Foreign Investment | Supreme Court Holds That Dividends Arising From Shares Acquired After a Reduction Decision Are Not Eligible for the Reduction

The key issues in this case can be summarized into the following two points.

The lower court held that the Swedish corporation received a reduction or exemption decision only for the initial 65% interest and did not receive a separate reduction or exemption decision for the 35% interest subsequently acquired, and that the reduction or exemption provision of the former Restriction of Special Taxation Act (Article 121-2 (3)) therefore could not be applied to the dividends corresponding to those additionally acquired shares.

In addition, with respect to the calculation of the withholding tax, the lower court found the tax authority's disposition lawful on the basis of the computation provision in the Enforcement Decree (the provision requiring the ‘lesser amount’ between the tax after applying the reduction or exemption and the tax calculated by applying the reduced tax rate under the tax treaty).

Based on the structure of the foreign investment reduction or exemption provisions, the Supreme Court held that the reduction or exemption decision is not a mere formality.

Article 121-2 of the former Restriction of Special Taxation Act has adopted a method of calculating the tax eligible for reduction or exemption by multiplying by the foreign investment ratio (paragraph (2)), so as to reduce or exempt only the portion to which the foreign investor substantively contributed among the income generated by the business eligible for the reduction or exemption, and of likewise limiting the reduction or exemption of dividends in proportion to the income from the business eligible for the reduction or exemption (paragraph (3)).

Accordingly, the application for the reduction or exemption (paragraph (6)) and the reduction or exemption decision (paragraph (8)) constitute a precondition for ‘deriving and identifying’ the foreign investor's contribution among the income from the business eligible for the reduction or exemption.

On this basis, the Supreme Court held that, where a foreign investor additionally acquires existing shares issued through domestic investment funds that were not included in the original reduction or exemption decision, the reduction or exemption benefits under the reduction or exemption provisions (paragraphs (2) and (3)) may not be applied to that additional acquisition, absent special circumstances such as a separate reduction or exemption decision being made for it.

In other words, the argument that, because a foreign investor additionally purchased shares, the dividends are naturally also subject to the reduction or exemption cannot be accepted, as it conflicts with the purpose of the reduction or exemption decision system (the identification of the substantive contribution).

The Supreme Court found, as the lower court did, that the withholding tax should be calculated in accordance with the computation provision in the Enforcement Decree. The gist is as follows.

The Court held that the lesser of these two amounts should be treated as the final tax payable, and that the tax authority's disposition was lawful.

At Daeryun Law Firm LLP, attorneys experienced in corporate, tax, and financial matters and other relevant legal professionals collaborate in foreign investment structures to provide the following legal services.

First, we determine the scope covered by the reduction or exemption decision (new shares or existing shares, and whether domestic investment funds are involved), and we review in advance whether the reduction or exemption procedure needs to be revised upon any change in equity holdings (additional acquisitions or changes in the equity ratio), thereby reducing the risk of escalation into a withholding tax dispute.

In addition, at the dividend stage, we manage the possibility of additional collection and penalty taxes in advance by verifying the withholding tax with both the tax after applying the reduction or exemption and the reduced tax rate under the tax treaty reflected.

Where necessary, we can consistently design a step-by-step strategy extending to a pre-assessment review (a Korea-specific procedure allowing a taxpayer to contest a tax assessment before it is formally issued), an objection, an appeal to the Tax Tribunal (a request contesting an administrative action before an agency prior to court litigation, comparable to seeking administrative review), and tax litigation.

If you need legal assistance in matters such as foreign investment, you are welcome to prepare a response through a legal consultation.