. Thus, in a case where the transfer price with a foreign specially related party appears to be different from the arm's length price calculated based on the data secured by the tax authority.

[2] The net profit ratio method is to calculate the arm’s length price based on the net profit ratio, index, or operating profit ratio reflecting sales expenses, such as sales cost and sales cost, and the arm’s length price calculation method is to have an impact on the difference in the function of business activities, such as the difference in the difference in the sales cost or the trading stage, which is based on the comparable third party price method or the gross profit ratio, different from the resale price method, which is based on the transaction price among other arm’s length price calculation methods. Therefore, in applying the net profit ratio method in calculating the arm’s length price, if the tax authority reasonably calculated the arm’s length price based on the data secured by the best effort, barring special circumstances, it cannot be readily concluded that the arm’s length price calculated based on the difference in the transaction cost or the trading stage, etc

[1] Articles 4, 5(1)4 (see current Article 5(1)6), 5(2), 11, and 13 of the former Adjustment of International Taxes Act; Article 4 subparag. 2 (see current Article 4(2)1(a) and (b), 6(2), 7, and 23 of the former Enforcement Decree of the Adjustment of International Taxes Act (Amended by Presidential Decree No. 18628, Dec. 31, 2004); Article 4 subparag. 2 (see current Article 4(2)), 5(1)1(a) and (b), 6(2), 7, and 23 of the former Adjustment of International Taxes Act / [2] Articles 4(1) and 5(1)4 (see current Article 6(1)6(1) and (2)4 (see current Article 779; Presidential Decree No. 18628, Dec. 18, 2002); Article 4(1)6(1)4) and (2)4)4) of the former Adjustment of International Taxes Act

[1] Supreme Court Decision 99Du3423 delivered on October 23, 2001 (Gong2001Ha, 2581)

Malovascene Ltd. (Attorneys Son Ji-yol et al., Counsel for the defendant-appellant)

Head of Seodaemun Tax Office

Seoul High Court Decision 2011Nu21272, 21289 decided December 20, 201

The part of the lower judgment against the Defendant regarding the imposition of corporate tax for the business year 2001 and 2002 shall be reversed, and that part of the case shall be remanded to the Seoul High Court. The remainder of the appeal shall be dismissed.

The grounds of appeal are examined.

1. Regarding ground of appeal No. 1

A. Article 132(2) of the former Enforcement Decree of the Corporate Tax Act (amended by Presidential Decree No. 18174, Dec. 30, 2003) under the delegation of Article 93 subparag. 5 of the former Corporate Tax Act (amended by Act No. 6852, Dec. 30, 2002) provides that “any of the following income generated from a foreign country and attributable to a domestic business place shall be deemed to be included in the domestic source business income of a foreign corporation.” Article 132(2) of the former Enforcement Decree of the Corporate Tax Act (amended by Presidential Decree No. 18174, Dec. 30, 200) provides that one of such income

B. The lower court acknowledged the following facts: ① (a) the Plaintiff, a foreign corporation whose head office is located in Hong Kong, opened a deposit account in the name of the Plaintiff’s head office in order to recover the prices of the chemical products sold in Korea and to support the Plaintiff’s sales funds necessary for the Plaintiff’s branch, a domestic business place; (b) the Plaintiff received a deposit of surplus funds from the Plaintiff’s branch or lent funds to the Plaintiff branch in the name of the Plaintiff’s head office, thereby deeming the amount of KRW 1,186,315,578 as the interest accrued during the period from 1999 to 2003 as the interest accrued during the business year from 199 to 2003; and (c) reported corporate tax to the tax authorities in Hong Kong as corporate tax; and (d) the Defendant deemed the Plaintiff’s head office as the document name and deemed the said interest and interest paid to the Plaintiff as the income accrued from each of the instant dispositions, such as imposing corporate tax for the pertinent business year.

