A simplified advanced pricing arrangement (APA) program is available in South Korea, beginning from 2015, for small and medium-sized (SME) foreign companies with annual sales of 50 billion Korean won* or less (approximately U.S. $46 million).
The concept of the simplified APA program is similar to the existing unilateral APA filing with the Korean Tax National Service (NTS) by which the taxpayer establishes an arrangement for the determination of transfer pricing over a fixed period of time without the involvement of foreign tax administrations.
Due to the complexity of the Korean APA process—which can take, more or less, two years to complete under the existing APA program—small and medium-sized foreign companies have encountered certain challenges associated with the incremental time and cost investments throughout the APA process, from the beginning step of preparing the APA application to the final conclusion.
Accordingly, the existing APA program has mainly been applied by large multinational conglomerates.
The official statistics of the NTS show that the average time taken for all APAs concluded by 2013 was 1.9 years and 2.4 years for unilateral and bilateral APAs respectively.
The APA program generally has not been perceived to be available, practically speaking, for small and medium-sized foreign companies to use in mitigating the tax risk with respect to related-party transactions.
The simplified APA program is intended to make available the benefits of APA for small and medium-sized foreign companies in Korea, by means of the streamlined requirements for information and for deadlines for concluding the APA within one year of submission of the application.
The following table illustrates the new streamlined requirements under the simplified APA program.
|Document List||Required for simplified APA?|
|1||APA application form
|2||Overview of business—business profile, organization, and investment relationship
|3||Financial statements for the past three years, a copy of tax returns, a copy of contracts for international transaction, and relevant documents
|4||Documents detailing suggested transfer pricing methodology (listed below)
Taxpayer can submit the simplified version or be exempt from submission
|a.||Methods used to evaluate comparability and adjustment of difference in factors determining comparability
|b.||When the financial statements of comparable companies are used, the difference in the accounting principle and its adjustment
|c.||When financial or cost data segmented by transaction item is used, segmentation standards
|d.||When two or more comparables are used, the arm’s length range and the method for its calculation
|e.||Information explaining conditions or assumptions for the transfer pricing method
|5||Method used to adjust difference between actual transaction prices and arm’s length price
|6||MAP application form
|7||Other data supporting the appropriateness of the transfer pricing method suggested for an APA
Source: Korea NTS
The simplified APA program will be offered first to certain qualified foreign companies (those with annual sales of 50 billion Korean won or less) from certain selected industries—namely manufacturing, wholesale/retail, and service industries. The simplified APA program then will be gradually made available to taxpayers in the remaining industries.
According to NTS statistics, foreign companies belonging to the three initially selected industries consist of 76% (7,023 companies) of the entire pool of foreign companies (9,212 companies). Because these industry sectors represent the majority of the foreign companies operating in Korea, this factor may be one of the reasons that initial access to the simplified APA program is being offered to them.
In addition, foreign companies in the manufacturing, wholesale/retail, and service industries are typically engaged in a relatively simple form of related-party transactions—i.e., transactions that do not necessarily require an in-depth analysis to substantiate compliance with the arm’s length principle. This factor thereby offers support for the streamlined requirement of information for the simplified APA by the nature of the related-party transactions of these entities.
For instance, a foreign manufacturing company in Korea may be providing contract manufacturing services for its headquarter company and receive in return an amount of service fees equivalent to the manufacturing and related costs plus a certain mark-up. In this situation, when applying for the simplified APA process, the level of information required to support the arm’s length nature of the related-party transaction may be limited to providing proof of the level of mark-up measured in a net cost-plus margin earned or expected to be earned by the foreign manufacturer (similar to the independent comparable companies in Korea). In this respect, the underlying assumption for the streamlined requirement of the documents detailing suggested transfer pricing methodology may be that the nature of the related-party transactions commonly observed in the selected sectors (manufacturing, wholesale/retail, service) is less complex than for other industries, such as the financial services sector.
Although the level of information under the simplified APA program is relatively “low,” this fact alone does not negate the need for appropriate transfer pricing analysis with respect to documents detailing the suggested transfer pricing methodology as a part of the streamlined submission. Extensive knowledge of economics, tax, accounting, law, and relevant industries allows the taxpayer to establish and demonstrate the appropriate profit level of the local Korean operation, in selecting and applying the most reasonable transfer pricing methodology.
In other words, the level of information may be simplified concerning an eligible foreign company’s application of the simplified APA process, but the essence of transfer pricing analysis must be maintained regardless of the complexity of the related-party transactions. In this regard, the knowledge and experience of transfer pricing specialists can be helpful under the simplified APA process.
With the one-year time period allowed for concluding the simplified APA process (one year from the time when the application is submitted to the NTS), eligible taxpayers can be expected to experience greater certainty as well as time and cost saving benefits.
In summary, the simplified APA program is viewed as providing a cost-effective and time-saving approach for small and medium-sized (SME) foreign companies to mitigate their tax risk in Korea.
Because the simplified APA program is to be implemented shortly after the open discussions between NTS and foreign companies operating in Korea, it can be reasonably expected that the NTS would be in favor of position taken by the applicants for APA terms and conditions.
With the submission of the APA application, applicants can also expect a tax audit “exemption” for the period of verification (from the time of the application to its conclusion) and also for the three- to five-year period covered by the APA, once concluded.
The simplified APA program offers distinctive and unprecedented benefits throughout the process and is ultimately aimed to provide the stable environment of operation for SME foreign companies in Korea.