The new standards are effective 15 February 2013.
Background
In 2010, the Korean tax authority (NTS) initially set up a model to determine arm’s length price for intercompany guaranty transactions.
In 2012, NTS applied the arm’s length guaranty rates and assessed taxes with respect to the intercompany guaranty transactions fees. However, the arm’s length guaranty fees calculated by NTS lacked legislative support, thus creating confusions among taxpayers.
To provide clarity and certainty, the Ministry of Strategy and Finance established new standards for calculating arm’s length guaranty fees for intercompany guaranty transactions (the new standards were added as guidance to the measures known in English as “Enforcement Decree of the Law for the Coordination of International Tax Affairs §6-2”).
Four methods for arm’s length price
Under the new standards, there are four methods that may be used in calculating the arm’s length price of guaranty fees for intercompany guaranty transactions.
Benefit approach - This method is based on the benefit that a guarantee is expected to receive from guarantor’s guaranty. The arm’s length price is to be calculated as the difference between guarantee’s financing cost, with and without the intercompany guaranty. Those financing costs are to be based on credit ratings of the guarantor and the guarantee, and to take into consideration the borrowing interest rates or bond yields, both with and without the intercompany guaranty. When establishing credit ratings, historical financial data as well as other information (e.g., logically predictable financial forecasts and non-financial information (such as country, region, level of technology, credit risks of the industries that guarantor and guarantee belong to)) are to be considered.
Cost approach - This method is based on guarantor’s expected risks and costs. The arm’s length price is calculated as a sum of guarantor’s expected risks from the guaranty provided and the related costs incurred. The guarantor’s expected risks are based on guarantee’s probability of default and expected recovery rate. Reliability, obtainability, and comparability of the supporting evidence are to be considered in calculating these rates.
Cost-benefit approach - This method is based on both guarantor’s expected risks and costs and guarantee’s expected benefits. The arm’s length price is reasonably adjusted from the arm’s length range derived from using the methods according to the benefit approach and the cost approach considering guarantor’s expected risks and costs and guarantee’s expected returns.
Price deemed arm’s length - If a guaranty fee was calculated based on the difference between borrowing rates, quoted by a lending financial institution, with and without a guarantee, or calculated with a method specified by a commissioner of the NTS, then it is deemed to be an arm’s length price.
For more information, contact a tax professional with KPMG’s Global Transfer Pricing Services group:
Gil Won Kang
+82 22 11 20 907