The Asian transfer pricing landscape continues to change, with new initiatives being announced by the governments of both China and South Korea designed to consolidate and protect the integrity of their respective tax systems. These initiatives continue to address the issues identified in the OECD’s Base Erosion and Profit Shifting (“BEPS”) project.

China

The Chinese State Administration of Taxation (“SAT”) has issued a directive to its officers to increase their focus on both royalty and service payments made to foreign related parties. While these have been areas of concern to the SAT for a number of years, the BEPS initiatives have brought additional focus on these transactions with the directive instructing the bureaus to report all royalty and service fee payments to offshore related parties in the period 2004 through 2013. These are all open years for Chinese taxpayers. While there has been no change in the Chinese law, the BEPS initiatives have brought into closer focus the use by multinationals of intellectual property holding companies, especially those which are passive holders of intellectual property (often located in low-tax jurisdictions) created by other parts of the multinational’s business. The royalty debate is further complicated by issues such as the generation of local marketing intangibles by Chinese distributors and local manufacturing intangibles due to process improvements and location-savings achieved by Chinese manufacturers. Similarly, with service payments, the increasing scrutiny that the SAT is putting on these transactions is focusing on ensuring that the amounts payable are truly arm’s length and commensurate with actual benefits derived from the services.

Companies with Chinese operations therefore need to be very cognizant that the precision and evidentiary standards required to be met in order to obtain either or both royalty and services deductions in China are significantly higher than in many developed countries. As such, the typically global approach many multinationals take to service fee and royalty compliance will not meet the expectations of the SAT, where the onus is effectively on the taxpayer to validate the deductibility of the expense. Furthermore, the Chinese analysis must address the local issues that will be pursued by the SAT.

South Korea

The South Korean government has announced new legislation that involves tightening rules around thin capitalization; increasing the penalties for tax evasion; relaxing related party disclosure thresholds; and introducing a new “corporate accumulated earnings tax” that is designed to encourage corporations to repatriate or use their profits rather than just retain and accumulate them. This new tax of 10% payable on net income applies to companies with in excess of KRW 50 billion in equity capital (USD 50 million) and certain Korean corporations worth in excess of KRW 5 trillion (USD 5 billion). The rate can be reduced by a formula that takes into account amounts spent on new investments, local remuneration and dividends.

The proposed reduction in the thin capitalization ratio from 3:1 to 2:1 is consistent with the approach of a number of Asia Pacific jurisdictions. Any non-qualifying interest paid will be treated as a non-deductible dividend for Korean tax purposes. The legislation also proposes that companies that fail to file or under-report income from related party transactions will be subject to a penalty of 60% of the evaded tax and it is proposed that the statute bar for evasion be extended from the current 10 years to 15 years. By contrast, the concessions on the transfer pricing reporting requirements are less significant, doubling the thresholds to KRW 200 million (USD 200,000) for each transaction and KRW 1 billion (USD 1 million) in aggregate for all transactions.

Comment

In an age when the OECD is talking about standardizing transfer pricing issues and compliance requirements across its members and more broadly, and is espousing the need for multinational (not unilateral) actions to address the issues associated with BEPS, individual countries continue to prioritise the protection of their own tax systems. This is not a criticism as each country has a sovereign right to tax and must protect its tax base but it is a reflection of the fact that the task the OECD has set itself to bring international consensus to the global taxing system is a massive ongoing task that will likely prove to be futile. In the meantime, multinationals must be aware of the specific issues required to be addressed in each country and should not fall into the trap of approaching regions or clusters of countries on a holistic basis.

Our partner firm for Transfer Pricing, Quantera Global, recently published this article. 

Steven Carey

Stean Hainsworth

Douglas Fone