Furthermore, the court below held that the part of each of the dispositions of this case is unlawful on the ground that the above interest and interest paid are deemed profit and loss belonging to the Plaintiff’s headquarters, in light of the following: (a) the Plaintiff’s headquarters is hard to be deemed as a document company merely because it holds a board of directors and engages in independent activities, such as distributing dividends; (b) the Plaintiff’s headquarters manages funds and the Plaintiff’s branch takes charge of domestic sales support activities; (c) the Plaintiff’s branch has no right to control, manage, and dispose of the deposit account in the name of the Plaintiff’s headquarters; and (d) the Plaintiff’s domestic customers have deposited direct payments in the Plaintiff headquarters without going through the Plaintiff branch; and (c) the above interest and interest paid were generated by the Plaintiff’s independent decision on the management of funds; and (d) there was no direct relation to

C. Examining the above provisions and relevant legal principles and records, the lower court’s determination is justifiable, and it did not err by misapprehending the principle of substantial taxation or the legal principles on domestic source business income of a foreign corporation that belongs to a domestic business place.

2. Regarding ground of appeal No. 2

A. Article 4 of the former Adjustment of International Taxes Act (amended by Act No. 6779, Dec. 18, 2002; hereinafter “State Adjustment Act”) provides that “The tax authorities may determine or rectify the tax base and tax amount of a resident (including a domestic corporation and a domestic place of business) on the basis of an arm’s length price, where the transaction price is less than or exceeds the arm’s length price in an international transaction in which one of the parties to the transaction is a foreign specially related person.”

In addition, Article 5(1)4 and Article 5(2) of the former Enforcement Decree of the Adjustment of International Taxes Act (amended by Presidential Decree No. 18628, Dec. 31, 2004; hereinafter “Enforcement Decree of the State Act”) Article 4 subparag. 2 of the former Enforcement Decree of the Adjustment of International Taxes Act (amended by Presidential Decree No. 18628, Dec. 31, 2004; hereinafter “the former Enforcement Decree of the State Act”) provides that “The method of calculating the arm’s length price” shall be one of the methods of computing the arm’s length price: “The method of determining the transaction price calculated based on the net trade profit ratio, such as the ratio of the sales of the net trade profit realized in the trades similar to the relevant trades, among the trades between a resident and an unrelated party, among the trades between the unrelated parties, may

Meanwhile, Article 5(1)1 of the Enforcement Decree of the National Assistance Act lists the criteria to be considered in choosing the arm’s length price computation method, and stipulates that “an international trade between the parties having a special relationship and the trades between the unrelated parties are highly likely to be compared.” In such cases, it refers to cases falling under any of the following items.” (a) Item (b) provides that “Where there is no significant impact on the compared price or net profit of the trades between the compared situation and the unrelated parties,” and subparagraph (b) provides that “where there is a significant impact on the compared price or net profit of the trades between the unrelated circumstances, a reasonable adjustment is possible to eliminate the difference due to the said impact”. Article 6(2) of the Enforcement Decree of the National Assistance Act provides that “Where the arm’s length price is calculated pursuant to the provisions of Article 5 of the Act, the price, profit, or net trade profit, or net trade profit, or any difference in the price, profit, or net trade profit, which is applied between the unrelated parties.”

B. (1) The lower court acknowledged the following facts by citing the reasoning of the first instance judgment.

① The Plaintiff purchased liquid chemical products, such as styrennas and softs, from its affiliated companies or non-affiliated companies, and sold them to domestic companies in a white or veterinary unit. The Plaintiff reported each corporate tax for each business year of 2001 and 2002 with respect to the sales and sales cost arising from the sales of products through the Plaintiff’s branch, a domestic business place, and the reported business profit rate for each business year of 2001 and the operating profit rate for each business year of 2002 is -3.3% and -1.5%.

② The Seoul Regional Tax Office: (a) deemed that there was a suspicion of transferring taxable income from the instant transaction that the Plaintiff’s branch, a resident, purchased the instant chemical product from a foreign specially related party, who is an affiliated company of the live group, in excess of the arm’s length price; (b) pursuant to the net profit ratio method, the Seoul Regional Tax Office: (c) pursuant to the Korea Chemical & Chemical Company, which runs the business of importing and selling the basic industrial compounds, etc.; (d) pursuant to the Korea International Trade Company; (e) pursuant to the 2001, 2002, the Seoul Regional Tax Office: (e) pursuant to the Korea International Chemical Company, which selected seven enterprises of the livers as the comparative company; and (e) calculated the arm’s length price by adjusting the financial data and risk level between the Plaintiff and the comparative company; (e) the amount of inventory assets owned and other sales assets; and (e) notified the Defendant of the adjustment of the Plaintiff’s gross profit and the amount of transfer income calculated in comparison with the gross profit ratio for the Plaintiff’s chemical product resale business sector;

③ Based on the above notification, the Defendant imposed corporate tax for each business year of 2001 and 2002 on the Plaintiff.

