Seoul High Court Decision 2011Nu21272, 21289 (Consolidated) Decided December 20, 201

Cho High Court Decision 2006No3456 (No. 13, 2010)

It is necessary to prove that the taxpayer cannot be deemed to lack economic rationality in the arm's length price range.

1. (As in the judgment of the court of first instance) The interest income shall be deemed as income from the business activities of the head office of Hong Kong; 2. (Reversal) The necessity of proving that the transfer price of the transaction of this case cannot be deemed to lack economic rationality due to the lack of economic rationality within the scope of the arm’s length price is for the taxpayer; and it cannot be readily concluded that the arm’s length price calculated by the tax authorities

Article 132(2) of the former Enforcement Decree of the Corporate Tax Act; Selection of Method of Calculating Normal Price under Article 5(1) of the former Enforcement Decree of the Adjustment of International Taxes Act

2012du1747, 1754(combined) revocation of disposition of imposing corporate tax

○○○ Incorporated Company

】 director of tax office

Seoul High Court Decision 2011Nu21272, 21289 (Consolidated) Decided December 20, 201

on April 04, 2014

The part of the judgment below against the defendant regarding the imposition of corporate tax for the business year 2001 and 2002 shall be reversed, and this part of the case shall be remanded to the Seoul High Court.

The remaining appeals are 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, 2002) provides that "any of the following income generated overseas from a domestic source business income of a foreign corporation shall be included in the domestic source business income of the foreign corporation" pursuant to the delegation of Article 93(5) of the former Corporate Tax Act (amended by Presidential Decree No. 1852, Dec. 30, 2002); however, it includes "income generated from lending money to a foreign person or other similar acts" as 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 and conducting financial transactions in the name of the Plaintiff’s head office in order to recover the price 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, thereby deeming the total interest income generated during the period from 1999 to 2003 in the name of the Plaintiff’s head office as attributable to the Plaintiff’s head office, and reported corporate tax to the Hong Kong tax authorities; (c) however, the Defendant: (a) deemed that the Plaintiff’s head office is merely a document nominal company; and (b) deemed that the said interest and interest paid accrue to the Plaintiff as the income accrued from the Plaintiff’s branch in Korea; and (c) accordingly, imposed each of the instant dispositions, including imposition of corporate tax

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 as profit and loss belonging to the plaintiff's headquarters, in light of the following: ① the plaintiff's headquarters is holding a board of directors and conducting independent activities such as distributing dividends, ② the plaintiff's headquarters is hard to be deemed as a document company; ② the plaintiff's branch is responsible for the management of funds, and the plaintiff's branch is responsible for the management, management, and disposal of the deposit account in the name of the plaintiff headquarters; and the plaintiff's domestic customers was paid directly to the plaintiff headquarters without going through the plaintiff's branch; ③ the above interest and interest paid are generated by the independent fund management decision of the plaintiff's headquarters; ③ the above interest and interest paid are generated by the plaintiff's own fund management decision of the plaintiff's headquarters; and are

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 of Dec. 18, 2002, hereinafter "the Adjustment of International Taxes 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 when one of the transaction parties is an overseas specially related person."

In addition, Article 5(1)4 of the Adjustment of International Taxes Act and Article 4(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 Adjustment of International Taxes Act") provides that "the method of calculating the arm's length price" as one of the arm's length price calculation methods: "the method of determining the transaction price calculated based on the net trade profit ratio, such as the ratio of sales of the net trade profit realized in transactions similar to the relevant transactions, among transactions between a resident and an unrelated party in a foreign country among transactions between the unrelated parties, shall be the arm's length price (However, where the transaction similar to the relevant transaction is not conducted with the unrelated party, the transaction conditions and situation of the relevant transaction may be used by the net trade profit ratio similar

Meanwhile, Article 5(1) of the Enforcement Decree of the Adjustment of International Taxes lists the criteria to consider in selecting an arm's length price computation method, and provides that "high possibility of comparison exists between the international trade between the parties having special relations and the trades between the unrelated parties." (A) Item (a) provides that "where the difference between the compared circumstances does not have a serious effect on the compared price or net profit of the transaction," and (b) Item (b) provides that "where a reasonable adjustment is possible to eliminate the difference due to the difference in the compared circumstances or net profit, even in cases where the difference between the compared circumstances has a serious effect on the compared price or net profit." In addition, Article 6(2) of the Enforcement Decree of the Adjustment of International Taxes Act provides that "where an arm's length price is calculated pursuant to Article 5 of the Act, the difference in the price, profit or net trade profit should be reasonably adjusted."

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 ice-Man-man and soft, from affiliated companies or non-affiliated companies of the △△ Group or non-affiliated companies, and sold them to domestic enterprises in several or a thousand tons. The Plaintiff reported each corporate tax for the business year of 2001 and 2002 regarding the sales of products through the Plaintiff’s branch, a domestic place of business, and the sales cost and sales cost, and the reported business profit ratio for the business year of 2001 and the business profit ratio for the business year of 2002 is -1.5%.

② Under the Adjustment of International Taxes Act, the head of △△△△ Regional Tax Office deemed that there was a suspicion of transferring taxable income to a foreign related party by trading in this case where the Plaintiff branch, who is a resident, purchased chemical products from a foreign related party overseas, who is an affiliated company of the △△△ Group. Accordingly, the head of △△△△△ Regional Tax Office, in accordance with the net profit ratio method, selected seven of the seven enterprises engaged in the import and sale of the basic chemical compounds, etc. for industry, as the comparative business, and calculated the operating profit ratio for the business year 2001, 2002. Based on this, the head of △△△△△△ Regional Tax Office, calculated the arm’s length price by adjusting the difference between the Plaintiff and the comparative business entity on the financial data and risk level, inventory assets holding amount and the level of investment in other business assets, and notified the Defendant of the transfer income adjustment calculated in comparison with the gross profit ratio of the Plaintiff’s chemical products resale business sector in the business year 201, 2002.

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 no possibility of comparison due to qualitative differences in handling products or transaction stages; and (d) the Plaintiff’s profitability is 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 most essential and most important, and the difference in the economic situation caused by such difference and the difference in the net profit.

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

(1) According to Articles 11 and 13 of the Adjustment of International Taxes Act, Articles 7 and 23 of the Enforcement Decree of the Adjustment of International Taxes Act, etc., a taxpayer who engages in international trade with a foreign specially related person bears the obligation to submit specifications of international trade, the obligation to select and select the most reasonable arm's length price calculation method, to submit data necessary for the final return of tax base and tax amount, and the obligation to keep and keep necessary data relating to the arm's length price calculation method. Therefore, in a case where the transfer price with a foreign specially related person is different from the arm's length price reasonably calculated based on the data secured by the best effort by the tax authority, the tax authority does not have to consider the scope of the arm's length price. Thus, in a case where the transfer price with a foreign specially related person shows a difference from the arm's length price reasonably calculated based on the data secured by the best effort, the transaction price between the independent business entity having a possibility of comparison may constitute the scope of the arm's length price, and the need to prove that the transfer price with the foreign specially related person cannot be deemed to lack

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 of the goods or the stage of the transaction. 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 price

(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 based on the determination, determined that the part concerning the transfer price taxation in each of the instant dispositions was unlawful. This is erroneous by misapprehending the legal doctrine on the legitimate requirements for arm’s length price according to the net trade profit ratio method under the Adjustment of International Taxes Act and the necessity for proof

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.