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

Interest income is income of the head office of Hong Kong, and the calculation of the arm's length price is improper.

Interest income shall be deemed as income from business activities of the Hong Kong head office, and since it cannot be deemed as a reasonable adjustment by calculating the arm's length price based on the comparable companies that failed to meet the requirements for comparison, the disposition imposing corporate tax after calculating the difference between the interest income of the Hong Kong head office and the arm's length price with the

Article 132(2) of the former Enforcement Decree of the Corporate Tax Act

Article 5 (1) of the Enforcement Decree of the Adjustment of International Taxes Act

209Guhap37982 Revocation of Disposition of Corporate Tax Imposition

2010Guhap45873(combined) revocation of disposition of imposing corporate tax

XXXXXXXXXXX 주식회사

○○ Head of tax office

April 19, 2011

June 10, 201

1. The Defendant’s imposition of KRW 144,351,540 of corporate tax for the business year 1999, which was made on March 16, 2005, the imposition of KRW 332,601,870 of corporate tax for the business year 2000, which was made on March 28, 2006, and the imposition of KRW 2,212,420,00 of corporate tax for the business year 2001, and the imposition of KRW 1,468,604,640 of corporate tax for the business year 2002, respectively, shall be revoked.

2. The costs of the lawsuit are assessed against the defendant.

The same shall apply to the order.

1. Details of the disposition;

A. BBCCC (hereinafter referred to as “CCC”) is a multi-national corporation that is the Netherlands corporation BBBB and a U.K. corporation Xfranchisp trading, and its main business is exploration and extraction of crude oil, production of refined-restricted petroleum products and chemical products, production of natural gas, and power production. The Plaintiff, as an affiliated company of the CCC, has its main office (hereinafter referred to as “Plaintiff”) in Hong Kong and has a branch office in Korea (hereinafter referred to as “Plaintiff”).

B. From January 1, 1999 to December 31, 2003, the Plaintiff’s head office included the total of KRW 20,86,315,578, and KRW 209,39,390,399 in the business year of 1999, KRW 563,590,023, and KRW 193,78,982 in the business year of 2001, KRW 20,847,355, KRW 14,418,819 in the business year of 209, KRW 209, KRW 209, KRW 397, KRW 2996, KRW 298, KRW 396, KRW 209 in the business year of 205, KRW 14,578, KRW 200, KRW 578, KRW 194, KRW 200 in the business year of 200, KRW 39,539639,2539.

C. The director of Seoul Regional Tax Office conducted a corporate tax investigation on the Plaintiff’s 199 through 203 business years from December 9, 2004 to January 26, 2005; the Plaintiff’s principal office is a nominal company on the documents; the Plaintiff’s principal office is deemed as the Plaintiff’s domestic source income for the business year from 199 to 203,186,315,578 won in total; the Plaintiff’s interest income for the business year from 199 to 203; 238,479,3366 won in total for the business year from 199 to 205; 209, 209, 209, 369, 205, 205, 360, 360, 297, 209, 396, 205, 207, 397, 294, 2985, 297

D. As of June 15, 2006, June 27, 2006, and September 5, 2006, the Plaintiff filed an appeal with the Tax Tribunal on each of the above dispositions. The Tax Tribunal rendered a decision to dismiss the Plaintiff’s remaining claims except for the amount of KRW 1,313,685,238 in total, which included rebates as entertainment expenses in the calculation of entertainment expenses as of June 7, 2009, September 17, 2009, and September 13, 2010. In accordance with the decision of the Tax Tribunal, the Defendant rendered a decision to dismiss the Plaintiff’s remaining claims except for the amount of KRW 1,313,685,238 (hereinafter referred to as “each of the dispositions in this case”), and the imposition disposition of corporate tax for the business year of 199,200 (hereinafter referred to as “the imposition disposition of corporate tax for the first imposition, 201, and 202”).

(The following table omitted)

[Ground of recognition] Facts without dispute, Gap evidence 1 through 5, Eul evidence 1 and 2, the purport of the whole pleadings

2.The arguments and issues of the Parties

A. The plaintiff's assertion

1) Each disposition of this case is unlawful and unjust as it denies the substance of the Plaintiff’s headquarters, which was duly established under the laws of Hong Kong, and the transaction relation performed by its headquarters, without any discrimination, in full, and it is taxed by deeming it as the act of the Plaintiff’s branch.