(2) The lower court, first of all, presumed that the tax authority is responsible for proving that the arm’s length price, which was the basis for taxation, is reasonably calculated based on the data secured by the best efforts, in a case where the arm’s length price formed in the transaction between a resident and a foreign related party is determined based on the arm’s length

Furthermore, the lower court determined that the part of each of the dispositions of the instant case is unlawful, on the ground that: (a) while the instant transaction takes the form of exporting petrochemicals only to Korea from abroad; (b) the transaction of the comparable company imports and resells various items, such as inorganic chemical products and chemical drugs, into Korea; and (c) there is lack possibility of comparison due to qualitative differences in the transaction stages; and (d) the Plaintiff’s profitability was affected by changes in international oil prices or international changes in the petroleum chemical industry, but the profitability of the comparable company was stable without any particular influence; (b) such difference was significantly affected by the price or net profit; (c) however, the arm’s length price calculated by the Defendant did not adjust the difference between the Plaintiff and the comparable company and the difference in the product dealing most essential and important, and the difference in economic circumstances caused by such difference and the difference in net profit.

C. However, the lower court’s determination is difficult to accept for the following reasons.

(1) According to Articles 11, 13, 7, and 23 of the Enforcement Decree of the National Assistance Act, a taxpayer engaged in international trade with a foreign specially related person bears the duty to submit a specification of international trade, the duty to select the most reasonable method of computing the arm's length price and to submit the method and reason selected at the time of filing a final return of the tax base and tax amount, and the duty to keep and keep necessary data relating to the arm's length price computation method. Therefore, the tax authority does not consider the above scope of the arm's length price by itself. Thus, in a case where the transfer price with a foreign specially related person is different from the reasonably calculated arm's length price based on the data secured by the tax authority's best effort, if there is a difference between the transfer price with a foreign specially related person and the foreign related person, the transaction price between the independent business person and the foreign related person and the taxpayer can constitute the scope of the arm's length price due to the lack of economic rationality should be returned to the taxpayer (see Supreme Court Decision 209Du34239, Oct. 23, 2001).

In addition, the method of net trade profit ratio is calculated on the basis of net profit ratio, index, or operating profit ratio reflecting business expenses, such as sales cost and sales cost, and the arm’s length price calculation method is not a comparable third party price method based on the transaction price among other arm’s length price calculation methods, or a resale price method or cost plus pricing method based on the gross sales profit ratio, but a functional difference, etc. in business activities, such as the difference in the difference in the function of the business activities, such as the difference in the difference in the vehicle or the trading stage, etc. of the product. Therefore, in applying the net trade profit ratio method in calculating the arm’s length price, if the tax authority reasonably calculated the arm’s length price based on the data secured by the best effort, barring any special circumstance, it cannot be readily concluded that the arm’s length

(2) According to the facts acknowledged by the court below, the comparable company selected by the defendant is among the companies that import and sell basic chemical products or basic chemical compounds, including organic chemicals, into Korea, and engaged in transactions similar to the conditions of the transaction in this case conducted by the plaintiff branch. The arm's length price calculated by the defendant according to the net trade profit ratio method is also adjusted to the driver's origin, etc. which may affect the operating profit ratio. Thus, the defendant can be deemed to reasonably calculate the arm's length price based on the data secured by best efforts. Thus, unless the plaintiff proves that the arm's length price exists within a certain scope and the transfer price of the transaction in this case cannot be deemed to lack economic rationality due to the lack of the pertinent arm's length price within the scope of the arm's length price.

D. Nevertheless, the lower court, solely on the grounds indicated in its reasoning, deemed that the arm’s length price calculated by the Defendant was correct, determined that the part of each of the dispositions in this case pertaining to the imposition of transfer price was unlawful. This is erroneous by misapprehending the legal doctrine on the legitimate requirements for arm’s length price according to the method of net trade profit ratio under the National Assistance Act and the necessity for proof of the existence

3. Conclusion

Therefore, the part of the judgment of the court below against the defendant regarding the imposition of corporate tax for the business year 2001 and 2002 is reversed, and that part of the case is remanded to the court below for a new trial and determination, and the remaining appeal is dismissed. It is so decided as per Disposition by the assent of all participating Justices on the bench.

Justices Park Poe-young (Presiding Justice)