Management fee
Service fee between related parties had been denied as deductible expenses of Korea subsidiary for long time. But one foreign subsidiary appealed the similar case to the Supreme Court and finally won. Because of this, National Tax Service (called as ‘NTS’ hereinafter) of Korea created NTS Guideline first. Soon after, NTS enacted related clause in the presidential decree. Let’s call service fee charge as ‘management fee’ because it is generally called in Korea.


Presidential decree to Law for Coordination of International Tax Affairs, Article 6-2 [Fair price for purchased service] (newly acted on August 24, 2006)

1. In case that following conditions are met for price of services performed by related companies located in foreign country to Korean entity in areas like management, finance advisory, guarantee of payment, assistance of computer and software, technical assistance and other areas for which similar services are necessary (called as ‘internal services’ hereinafter), such price is regarded as arm’s length one, being accepted as deductible expenses.
 

① Service provider shall contract internal service before service is provided and real service shall be provided according to that contract

 

② There shall be additional revenue or savings of costs to Korean entity by that internal service.

 

③ Price shall be computed by fair pricing rule stipulated in Law for the Coordination of International Tax Affairs (Note: Comparable 3rd party price method, Reselling price method, Cost plus mark-up method, Profit split method, Transactional net profit ratio method and Berry ratio method are accepted as fair price for transfer pricing by Law for the Coordination of International Tax Affairs). In case of Cost plus mark-up method and Transactional net profit ratio method, price shall be computed by following two bases.

 

a. Costs incurred must include all costs, no matter whether they are direct and indirect, incurred in relation with internal service.

 

b. When service provider subcontracts part or all of internal service to other related companies or 3rd parties and charges back its payment to Korean entity, service provider shall add mark-up only to internal service which service provider performed by itself, provided; proceeding clause may not be applicable when no application is reasonable by considering contents of internal service, environment and practice.

 

④ Documents to prove ① to ③ is prepared and kept

2. In case that same internal service is done internally by itself in case of other related company located in foreign country or is performed by 3rd parties to other related company located in foreign country, item 1 is not applied (Note: This means arm’s length price and deductibility may be questioned because service between related companies is not inevitable), provided; item 1 is applied when duplicated internal service is performed temporarily for reasonable motives like reorganization of business and department, restructuring, and reduction of error of management decision etc.


NTS Guideline 4-0--2 [Deductibility of management fee]

1. The clause of ‘real service shall be provided’ in Article 6-2, item 1-① of presidential decree to Law for the Coordination of International Tax Affairs means, the fact of service being provide must be verified by service master schedule, time schedule of work, service providing company and its employees, related expense claims etc. (amended on February 2, 2009)
2. Following services, as being provided as shareholder of Korean entity by foreign related companies like foreign mother company etc, doesn’t belong to item 1
(Note: This means ‘not deductible expenses’).
 

① Preparation of financial statements according to GAAP of the country where mother company is located.

 

② Consolidation work as reporting obligation of mother company.

 

③ Audit or other supervisory work such as external auditing.

 

a. Costs incurred must include all costs, no matter whether they are direct and indirect, incurred in relation with internal service.

 

b. When service provider subcontracts part or all of internal service to other related companies or 3rd parties and charges back its payment to Korean entity, service provider shall add mark-up only to internal service which service provider performed by itself, provided; proceeding clause may not be applicable when no application is reasonable by considering contents of internal service, environment and practice.

 

④ Documents to prove ① to ③ is prepared and kept



Withholding issue

When internal service is performed in Korea, tax shall be withheld at 22% when management fee is wired. If there is tax treaty applicable, tax treaty shall be applied first of all in withholding.
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