Ask a Lawyer is a regular column written by attorneys at Yoon & Yang LLC on various legal aspects of the Korean life or business. The content provided here is general legal information, not legal advice on a specific situation. -- Ed.

Q: What tax issues should I take into consideration when determining the prices of goods imported from foreign affiliates?

A: Company A (“A”) recently imported raw materials from foreign affiliate B (“B”), and A paid customs duties and income taxes based on the price of the raw materials paid to B. However, the National Tax Service imposed income taxes on A on the grounds that the price paid by A was higher than the raw materials’ market price (arm’s length price). A requested the Korea Customs Service issue a refund of customs duties on the grounds that the NTS recognized a lower price for the imported raw materials. However, the KCS denied the request. In conclusion, A paid higher customs duties.

A cannot but wonder why the KCS refused to accept the price recognized by the NTS. Further, A would have a difficult time understanding this, particularly because the Korean tax laws allow a taxpayer to request the KCS or the NTS for a refund of taxes if the NTS or the KCS imposes taxes after adjusting import prices.

Companies that have transacted with foreign affiliates could have likely experienced situations similar to the example above. Why do such situations occur?

Let us first approach this issue from the perspective of tax laws. Incidents described above occur because national taxes and customs duties (i) are based on different laws and (ii) serve different purposes. Second reason stems from a practical perspective. There are practical limitations in handling national tax-related work and customs duty-related work in a consistent manner, because the agencies in charge of collecting and refunding national taxes and customs duties are separated.

This issue can also influence taxes of the foreign affiliates. To illustrate using the example described above, if A and B were to continue trading raw materials at the market price recognized by the NTS, the tax authority of the country where B is located may not accept the market price recognized by the NTS. The Foreign Tax Authority would impose income taxes on B based on the original transaction price, on the grounds that B has supplied the raw material at a price lower than the actual price. The foregoing scenario may play out because the Foreign Tax Authority is not bound by the market price recognized by the NTS or the KCS, considering the fact that countries exercise sovereignty over taxation within their respective territories.

The transacting parties could determine the prices of goods considering profits, business conditions, etc. However, in trading with foreign affiliates, the NTS and the KCS look into the adequacy of the actual transaction price, because there are possibilities of the relevant parties evading taxes by transferring taxable income to foreign countries, or by determining prices that are inconsistent market prices. Accordingly, for a company to avoid tax risks in trading with a foreign affiliate, it should determine the arm’s length price by considering the fact the price would affect not only national taxes and customs duties, but also taxes of the foreign affiliate.

By Jeon Wan-kyu
Attorney and partner of law firm Yoon & Yang LLC