South Korea: International Marketing Fees Incurred By Multinational Enterprise's Subsidiary Can Be Taxed As Taxable Value Of Imported Goods If They Constitute Royalties In Substance

Last Updated: 18 January 2017
Article by Yulchon LLC

Global marketing efforts by multinational enterprises on the global sports items market have rarely been as active as lately. Sponsoring international sports events like the Olympics, the World Cup, or world-renowned athletes is used as a means to maximize marketing effects, and with this trend, agreements establishing Central Marketing Funds ("CMF") or International Marketing Funds ("IMF") by which the costs involved in these marketing efforts are borne by sales entities in various countries are becoming more and more common. Most recently, a judgment has been rendered which addresses the question of whether such costs borne by a domestic sales entity with regard to a specific product that it imports can be added to the importing value of said product (Decision 2015Du52098 rendered by the Korean Supreme Court on 30 August 2016).

In this Supreme Court case, the importer was a subsidiary of an international sports merchandise manufacturer situated in Germany. The Korean subsidiary entered into a license agreement with the German headquarters regarding use of the brand, as well as a separate agreement regarding payment of IMF fees. The subsidiary then added the brand royalties to the taxable value of the imported goods and declared customs. However, the tax authorities argued that the IMF fees also had to be added to the taxable value and accordingly made customs assessments.

The Supreme Court recognized the following facts:

  • The IMF fees in this case are not individual marketing costs of the imported goods but are costs incurred in the process of exposing the royalties attached to said imported goods.
  • Not only does Plaintiff receive no payment for its contribution to the increase of brand value, but the headquarters also does not disclose any details of the international marketing activities to Plaintiff, nor does any adjustment or recalculation of related costs occur afterwards.

Based on this premise, the Supreme Court considered that in substance the IMF fees, regardless of the nominal terms found in the agreement, constituted payments for use of royalties. The Supreme Court thus held that in substance the IMF fees were closer to royalties paid for brand value increased by the marketing activities, rather than direct allocations of international marketing fees.

Under the Korean Customs Act, royalty payments made for use of brands etc. are under certain conditions added to the transaction value of individual imported goods, thus constituting the taxable value of the imported goods for customs purposes. In these cases, it is required that the royalty payment concerns the imported good itself, and that a conditional relationship for importation of said good must depend on payment of such royalties. However, since international marketing fees do not relate to individual imported goods, the Agreement on Implementation of Article 7 of GATT also does not recognize them as constituting taxable value of imported goods.

In the case discussed above, the license agreement and the IMF agreement were entered into separately, and the royalties were already added to the value of the imported goods. It is thus problematic to find that the IMF fees additionally constitute royalties, and to further add them to the value of the imported goods also. For these reasons, the Supreme Court judgment is in many ways understood to be in discord with the understanding of international marketing fees found in the Agreement on Implementation of Article 7 of GATT.

However, the judgment cannot serve as a basis to assume that all international marketing fees constitute royalty payments in nature. The judgment must be understood as dealing with a case in which the international marketing fees at issue exceptionally had the nature of royalty payments. In other words, the judgment addressed a case in which the main focus of the international marketing activities lay in the improvement of brand value rather than improvement or increase of sales. Yet there is a risk that the judgment will contribute to tax authorities taking aggressive tax measures in future CMF or IMF cases, and that further withholding tax issues will be spawned with regard to royalty payments. As such, enterprises that are currently making use of similar agreements will have to take additional care to identify in the agreements the respective roles of the headquarters and the domestic entities with regard to marketing activities. It will further be necessary to review the structure of the relevant transactions, and to clearly specify that significance lies in the increase of sales, as opposed to the increase of brand value.

Yulchon LLC with its specialized customs team is able to provide comprehensive and effective solutions, including but not limited to prevention, review and court proceedings, to the various legal issues faced by multinational enterprises with regard to customs investigations, customs assessment, transfer pricing and others. If you have any inquiries with regard to the legal issues discussed in this newsletter, please do not hesitate to contact the following professionals.

Tax Legal Update November 2016

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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