Generally speaking, intra-group services between related parties in a multinational enterprise (MNE) group are provided for the improvement of cost-efficiency and effectiveness of business activities of such groups. For example, all the subsidiaries of a MNE group cannot hire their local lawyer for their legal issues in each jurisdiction from a cost-benefit perspective. Instead, the foreign headquarters can hire the in-house legal counsel in order to mitigate and manage the common legal exposures or issues of the group, which will provide some benefits to all the subsidiaries. In this regard, the costs for the in-house legal counsel, plus an arm’s length mark-up, need to be charged to the subsidiaries. As this is very natural, OECD Transfer Pricing (TP) Guidelines and also the Korean tax law basically allow a Korean subsidiary to bear such charges on that basis from the intra-group service centre of the headquarters, or regional headquarters, if some requirements are met.
Under the Korean International Tax Coordination Law (the ITCL), the intra-group service fee paid to the foreign related party can be deductible for Korean corporate income tax purpose when the following four conditions are met:
In accordance with the revision of OECT TP Guideline in 2017, the Korean tax authority introduced the concept of low value-adding intra-group services (LVIS) in 2020 through the revision of ITCL, which is as follows.
1. Deductibility of the fee for LVIS under the ITCL
Under the revised ITCL, where the taxpayer determines the arm’s length price of fees for the services satisfying all the following conditions (i.e. LIVS) as the amount of ‘their costs plus 5% mark-up’, it would be deemed that such fees are determined at the arm’s length price for Korean tax purposes:
a. Research and development services;
b. Extraction, exploration, or processing of natural resources, manufacturing and production services;
c. Purchasing activities relating to raw materials, manufacturing, sales, marketing and promotion activities; and
d. Financial transactions, insurance and reinsurance.
a. The use of unique and valuable intangibles or the creation of unique and valuable intangibles; and
b. The assumption or control of substantial or significant risk by the service provider, or the creation of significant risk for the service provider.
2. Another threshold for the deductibility of LVIS fee:
Where the service provider’s charge on providing the above LVIS (i.e. cost plus 5% mark-up) exceeds the smaller of i) 5% of the service recipient’s sales amount or ii) 15% of the service recipient’s operating expenses, the above simplified approach rule on LIVS will not be applied.
Although the Korean tax law does not regulate the detailed documentation method for deductibility of LVIS fees, under the OECD TP guidelines, it is reasonably expected that at least the following documentation is required;
Min Jae Lee
Sung Soo Jin