2) In the event that the assessment of transfer price is intended to adjust the arm’s length price on the basis of the comparable company, a reasonable adjustment should be made pursuant to Article 5(1) of the former Enforcement Decree of the Adjustment of International Taxes Act. Although there is a serious difference between the Plaintiff and the comparable company in the dealing product or the trading stage, etc., and there is a low possibility of comparison between the international trade among the related parties and the trades between the unrelated parties, the imposition disposition of the instant case No. 2 includes an error of simply

B. Defendant’s assertion

1) The Plaintiff’s headquarters is a company in document without physical and human facilities, and did not engage in the business activities, and did not make any decision on the management of funds. Interest income accrued from the Plaintiff’s headquarters generated income from domestic business activities, and the Plaintiff’s branch actually performed the management function of the Plaintiff’s account. Thus, the instant interest income belongs to a domestic business place in accordance with the substance over form principle under the Framework Act on National Taxes, and constitutes domestic source income under Article 132(2)1 of the former Enforcement Decree of the Corporate Tax Act (amended by Presidential Decree No. 18174, Dec. 30, 2003).

2) In relation to the transfer pricing taxation of the instant case, it is reasonable for the Defendant to apply the net profit rate method as the arm’s length price calculation method, and the selection procedure of the comparable company is also reasonable, as well as the reasonable difference between the Plaintiff and the comparable company’s financial data. Accordingly, each of the instant dispositions is lawful.

C. Relevant statutes

The entries in the attached Table-related statutes are as follows.

D. Issues of the instant case

Therefore, the issues of this case are as follows: ① Whether the interest income of this case reported by the Plaintiff’s head office to the Hong Kong tax authorities is included in the Plaintiff’s domestic source business income of the Plaintiff branch; ② whether the transaction price (transfer price) of petrochemicals purchased from the Plaintiff’s foreign related party to export and sell to the customers of Korea, a third party who does not have any special relationship under the tax law, can be considered as the arm’s length price and thus, whether it can be included in the loss without tax adjustment under the Adjustment of International Taxes Act; and

3. Judgment on the first issue

(a) Facts of recognition;

1) The Plaintiff’s head office was established in Hong Kong pursuant to the Hong Kong Act in order to conduct the chemical product business on January 28, 197. As of the end of 1999, the Plaintiff’s head office paid dividends of USD 33,870,00 in total assets, USD 29,363,00 in total assets, USD 4,507,00 in equity capital (= USD 3,027,000 in total assets + USD 1,480,000 in earned surplus + USD 1,480,000 in earned surplus). During 200, the Plaintiff’s principal office paid dividends of USD 7,60,000 in dividends of USD 3,50,000 in earned surplus at the end of 203 (Evidence 6-2 in evidence 6-4).

2) On March 197, the Plaintiff’s branch was established to conduct business activities in Korea. The Plaintiff’s branch is operating a sales support business (i.e., the support business that the Plaintiff’s main office purchases chemical products from CCC’s affiliates or non-affiliated affiliates and supports the sales of them to domestic customers, (ii) the business that CCC’s affiliates directly sell chemical products to domestic customers, (iii) the business that collects and provides necessary data and information to CCC’s affiliated companies, and (iv) the business that was transferred from the Plaintiff’s main office, and the business that was operated as the price for service revenue received from each affiliated company while performing the service business.

3) In the 1970s and 1980s, when the Plaintiff was established, domestic manufacturers (consumers) of petrochemicals did not have the ability to directly engage in the trading due to lack of international business capacity. Even if there was such ability, under the foreign trade or foreign exchange transaction regulations, domestic companies were prohibited from engaging in the trading outside the trading in foreign countries, and there were many legal regulations, such as prohibiting domestic companies from purchasing and importing goods outside the country, and resale them outside the country. Therefore, domestic companies were not able to engage in the trading with foreign trading companies.

4) The details of division of duties of the Plaintiff head office and the Plaintiff branch regarding the sales business of petrochemicals related to the instant case are as follows.

