“Hygiene Corp” is a manufacturer of hygiene products, diapers, sanitary napkins, toilet paper, which it sold to forty‐five overseas related parties at cost plus 8%, the same markup applied to four unrelated foreign purchasers. It also dispatched skilled employees abroad under an internal exchange programme and transferred patented know‐how free of charge to another related affiliate.
Following an audit for FY 20152019 the tax authorities issued an assessment of additional taxable profits due to non-arm’s length pricing of sales to related parties and unpaid service fees and royalties from related parties.
An appeal was filed where “Hygiene Corp” argued that its sales prices (manufacturing cost plus an 8% margin) mirrored prices charged to independent third parties and so already reflected an arm’s-length result. It emphasised having genuine internal comparables, growing share of non-related-party exports (over 20% by 2019), and meaningful economic rationale for low-margin pricing to utilize idle capacity amid a sharp decline in Korea’s birth rate after 2016. Citing OECD Guidelines and case law, it argued that the cost-plus method based on internal comparables should prevail over a net margin method reliant on entirely different companies, and that economic strategy and market-penetration considerations are valid under the arm’s-length principle. It also challenged the comparability and selection process for the twenty external companies used by the tax authorities, contending major functional, product and scale differences, and inconsistent treatment of administrative, R&D and early-retirement costs.
The tax authoritoies countered that the claimant’s related-party transactions lacked “economic rationality” because they generated operating losses at the 8% markup level, and that true arm’s-length pricing would yield positive profitability. It held that internal comparables must still satisfy the five comparability factors, and found the claimant’s four independent customers to depend on the parent’s licensing policy and thus not genuinely independent. In selecting its own comparables, some 309 firms in paper and textile manufacturing were screened via a commercial database, quantitative and qualitative filters were applied, and a median net-margin was determined. It also reallocated common administrative and R&D expenses to exports, treated early-retirement charges and fixed-cost increases as ordinary costs, and upheld the addition of an 8% service margin on dispatched staff and on the labour-cost base of transferred intangible assets.
Decision
The review bord judgment accepted parts of both sides’ positions. It affirmed that internal comparables must meet stringent comparability criteria and that a transaction formed under group transfer-pricing policy cannot automatically serve as an arm’s-length benchmark, agreeing that the claimant’s export price alone did not prove comparability. It nonetheless observed that the authorities comparable‐company selection should be revisited, since its qualitative filters (for example, requiring comparables to have export ratios at or above 10%) may have inadvertently skewed results toward firms with higher profitability and different business models. Regarding service-fee and intangible-asset adjustments, the decision recognized that gratuitous transfers and internal service charging arrangements formed part of the group’s global policy and so could not be disregarded without clear evidence that these had been factored into royalty rates.
The board ordered recalculation of the arm’s length price for product sales using a revised comparable set under the TNMM, while disallowing adjustments for services and gratuitous intangible transfers that reflected the group’s integrated licensing policy. The matter was remitted to the tax authorities to issue an adjusted assessment.
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