Recent Trends In Korean Court Decisions For International Tax (1) - Focusing On Taxation For "Domestically Unregistered Patents" Under The United States-Korea Income Tax Convention

• Published date: 31 October 2022
• Subject Matter: Intellectual Property, Tax, Patent, Income Tax, Corporate Tax, Tax Authorities
• Law Firm: DR & AJU LLC
• Author: Sang Yeon Cho

1. Introduction

In Korea, what taxation would be levied on foreign corporations that do not have a permanent establishment in Korea if they receive royalties from Korean domestic corporations in exchange for the transfer (or licensing) of patents and other intangible assets?

The domestic corporation will most likely withhold part of the royalties to pay to the Korean government, which would be unproblematic if the foreign corporation was established in a country other than the U.S. Most tax treaties signed between Korea and foreign countries, with the exception of the U.S., are based on the place of "payment." Therefore, if a foreign corporation receives royalties from a Korean domestic corporation, the royalties are considered a domestic source income, and the foreign corporation becomes subject to taxation. (Regulations for tax rates may differ according to the tax treaty.)

However, the situation is different for U.S. businesses. The U.S.-Korea Income Tax Convention uniquely levies tax based on the place of "use," which means if an intangible asset, such as a patent, is not used in Korea, the royalty paid will not be considered a domestic source income, thereby exempting the concerned U.S. business from any tax obligations. In this situation, it would be wrong for a Korean corporation to withhold tax. Either the Korean corporation or the U.S. corporation can submit a request for correction to the Korean tax authority. If the tax authority refuses the request, the matter can be settled through administrative litigation.

The problem is that when a patent of a U.S. corporation is registered only in the U.S and not in Korea, it is not always clear as to what it means to "use" the patent in Korea. This is an issue that the Korean courts and tax authorities have been fervently debating over for more than 30 years. The following is an introduction to a basic outline of this "30 Years' War," which will be followed by an explanation of a Significant Supreme Court ruling that took place at the beginning of the year and recent legislative amendments.

2. Previous Events: ① Initial Ruling (1992) ② Amendment (2008) ③ Second Ruling (2014)

[Initial Ruling] In 1992, regarding a case where a U.S. corporation claimed that a Korean domestic corporation infringed on its patent rights by selling electronic products to the U.S. and received settlement payment in consideration of granting the Korean corporation the license of the patent, the Supreme Court ruled in favor of the...