(The following table omitted)

5) The Plaintiff’s head office purchased products from the CCC’s affiliated company or non-affiliated company and sold them to domestic customers under its name. The Plaintiff’s main business activities on behalf of the Plaintiff’s head office, such as contact with manufacturers, contact with customers, and determination of resale price, constitutes the Plaintiff’s head office’s domestic permanent establishment under the Corporate Tax Act, and thus, the Plaintiff’s branch reported corporate tax including all sales and sales cost arising from domestic product sales, as the Plaintiff’s head office constitutes a domestic permanent establishment under the Plaintiff’s head office, thereby filing a report on domestic source income.

6) The Plaintiff’s headquarters provided the Plaintiff’s branch with operating funds ( approximately KRW 7.7 billion at the end of 2003) to conduct domestic business activities. The Plaintiff’s headquarters temporarily conducted financial transactions, i.e., recovery and payment of funds, deposit of surplus funds, and borrowing of shortage funds in connection with the transaction of chemical products purchased from overseas, etc. from the Plaintiff’s headquarters, and conducted financial transactions at Hong Kong Y Bank, etc. in the name of the Plaintiff’s headquarters.

7) The Plaintiff’s principal office caused the above deposit of surplus funds and the borrowing of shortage funds, as follows, the total of KRW 1186 million interest during the business year from 199 to 2003, and the total of KRW 239 million interest on the payment (see, e.g., the details of the disposition).

(The following table omitted):

8) The Plaintiff’s domestic customer companies, the importer, directly or through the issuing bank of the domestic L/C, deposited the Plaintiff’s principal office’s bank account, which is a party to a transaction directly and legally, without going through the Plaintiff’s branch. The Plaintiff recorded the amount of petrochemicals purchase and sales only in the account book of the Plaintiff’

9) According to the minutes of the board of directors’ meeting held in Hong Kong, foreign directors of the board of directors held in Hong Kong approved a proposal to conclude a contract for the supply of Alphin products between the Plaintiff and the Bottleneck industry. A number of important management or commercial decision-making were conducted through the board of directors held outside of Korea, such as determining to sell the Plaintiff’s investment shares to the AX corporation in full.

10) The Plaintiff’s headquarters entered into a mutual agreement with the Hong Kong-related related company located in Hong Kong, and entrusted the matters related to the finance and funds of the Plaintiff’s headquarters and the corporate visa function (such as preparation for holding a board of directors, preparation for documents, and submission of various reports, etc.) to the sel Park long-gu.

11) The right to withdraw the Plaintiff’s principal deposit account is authorized only to the signature-holder separately designated in accordance with a resolution of the relevant board of directors (No. 6-1 and 5), and the Plaintiff’s branch did not have the right to manage the said deposit account.

12) Meanwhile, since the establishment of the Plaintiff’s headquarters, the Hong Kong tax authorities filed corporate tax returns on the above interest income and paid interest, but such interest income and paid interest under the Hong Kong tax law were non-taxable items, and thus, there was no tax amount actually paid in Hong Kong.

[Ground of recognition] Facts without dispute, entry of Gap evidence 6, 7, and 8, the purport of the whole pleadings

B. Determination

As to whether the interest income of the headquarters of this case is included in the domestic source business income of the Plaintiff branch, in full view of the following circumstances, the interest income of the headquarters of this case should be viewed as income from the independent business activities of the Plaintiff headquarters, a foreign corporation, and thus, the first imposition disposition of this case imposing corporate tax on the Plaintiff branch and the second imposition disposition related to the first issue of this case is illegal.

1) In light of the legal and economic circumstances in Korea at the time the Plaintiff was established, in order for CCC to efficiently supply the chemical products of CCC to domestic consumers, it appears that CCC established a legal entity overseas rather than establishing a legal entity that bears the burden of legal regulation as seen earlier, and that Korea has selected a business structure that establishes the Plaintiff branch and supports its business in Korea. Such business form has been maintained for not less than 30 years, and the Plaintiff branch reported domestic source income to the Plaintiff branch as a result of product sales, it is difficult to view that the Plaintiff was merely established for the purpose of tax avoidance.

