News

Korea Tax Alerts (Dec. 31, 2014)

In November 2014, the Supreme Court rendered a decision on Korean taxation in relation to the source of royalty income under the Korea-US tax treaty. In this case, the Supreme Court ruled that the payment made as consideration for the use of patent, which was not registered in Korea, should not be treated as the Korea source income under the Korea-US tax treaty, regardless of whether the patent was used for manufacturing or sales in Korea.


Background

Under the Article 93 of the Corporate Income Tax Law (“CITL”), the income for use of intangible assets (including patent) in Korea or the income paid in Korea shall be treated as the Korea source income, which is subject to withholding tax (16.5% including 10% local income surtax) under the Korea-US tax treaty. Under the Paragraph (3), Article 6 of the Korea-US tax treaty, however, royalties shall be treated as Korea source royalty income only if paid for the use of, or the right to use, such property within Korea. In 2007, the Supreme Court rendered a decision that patent can be effective only in the jurisdictions where such patent is registered in accordance with the territorial principle of patents, therefore, the payment for use of patent shall be treated as the Korea source income only if such patent is registered in Korea under the Korea-US tax treaty. In other words, it can be interpreted that if the patent is registered outside Korea, the consideration for use of the patent is not considered to be the Korea source income under the Paragraph (3), Article 6 of the Korea-US tax treaty.

Considering this conflict between the CITL and the Korea-US tax treaty, the Korean tax authorities revised the relevant article of CITL in 2008 (effective from 2009) by adding explicitly that in case where patent is registered outside Korea, but is used for manufacturing or sales in Korea, such patent is deemed to be used in Korea regardless of whether or not it is registered in Korea.
By relying on such revised CITL provision, the Korean tax authorities have taken a position that the withholding tax can be levied on royalties paid for use of the patent in Korea, even though the patent is not registered in Korea.

Summary of the Supreme Court Case

According to this Supreme Court decision, if the patent is not registered in Korea but only registered in US, the consideration for use of such patent does not fall under the Korean source royalties regardless of whether the patent is actually used for manufacturing or sales in Korea based on the following grounds:

  • Even though the CITL was revised that the patent which is not registered in Korea, but is used for manufacturing or sales in Korea, is deemed to be used in Korea, the Korea-US tax treaty shall take precedence over the revised CITL as can be confirmed by the International Tax Coordination Law;
  • The Korea-US tax treaty is interpreted that consideration for use of the patent falls under the Korea source income, only if such patent is registered and used in Korea; and
  • Thus, the fact of whether or not the patent is used for manufacturing or sales in Korea is not necessarily relevant and consideration for use of the patent does not fall under the Korea source income, if patent is only registered in US under the Korea-US tax treaty.


Observations and Implications

This is the first Supreme Court decision rendered after the revised CITL is effective and it clearly addresses that the Korea-US tax treaty takes precedence over the domestic tax laws. Thus, whether the patent not registered in Korea is actually used in Korea or not does not affect the determination of the Korea source income under the Paragraph (3), Article 6 of the Korea-US tax treaty.
According to the Korean tax laws, an amended tax return to claim the refund of inappropriately paid withholding tax can be filed within 3 years after its original filing due date. Therefore, it is expected that there would be a number of amended tax returns to be filed for the withholding tax refund based on this Supreme Court case.

Korea Tax Alert
Did you find this useful?