When a foreign subsidiary of a Korean company uses a loan from the financial institutions in the foreign country, the Korean company usually provides the foreign subsidiary with payment guarantee and the foreign subsidiary pays a fee for the payment guarantee. Based on the announcement of National Tax Service (“NTS”), the amount of payment guarantees for the foreign subsidiaries provided by the Korean parent companies steeply increased to USD 12 billion, 23 billion and 42 billion in 2007, 2008 and 2009, respectively.
Under the Korean tax law, the fee for payment guarantee received from the foreign subsidiary is treated as taxable income and subject to the Korean transfer pricing rules. However, as it is not clear how to determine the arm’s length price of the fee for payment guarantee, certain Korean parent companies were deemed to have received the fees for payment guarantee at a lower level and as a result, there have been disputes on the appropriateness of the fees for payment guarantee between NTS and the taxpayers over the years.
NTS has collected the information on the payment guarantees from the Korean parent companies and the relevant financial institutions, and recently developed a calculation model of arm’s length price of the fee for payment guarantee. It is known that NTS plans to, based on the calculation model, recommend certain taxpayers to file amended corporate tax returns or impose underpaid corporate taxes on the Korean companies which have received the lower fees for payment guarantees than the arm’s length prices.
Considering the size of payment guarantees, the number of relevant Korean companies and the number of years concerned, NTS is likely to levy a significant amount of taxes in relation to the payment guarantee. In this connection, it is likely that tax appeals or litigations by the relevant Korean companies against the tax assessments by NTS will increase.