SOUTH KOREA: An Introduction to Tax: Consultants

In the past few years, the Korean National Tax Service (NTS) has aggressively assessed tax on multinational enterprises (MNEs) and foreign-owned businesses operating in Korea. This article will explore the two most frequently disputed tax issues for foreign entities with an investment or presence in Korea: permanent establishment (PE) and beneficial ownership.

Permanent Establishment

Key issues

Under Korean tax law, a foreign entity can generally be deemed to have a permanent establishment (PE) in Korea based on a physical PE, agent PE, service PE or construction PE. The two most commonly disputed types of PEs are physical PE and agent PE (service PE is often an issue for foreign entities dispatching their employees to Korea). Korea has recently amended its tax law to broaden the scope of physical PE and agent PE following the OECD Model Tax Convention and Multilateral Instrument (MLI), and the NTS can now interpret and apply these PE provisions very broadly.

Physical PE

A foreign entity may have a physical PE in Korea if it has a fixed place of business (including a subsidiary, branch or representative office) in Korea and the foreign entity carries out business activities at this fixed place of business through its employees or a person receiving instructions from the foreign entity. In tax audits, the NTS auditors often conclude that a foreign entity has created a physical PE in Korea on the basis that certain equipment and/or a business unit owned by the foreign entity’s Korean subsidiary constitutes a fixed place of business through which the foreign parent carries out business activities in Korea.

Agent PE

Even if a foreign entity does not have a fixed (physical) place of business in Korea, it may still be deemed to have an agent PE in Korea if it conducts a business in Korea:

 • through a person who has the authority to conclude contracts on behalf of the foreign entity and where that person habitually exercises such contract-concluding authority; or

 • through a person who does not have the authority to conclude contracts on behalf of the foreign entity but where that person repeatedly plays a principal role leading to the conclusion of contracts which are routinely concluded without material modification by the foreign entity. In tax audits, the NTS auditors often find the existence of an agent PE in traditional commissionaire arrangements.

If a foreign entity is deemed to have a PE in Korea, the resulting Korean tax liability can be significant:

 • the NTS often attempts to apply the profit split method when determining how much income should be attributable to the Korean PE as it results in a greater amount of taxable income than other transfer pricing methods; and

 • the amount of historic VAT liability can be material due to the administrative penalties and interest charges relating to retroactive VAT assessments.

There are also various secondary effects to consider:

 • in respect of intercompany service arrangements, if the supply of services was zero-rated, the NTS can deny the previous application of zero-rate VAT on the basis that the service was actually supplied to the Korean PE (ie, supplied within Korea); and

 • in respect of importation of parts and components to Korea, the NTS can deny the input VAT credits previously claimed by the Korean importer on the basis that the Korean PE was the supplier (ie, purchased within Korea).

Supreme Court Decision 2014Du3044, 2014Du3051 (consolidated), 12 October 2017 

In this case, the plaintiffs (mostly US and Bermuda limited partnerships set up by Lone Star Funds, a global private equity firm) owned holding companies in Belgium that received dividends from Korean companies and recognised substantial amounts of capital gains from the sale of shares in Korean companies. The NTS took the view that the Belgium holding companies were merely conduits, and the plaintiffs received the dividends and capital gains through their PEs in Korea. Accordingly, the NTS issued PE tax assessments to the plaintiffs.

On behalf of the taxpayer, we (Yulchon LLC) appealed the PE tax assessments, and the Supreme Court cancelled the PE tax assessments. The Supreme Court concluded that the plaintiffs did not have a physical PE or agent PE in Korea primarily on the basis that key decisions were made in the USA and that the executives of the Korean affiliates (who were also the directors of the plaintiffs’ general partner) performed their activities in their capacity as the executives of the Korean affiliates, which are separate legal entities from the plaintiffs’ general partner. Even though the Korean affiliates are closely related to Lone Star Funds and are effectively controlled by the founder of Lone Star Funds, it is difficult to disregard the separate legal personality of the Korean affiliates solely based on such factors.

Beneficial Ownership

Key issues

Income derived by a foreign entity (with no PE in Korea) is only subject to tax in Korea if it is one of the types of Korean-sourced income explicitly listed in the tax law, which includes, among other things, interest, dividends and royalties received from a Korean entity, and capital gains recognised from the transfer of shares in a Korean company. If the foreign entity receiving such Korean-sourced income is resident in a country that has a double tax treaty with Korea, the foreign entity can claim a reduced tax rate or tax exemption in respect of the Korean-sourced income under the relevant tax treaty, to the extent the foreign entity qualifies as the “beneficial owner” of the income.

The term “beneficial owner” refers to a person who bears the legal and economic risks related to the Korean-sourced income in question and who effectively holds ownership rights over that income, including the rights to dispose of the income. Historically, there was great uncertainty around the issue of beneficial ownership as Korean tax law did not specify how to identify the beneficial owner of Korean-sourced income. Accordingly, in cases where the recipient of Korean-sourced income was a foreign entity – particularly a foreign entity with no physical or economic substance – the NTS often challenged and denied the recipient’s beneficial ownership of the income. Over the past few years, the Korean Supreme Court has rendered a series of decisions on the issue of beneficial ownership and consistently ruled in favour of the foreign income recipients seeking to apply tax treaty benefits (apart from in exceptional cases). In these cases, the Supreme Court made it clear that if there is no discrepancy between the legal ownership and the effective management and control of particular income, the NTS cannot deny the income recipient’s beneficial ownership by applying the substance-over-form principle simply because the investment structure results in a reduction of Korean tax liability. However, the NTS is still very determined to deny the beneficial ownership of direct income recipients and issue tax assessments. For royalties in particular, the NTS tends to apply more stringent requirements and there are also quite a few beneficial ownership cases in which the courts have ruled against taxpayers. 

In addition, Korea has recently amended its tax law to strengthen the procedure for applying a tax treaty exemption in respect of Korean-sourced income, particularly the requirement to submit supporting documents. It is unclear whether the recent legislative amendment was driven by the unfavourable court rulings against the NTS, but the amendments will certainly enable the NTS to conduct more thorough and targeted investigations of foreign entities deriving Korean-sourced income and their beneficial owner status. 

Supreme Court Decision 2023Du55450, 12 January 2024  

This case concerned royalties paid by a Korean licensee to a Hungarian company. The Korean licensee did not withhold any tax on the royalties pursuant to the Korea-Hungary tax treaty. However, the NTS took the view that the beneficial owner of the royalties is the Hungarian company’s ultimate parent in the USA and issued withholding tax assessments by applying the Korea-US tax treaty.

On behalf of the taxpayer, we (Yulchon LLC) successfully persuaded the Supreme Court to cancel the withholding tax assessments. The Korean courts accepted our arguments that for royalties:

 • the beneficial owner is determined based on whether the recipient of income has the authority to use, profit from, and dispose of, the income concerned, and to effectively control and manage such income; and

 • the recipient of the income does not necessarily have to possess the technical capabilities to develop, maintain and repair the underlying IP that forms the basis of the royalties in question.