CONTENTS
- 1. Foreign Investment | Dispute Over Withholding Tax on Dividends of a Foreign-Invested Company and the Application of the Reduction or Exemption
- - The Scope of the Reduction or Exemption Decision and the Treatment of Additionally Acquired Existing Shares
- 2. Foreign Investment | The Supreme Court's Determination
- - The Reduction or Exemption Decision Is a Necessary Precondition for ‘Identifying the Substantive Contribution’
- - The Withholding Tax Is the Lesser of the ‘Tax After Applying the Reduction or Exemption’ and the ‘Tax at the Reduced Tax Rate Under the Tax Treaty’
- 3. Foreign Investment | Key Points in Managing Foreign Investment Risk
- - Points to Review Before Investment, Changes in Equity Holdings, and Dividends
- - Assistance From Daeryun Law Firm LLP
1. Foreign Investment | Dispute Over Withholding Tax on Dividends of a Foreign-Invested Company and the Application of the Reduction or Exemption
A Swedish corporation (△△△ AB) acquired shares in the plaintiff, a foreign-invested company (○○○ LLC), and received dividends.
For the 65% interest acquired at the time of the plaintiff company's establishment, the Swedish corporation received a tax reduction or exemption decision under the foreign investment reduction or exemption provisions of the former Restriction of Special Taxation Act. However, when it subsequently acquired the remaining 35% interest from a domestic investor, it did not receive a separate tax reduction or exemption decision for that portion.
Article 121-2 of the Restriction of Special Taxation Act (Reduction or Exemption of Corporate Tax, etc. on Foreign Investment) Deleted on January 1, 2014
When the dividends were subsequently paid, the tax authority reflected the reduction or exemption only within the scope covered by the reduction or exemption decision and treated the remainder as included in the withholding tax, imposing a disposition to collect corporate (withholding) tax. The plaintiff disputed this and sought revocation of the collection disposition.
The Scope of the Reduction or Exemption Decision and the Treatment of Additionally Acquired Existing Shares
The key issues in this case can be summarized into the following two points.
(2) When calculating the withholding tax after applying the reduction or exemption, which of the domestic statutory tax rate and the reduced tax rate under the tax treaty (the Korea-Sweden tax treaty) should be applied, and how
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).
2. Foreign Investment | The Supreme Court's Determination
The Supreme Court made the following determination in this case.
The Reduction or Exemption Decision Is a Necessary Precondition for ‘Identifying the Substantive Contribution’
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 Withholding Tax Is the Lesser of the ‘Tax After Applying the Reduction or Exemption’ and the ‘Tax at the Reduced Tax Rate Under the Tax Treaty’
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.
3. Foreign Investment | Key Points in Managing Foreign Investment Risk
This judgment conveys a message of considerable practical importance in the taxation of foreign investment.
Points to Review Before Investment, Changes in Equity Holdings, and Dividends
Category | Points to Review | Practical Risk |
Investment structure | Whether it is a subscription for new shares or a purchase of existing shares (including whether domestically held shares are involved) | Possible omission from the scope of the reduction or exemption decision |
Reduction or exemption procedure | Whether the scope of the shares and investment funds covered by the application and the reduction or exemption decision is accurate | Exclusion of the dividend reduction or exemption, and additional withholding tax collection |
Changes in equity holdings | The need to revise the reduction or exemption decision upon additional acquisition of shares | Non-recognition of the reduction or exemption for dividends on additionally acquired shares |
Dividend policy | Comparison of the tax after applying the reduction or exemption versus the reduced tax rate under the tax treaty | Withholding tax calculation errors and penalty taxes |
Document management | The reduction or exemption decision, investment agreement, share transfer agreement, dividend resolution, and withholding tax records | Disadvantage in the event of a failure of proof |
Assistance From Daeryun Law Firm LLP
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.
See More
