[Tariff-Driven Corporate Tax Confusion] ① Profits Fall Due to Tariffs... But Are Taxes Unchanged?

Editor's NoteThe Korea-US tariff negotiations were finalized on the 29th, relieving companies from tariff-related uncertainties. However, the impact of the 15% reciprocal tariffs is highly likely to extend to issues regarding taxes (corporate tax). For companies where a domestic parent sells products to its US-based subsidiary, the amount of tax paid in each country may differ depending on which entity bears the losses from the tariff increase. If the parent company absorbs an excessive portion of the losses, the Korean government will inevitably face a reduction in tax revenue. The Asia Business Daily examines the tax uncertainties facing Korean companies and explores response strategies to minimize them. [Editor's Note]

A domestic food company exporting K-food to the United States is now inevitably facing reduced profits due to the tariff hike. The issue is not limited to tariffs alone; there is also a high likelihood of encountering uncertain tax (corporate tax) issues. This is because the amount of tax paid to the US will differ depending on whether the parent company A or its US-based subsidiary B absorbs the reduced profits. As a result, tax uncertainties, in addition to the loss of profits caused by the tariffs, are becoming a burden on corporate management.

On the 30th, Lee Younghan, a professor at the Graduate School of Taxation at the University of Seoul, stated, "For companies exporting to their US-based subsidiaries in sectors such as food, automobiles, and steel, the group will seek to adjust the impact of tariffs in order to minimize the overall tax burden. When tariffs drive up costs, resulting in reduced sales, local corporate taxes will decrease, so companies need to develop appropriate response strategies."

Export companies are inevitably facing a decline in sales due to the US tariff increase. While companies are trying to absorb the tariff hike through cost-cutting measures, ultimately, they are forced to raise their product prices. According to a survey conducted by the Korea Customs Service in August this year on 667 small and medium-sized exporters to the US, 53.8% of responding companies predicted that their export volume would decrease by "10% or more but less than 50%" due to the 15% reciprocal tariffs. Another 8.4% of companies were concerned that their export volume would drop by more than 50%. Only 33.7% of companies expected "no impact or a decrease of less than 10%."

The entity bearing the burden of price increases resulting from the tariffs varies by company. 28.9% of companies responded that "exporters and importers will share the burden at a certain ratio," 28.5% said the importer would bear the cost, and 18.7% said the exporter would absorb the increase. Ultimately, both exporters and importers are absorbing the price increase, raising concerns about reduced sales and profits due to weakened price competitiveness.

In transactions between unrelated companies, or so-called third-party transactions, the product price is set by contract, and the resulting loss of profit is absorbed accordingly. However, in transactions between related parties, such as a parent and subsidiary, the amount of corporate tax paid in Korea and the US may vary depending on whether the tariff increase is reflected in the export price or the local sales price. This applies when a parent company exports products to its overseas sales subsidiary, which then sells the products locally.

The transaction price between a parent and subsidiary should be similar to that of other comparable companies in the same industry. However, problems arise if the price is artificially set higher or lower to boost profits for one entity. For example, if the parent company increases the supply price to the subsidiary from 100 won to 115 won to reflect the tariff increase, the overseas subsidiary's profit margin will drop. In this case, the local tax authority may deem this an "artificial price adjustment" and impose taxes based on the previous profit margin.

Professor Lee pointed out, "Due to the tariff burden, the profits of US subsidiaries may decrease, resulting in lower corporate tax payments to the US. The US Internal Revenue Service is likely aware of and monitoring this. In particular, in transactions between related parties such as parent and subsidiary companies, the US tax authorities may question the appropriateness of transfer pricing." Transfer pricing refers to the prices applied to transactions of raw materials, products, and services between companies. Tax authorities assess the appropriateness of transfer pricing and apply transfer pricing taxation, which calculates taxable income based on arm's length prices.

The basis for taxation is the "double taxation avoidance" tax treaties signed between countries and the provisions of domestic tax law. If transactions between related parties are set or imposed under different conditions than those between independent (third-party) companies, and this results in income not being realized by the company, the relevant country may add the income back and impose taxes accordingly.

The reverse situation also applies. If the parent company receives a lower price for its products, its profit margin decreases, increasing the risk of taxation by the tax authority in the parent company's country. In the case of a Korean parent company exporting and selling products through its US subsidiary, if the profit margin of the Korean parent company falls, the Korean National Tax Service may impose taxes. If the profit margin of the US subsidiary decreases, the US tax authorities may do the same.

The same applies when building a manufacturing plant in the US. If a parent company establishes a manufacturing subsidiary overseas, and the subsidiary uses the parent company's manufacturing technology to produce goods and sell them directly in the local market, the Korean National Tax Service may impose taxes if no royalty is paid. Conversely, if the royalty is set too high, the US tax authorities may raise issues.

The Korean National Tax Service is aware of the tax uncertainties that export companies may face and is preparing countermeasures. An official from the National Tax Service stated, "To minimize the tax difficulties faced by our export companies, we will first hold working-level meetings with the US Internal Revenue Service to actively communicate Korea's concerns. In addition, we will actively pursue tax diplomacy by maintaining close communication with other tax authorities as well."