2) The Plaintiff’s head office shall hold a board of directors and conduct dividends, and conduct independent activities of the company, such as capital increase and sales of assets, so it is difficult to be deemed a document company.

3) The Plaintiff branch did not have the right to control, manage, and dispose of the Plaintiff’s bank account at all, nor did it be deemed that the Plaintiff branch deposited or invested funds in the said bank account. The Plaintiff’s domestic customer company deposited funds directly into the Plaintiff’s principal office without going through the Plaintiff’s branch. Therefore, the Plaintiff branch did not have the right to temporarily hold the funds.

4) The Plaintiff’s headquarters reported as the domestic source business income of the Plaintiff branch with respect to the transaction in which the Plaintiff’s headquarters exported and sold petrochemicals to the domestic customers (However, the Plaintiff’s branch’s account book did not keep the records on the Plaintiff branch’s account book), which is regarded as related to the business activities of the branch office in Korea, since the Plaintiff’s main office is carrying out an important contract activities such as consulting on the terms and conditions of transaction under the above sales order, and the interest income of the instant main office is generated from the deposit account of the Plaintiff’s main office, and thus,

5) The interest and interest paid on the income of the Plaintiff’s headquarters were generated by the independent decision-making on the management of the Plaintiff’s headquarters’s own funds, such as capital increase, dividend, and sale of assets, and there is no direct relation to the activities of the Plaintiff’s branch (the activities for increasing

6) The reason that the Plaintiff’s head office did not pay corporate tax on the interest income of the instant head office in Hong Kong is that the Hong Kong Corporate Tax Act provides that such type of income shall not be imposed. The Hong Kong tax authorities do not exclude the said income from taxation on the ground that it is a domestic source income.

7) According to the statement in the letter of answer (No. 3), the Plaintiff’s branch was engaged in the business related to the sales activities of the Plaintiff’s headquarters. This is merely a statement concerning the division of work and the business activities, and it cannot be readily concluded that the subject of legal attribution of the price is the Plaintiff’s branch.

4. Judgment on the second issue

(a) Facts of recognition;

1) The director of the Seoul Regional Tax Office held that, compared to the gross sales profit ratio of chemical products purchased from a person with a special relationship abroad during the business year 2001 and 2002 by the Plaintiff, the gross sales profit ratio of chemical products purchased from a foreign related party is considerably lower than the average of five years (199 to 2003). Thus, the Plaintiff was suspected of transferring taxable income to the foreign related party.

2) The director of the Seoul Regional Tax Office, among the enterprises deemed to engage in the same type of business as the Plaintiff, selects the enterprises engaged in import and sale of basic industrial compounds (market), synthetic rubber and plastic materials import and sale (market), and basic industrial compound import and sale (market) from among the product wholesale business, and finally selects seven companies, including (1) 42 corporations, listed corporations, and KOSDAQ-registered corporations, from among the total 1,904 companies, which were subject to external audit, and (2) 42 corporations subject to external audit, with no financial data for the last three business years, or there is no financial data for the latest three business years from among the 42 companies subject to external audit, excluding the five companies other than the special accounts, the form of business or the difference between major items to be handled, and the opinion on audit, and the listed companies, and one company whose type of transaction is similar to those of goods wholesale business and KOSDAQ-registered corporations, as comparative companies.

3) After calculating the Plaintiff’s annual operating profit ratio in the business sector of the resale of chemical products compared with the annual operating profit ratio of the comparable company, the director of the Seoul Regional Tax Office examined the comparableness between the Plaintiff and the comparable company, adjusted the difference between the financial data and risk level in order to enhance comparableness with respect to the difference between the difference between the comparable company and the Plaintiff’s net trade profit, and adjusted the difference in the impact on the income statement item by calculating the interest cost on the difference in the balance sheet items. This adjusted the Plaintiff’s annual average sales claim and purchase debt amount by converting the Plaintiff’s annual average sales claim and purchase debt amount into the annual average sales amount of the comparable company, and then multiplying the amount calculated by multiplying the amount calculated by multiplying the annual average sales claim and purchase debt amount of the comparable company by a specified interest rate, and adjusted the difference between the Plaintiff and the comparable company’s annual operating profit ratio and the investment capital level for other business assets by similar means.

