A Key VAT Consideration When Setting Up a Korean Sales Support Entity
Many multinational companies operate under a centralized sales model.
Under this model, products and services are sold directly by the parent company to customers worldwide, while local entities perform supporting functions such as sales support, customer relationship management, marketing coordination, and business development activities.
As a result, the local entity does not generate revenue from local customers. Instead, it earns service income from the parent company for the support services it provides.
One of the most common approaches for compensating the local entity is a cost-plus fee arrangement.
Under this arrangement, the Korean subsidiary (or branch) charges the parent company for its operating costs plus an arm’s length profit margin.
This model is widely used because it:
- Provides funding for local operations
- Simplifies profit allocation
- Allows the local entity to fulfill its minimum tax compliance obligations in Korea
- Can facilitate transfer pricing compliance when an appropriate markup is determined based on transfer pricing principles
Typical Tax Considerations in a Cost-Plus Structure
When a Korean entity operates under a cost-plus arrangement, the following tax issues are commonly discussed:
Permanent Establishment (PE) Risk
Multinational groups often need to assess whether the activities performed by the Korean entity could create a permanent establishment for the foreign parent company in Korea.
Transfer Pricing Issues
The mark-up applied to the cost base must generally be consistent with the arm’s length principle and supported by appropriate transfer pricing documentation.
However, these risks are not unique to a cost-plus structure.
In practice, there is no business model that completely eliminates tax risk. Companies must balance commercial objectives, operational efficiency, and tax considerations when designing their operating structure.
The Often Overlooked Issue: VAT Treatment of the Cost-Plus Fee
One important issue is frequently overlooked during the setup phase.
Should the Korean entity charge 10% VAT or apply the 0% VAT rate when invoicing the parent company?
This question is critical because an incorrect VAT treatment can create significant financial exposure over time.
Many companies assume that a service provided to an overseas parent company automatically qualifies for the 0% VAT rate.
Unfortunately, this assumption is not always correct.
Conditions for Applying the 0% VAT Rate
Under the Korean VAT Law, a Korean company may apply the 0% VAT rate to service fees charged to a foreign customer only when all relevant requirements are satisfied.
The following conditions are generally required:
Condition 1
The recipient of the service must be a non-resident (including a foreign corporation) that does not have a permanent establishment in Korea.
Condition 2
The services must be provided in Korea.
Condition 3
The consideration must be paid in foreign currency such as USD, EUR, or GBP.
Condition 4
The recipient’s country must provide an equivalent tax benefit to Korean residents or Korean corporations.
This is commonly referred to as the reciprocity principle.
The requirement may be satisfied if:
- Similar zero-rating rules exist in the recipient’s jurisdiction, or
- There is no equivalent indirect tax system (such as VAT or sales tax) in that jurisdiction.
The Practical Challenge: Proving Reciprocity
In our experience, the reciprocity requirement is one of the most frequently overlooked conditions when applying the 0% VAT rate to services provided to foreign companies. Before issuing a tax invoice at the 0% VAT rate, it is advisable to confirm that all statutory requirements, including the reciprocity requirement, have been satisfied.
Korean tax professionals generally cannot independently verify foreign tax laws in every jurisdiction.
Therefore, the Korean entity should obtain supporting documentation from:
- The foreign parent company
- The parent company’s tax advisors
- Legal or tax professionals in the foreign jurisdiction
The supporting documentation should clearly explain the applicable foreign tax provisions and should be retained as evidence for Korean VAT compliance purposes.
An Issue Frequently Discovered Too Late
From my experience supporting foreign-invested companies in Korea, I have occasionally encountered situations where the VAT treatment of a cost-plus arrangement had never been properly reviewed.
The Korean entity proceeded on the assumption that the 0% VAT rate automatically applied because the services were provided to a foreign parent company.
However, upon closer review, the reciprocity requirement was not satisfied.
As a result, the Korean entity should have charged 10% VAT on the service fee.
Discovering this issue years later can create substantial VAT exposure and unexpected costs for the multinational group.
Review the VAT Position Before Establishing the Korean Entity
When setting up a Korean subsidiary or branch, multinational groups usually focus on:
- Corporate structure
- Transfer pricing
- Employment matters
- Funding arrangements
However, the VAT treatment of intercompany service fees should also be reviewed before operations begin.
Companies considering a cost-plus fee arrangement should confirm:
✅ How operating costs will be funded
✅ Whether a cost-plus model is appropriate
✅ Whether the 0% VAT rate is available
✅ What supporting documentation is required
Addressing these issues early can help prevent costly VAT exposures and compliance challenges in the future.
About the Author
Matt Shin, CPA
Advising foreign-invested companies in Korea on tax, accounting, payroll, corporate secretarial, and regulatory compliance matters for more than 25 years.