Korea: Imputation of arm’s length interest on accounts receivable from foreign affiliate was reasonable

The Tax Tribunal held (2022 Joong 2863, 20 March 2023) that the tax authority’s imputation of an arm’s length rate of interest on overdue accounts receivable from the taxpayer’s foreign affiliate was reasonable. 

The taxpayer sold yarn to a foreign affiliate to be used in the affiliate’s fabric dyeing business. The tax authority audited the taxpayer and found that the taxpayer did not try to collect accounts receivable from the affiliate in a timely manner. Consequently, the tax authority calculated an arm’s length interest amount based on the weighted average borrowing interest rate from third parties stipulated in Article 4 of the Law for the Coordination of International Tax Affairs (LCITA) and included such amount in the taxpayer’s taxable income.

The taxpayer appealed to the tribunal, which held that the tax authority’s inclusion in the taxpayer’s taxable income of an arm’s length interest amount was reasonable because even though the taxpayer incurred losses from the uncollectible accounts receivable, the taxpayer continued to sell yarn to the affiliate on credit without developing any measure to collect the accounts receivable. In addition, by comparison, the taxpayer deducted interest paid to domestic affiliates.

The tribunal also held that the tax authority’s use of the weighted average borrowing interest rate from third parties stipulated in Article 4 of the LCITA was reasonable because it was difficult to analyze the credit rating of the foreign affiliate and identify comparable transactions since the maturity of the accounts receivable was never fixed.

In regards to a separate issue, the tribunal also held that the tax authority’s denial of the taxpayer’s deduction of amounts paid with respect to a debt of the foreign affiliate for which it was the guarantor was reasonable.

Read a June 2023 report [PDF 347 KB] prepared by the KPMG member firm in Korea