4) The products and transaction stages between the Plaintiff and the comparable companies are as follows.

(The following table omitted)

5) The Plaintiff’s composition of sales from the resale business of chemical products is as follows.

(The following table omitted)

6) 원고가 판매한 화학제품은 스티렌모노머, 솔벤트 등 주로 합성수지나 합섬 원료와 같은 2차적 화학제품을 생산하는 데 사용되는 기초 석유화학제품으로서 액체 상태로 운반되어 수백 또는 수천 톤 단위로 판매되었으며, 삼성물산, SK네트웍스 등과 같이 화학제품을 실수요자에게 재판매하는 종합상사나, 제일모직, 한화석유화학, 코오롱유화 등 대기업 실수요자에게 주로 판매되었다.

7) The business profit ratio between the Plaintiff and the comparable companies from 1999 to 2003 is as follows.

(The following table omitted)

8) Meanwhile, according to the 2000s global price trends related to petrochemicals, the facts that continued price decline since 200, and that have been recovered since 2002, can be acknowledged.

[Ground of recognition] Facts without dispute, entry of Gap evidence Nos. 9 through 18, purport of the whole pleadings

B. Determination

1) As seen earlier, the Plaintiff’s petrochemicals transaction is in the form of exporting it to the Republic of Korea from a foreign country, and thus, in order to calculate the arm’s length price of the instant case, ① an unrelated international trade is subject to comparison, and ② the said transaction is required to have a high possibility of comparison with the relevant international trade in question. In determining whether a high possibility of comparison exists, elements such as the function of business activities that may affect the price or profit, contractual terms, risks accompanying the transaction, kinds and features of goods or services, market conditions change, and economic conditions should be analyzed. Meanwhile, in a lawsuit seeking revocation of a tax disposition, the burden of proving the legality of the pertinent tax disposition is, in principle, on the grounds that the tax authority bears the burden of proving the legality of the relevant taxation disposition, in calculating the arm’s length price and determining the tax base and tax amount on the basis of the arm’s length price for reasons that the transaction price formed between the resident

2) In light of the above legal principles, in full view of the following circumstances, as to whether the arm’s length price calculated by the Defendant is legitimate, the part relating to the second issue among the second issue of the instant imposition disposition is deemed to have been made on the basis of the arm’s length price calculated based on the comparable companies that failed to meet the requirements for comparison prescribed by the Adjustment of International Taxes Act.

A) In this case, the products handled by the Plaintiff are "organic chemical (petroleum chemical) or mineral raw materials (petroleum and primary processed products)" and both of them constitute organic chemical products, and the Plaintiff's transaction is in the form of "export only to Korea from abroad". On the other hand, the comparable companies selected by the Defendant are "importing and re-sale various items such as "organic chemical products and chemical chemical products" in the domestic market, and there seems to be lack possibility of comparison due to difference in the treatment products or qualitative stages of transaction.

B) While the Plaintiff’s profitability changed due to changes in international oil prices and international changes in the petroleum chemical industry, the profitability of comparable companies selected by the Defendant during the same period was stable without any particular influence, it is deemed that such difference has significant impact on the compared price or profit rate.

C) Considering the foregoing economic pattern such as the international price trend related to the petrochemicals, the Plaintiff’s recording of the low operating profit rate in the business year 2001 and 2002, referring to the international market tax, was set at the transfer price, but it appears that the transfer price was due to the Plaintiff’s continuous decline in international market price at the time of the determination of transfer price which is reflected after the international market price, and there is no evidence to deem that the Plaintiff was at a higher level of transfer price regardless of international market price.

D) As seen earlier, the difference adjustment is an adjustment generally conducted at almost all transfer pricings, and the difference between the Plaintiff and the comparable companies’ inherent and most important kinds of products in this case and the impact on net profit on the economic environment and net profit caused by the difference in the kinds of products dealt with in the instant case is deemed not to have been adjusted, and there is no evidence to acknowledge that there has been a reasonable adjustment to the extent that the difference in the instant transaction would have been overcome.

5. Conclusion

Therefore, since each of the dispositions of this case is unlawful, the plaintiff's claim of this case shall be accepted on the grounds of all of them, and it is so decided as per Disposition.