Korea: Related-party marketing fees not subject to customs duty

High Court decision in South Korea

The high court in Seoul held that a Korean entity was not liable for additional customs duty on international marketing fees paid to its corporate international headquarters. The high court, thus, overturned a decision of a South Korean administrative court, and instead agreed with the taxpayer that the international marketing fees differed from a “standard” brand royalty payment.

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Background

A licensing agreement between the Korean entity and the multinational entity’s international headquarters provided that the Korean entity would pay 4% of its net sales as an “international marketing fee” in addition to the standard brand royalty payments. The Korea Customs Service made an additional assessment of customs duties with respect to the international marketing fee of approximately KRW 5.9 billion (approximately U.S. $5.5 million).

The issue before the administrative court, therefore, was whether the international marketing fee was in substance consideration for the use of the brand, i.e., a royalty. The Korean entity asserted that the international marketing fee differed from the brand royalty payment in that the fee was an allocation of global advertising expenses incurred by the international headquarters. However, the administrative court found that: 

  • The international marketing fee was not based on the actual advertising cost of the headquarters but was actually based on net sales of the Korean entity. 
  • The license agreement stated that the international marketing fee would be charged without any increase in the brand royalty, notwithstanding the expanded global marketing activities conducted by the headquarters.
  • The Korean entity paid withholding tax with its remittance of the international marketing fee, as a “royalty.”

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High court's decision

The high court in a recent decision reversed and found that the headquarters’ international marketing fees were actual international marketing expenses—i.e., advertising costs paid with respect to global sports stars—incurred by the headquarters office. 

The high court explained that the Korean customs authorities, in imposing customs duties on the marketing fees, seemed to misinterpret the substance of the international marketing fees, thereby distorting the signed agreement’s original intention. Notably, the intercompany agreement between the international headquarters and the Korean entity clearly specified that the international marketing fees were to be distinguished from a royalty. 

KPMG observation

When the administrative court issued its decision, tax professionals observed that: (1) the international marketing fee was not based on the actual advertising cost of the headquarters but was actually based on net sales of the Korean entity; (2) the license agreement provided that the international marketing fee would be charged without any increase in the brand royalty, notwithstanding the expanded global marketing activities conducted by the headquarters; and (3) the Korean entity paid withholding tax with its remittance of the international marketing fee, as a “royalty.” 

Now that the high court has reversed, tax professionals have noted that the high court acknowledged the provision in the related-party agreement that specified that the international marketing fee would be differentiated from a royalty payment, and that actual international marketing costs were incurred for the headquarters’ international marketing purposes. It therefore appears that the high court was reluctant to make a broad interpretation or analogy that would treat royalty payments in favor of the customs administration.

Companies with similar issues need to consider the high court’s decision, but given that each decision of the courts may depend on a specific court interpretation of royalty payments, taxpayers need to determine whether they have agreements that are carefully drafted and structured and that take into consideration the nature of their intercompany payments as well as address possible challenges to payment classifications in the future audit.

 

For more information, contact a tax professional with KPMG’s Global Transfer Pricing Services in South Korea:

Tae Hyun (Pius) Park | +82 (2) 2112 6757 | taehyunpark@kr.kpmg.com

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