Supreme Court: Foreign Corporations' Income Earned Abroad Not Eligible for Foreign Tax Credit

The Supreme Court has ruled that taxes paid by a foreign corporation with a permanent establishment in Korea on income earned in its country of residence are not subject to foreign tax credit under the Corporate Tax Act. In the case where the Seoul branch of Bank of China earned income in China using funds deposited domestically, the primary taxing right belongs to Korean tax authorities, and China has the obligation to avoid double taxation, the court stated.

The purpose of allowing foreign tax credits under the Corporate Tax Act only for domestic corporations' foreign-source income is to enable the country of residence to exclusively fulfill the obligation to avoid double taxation. Therefore, when applying this to foreign corporations with a permanent establishment in Korea, foreign tax credits should only be allowed for income earned from a third country, not the country of residence of the foreign corporation's domestic permanent establishment.

Supreme Court, Seocho-dong, Seoul.

According to the legal community on the 19th, the Supreme Court's First Division (Presiding Justice Seo Kyunghwan) upheld the lower court ruling that dismissed the appeal filed by Bank of China against the corporate tax assessment by Jongno Tax Office.

Bank of China, headquartered in China, deposited funds raised by its Seoul branch into its Chinese branches or lent them to Chinese businesses, earning interest income, which was attributed to the Seoul branch.

Bank of China paid corporate tax to the Korean government while deducting approximately 10% withholding tax paid to the Chinese government.

The tax authorities determined that the foreign tax credit system under the Corporate Tax Act did not apply and imposed corporate tax of 35.87 billion KRW including penalties on income earned from fiscal years 2011 to 2015. Bank of China filed a lawsuit in response.

Under the Corporate Tax Act, when a foreign corporation pays corporate tax in Korea, it can deduct the amount of tax paid abroad. This is called foreign tax credit, a system to prevent double taxation.

However, there was no Supreme Court precedent on whether the foreign tax credit system can be applied to income earned by a foreign corporation in its country of residence, as in this case.

The first-instance court ruled in favor of the plaintiff, Bank of China.

The court cited ▲ the absence of provisions in the Korea-China tax treaty limiting the residence country's taxation on income attributable to a permanent establishment ▲ and that the pre-amendment Article 97(1) of the Corporate Tax Act, applicable in this case, allows foreign tax credit by applying Article 57(1)(1) of the old Corporate Tax Act to foreign-source income attributable to a foreign corporation's domestic permanent establishment without specifically limiting the scope of foreign tax credit.

Article 57(1)(1) of the old Corporate Tax Act (Foreign Tax Credit, etc.) allows deduction of foreign corporate tax within a certain calculated limit from the corporate tax for the relevant fiscal year.

Article 97(1) of the old Corporate Tax Act stipulates that Article 57(1) applies mutatis mutandis to foreign corporations.

On the other hand, the appellate court ruled in favor of Jongno Tax Office.

The court stated, "According to the Korea-China tax treaty, the primary taxing right over the income in question belongs to Korea, the country where the permanent establishment is located, and China, the country of residence, has the obligation to avoid double taxation."

It further concluded, "Based on the wording and legislative intent of Article 97(1) of the old Corporate Tax Act, which applies Article 57(1), foreign tax credit cannot be allowed for the withholding tax paid to China, the country of residence, on the income in question."

The Supreme Court also found no issue with the appellate court's judgment.

The court explained, "According to the wording and structure of the Korea-China tax treaty provisions, income earned in China, the plaintiff's country of residence, but attributable to a permanent establishment located in Korea, can be primarily taxed by Korea. The adjustment of double taxation is then made by China, the country of residence, by granting tax credits for taxes paid to Korea when taxing the plaintiff."

The court added, "The purpose of Article 97(1) of the old Corporate Tax Act, which applies Article 57(1), is fundamentally to allow foreign tax credits to foreign corporations with domestic permanent establishments for taxes paid in third countries, similarly to domestic corporations. Considering this purpose and the wording and structure of related provisions, income earned in the foreign corporation's country of residence but attributable to its permanent establishment in Korea, where Korea has the primary taxing right under the tax treaty and double taxation adjustment is made by the country of residence, cannot be considered eligible for foreign tax credit under Articles 97(1) and 57(1)(1) of the old Corporate Tax Act, even if tax was paid to the country of residence."

For example, if the Seoul branch of Bank of China earned profits in Japan, a third country, and paid corporate tax there, it could claim foreign tax credit when paying corporate tax in Korea. However, if the Seoul branch earned profits in China, its country of residence, and paid corporate tax there, Korea should tax first, and China should grant a subsequent credit, the Supreme Court concluded.

A Supreme Court official said, "The Corporate Tax Act allows foreign tax credits for foreign corporations with permanent establishments in Korea. Therefore, for income earned in a third country other than the foreign corporation's country of residence or Korea (the country where the permanent establishment is located), foreign tax credits can be recognized in Korea for taxes paid to that third country."

He continued, "However, the issue was whether foreign tax credits can be recognized in Korea for taxes paid to the foreign corporation's country of residence on income earned there but attributable to its permanent establishment in Korea. Through this ruling, the Supreme Court explicitly set the criteria for recognizing foreign tax credits under the Corporate Tax Act for taxes paid by foreign corporations to their country of residence on income earned there for the first time."

This content was produced with the assistance of AI translation services.