The Korean National Assembly passed amendments to the Corporate Income Tax Law of Korea (CITL), including provisions that allow the Korean tax authority to impose withholding tax on royalties paid to U.S. entities for licenses to foreign patents, by expanding the definition of "domestic-source" royalty income. This amendment took effect as of January 1, 2020.

According to the amended CITL, the consideration for any manufacturing know-how, technical information, etc. that is included in a patent not registered in Korea and is used for domestic manufacturing, production, etc. is deemed within the scope of "Korean-source royalties."

As a background, Article 93 of the old CITL provided that income or fees received by a foreign company from a Korean licensee's "use" in Korea of patents registered overseas for manufacturing, sale, etc., constitute domestic-source income, even if corresponding patents are not registered in Korea. However, in November 2014, the Korean Supreme Court held in Case No. 2012du18356 that royalties received by a U.S. entity from a Korean entity must be treated differently for tax purposes, on the basis that (i) the Korea-U.S. Tax Treaty supersedes domestic Korean law under Article 28 of the International Tax Coordination Law for purposes of classifying income as domestic-source, and therefore (ii) royalties received by a U.S. entity from a Korean entity for the license of patents registered overseas but not in Korea do not constitute domestic-source income as defined in Article 6, paragraph 3 and Article 14, paragraph 4 of the Korea-U.S. Tax Treaty, regardless of whether there are manufacturing or sales activities in Korea related to such patented inventions (see our Spring 2015 Newsletter here). Since the Supreme Court's decision, royalty income paid to U.S. entities specifically for foreign patents has been deemed not subject to Korean withholding tax. 

In order to allow the Korean tax authority to resume taxing royalties paid for the "use" of foreign patents in Korea, in 2019, the Ministry of Economy and Finance (MOEF) proposed tax law amendments that would expand the definition of "domestic-source" royalty income by defining any consideration paid for any manufacturing know-how, technical information, etc. that may be disclosed in a patent registered outside Korea and that is used for manufacturing, production or other commercial activity in Korea as "remuneration for other similar property rights" under the Korea-U.S. Tax Treaty, which would allow Korea to tax U.S. entities' royalty income. In December 2019, the Korean National Assembly passed these tax law amendments.

The changes to treatment of royalty payments for foreign patents are summarized below.

A. Change in scope of Korean-source royalty income in relation to the use of patents not registered in Korea [Article 119 of the Individual Income Tax Law (IITL), Article 93 of the Corporate Income Tax Law (CITL)]

B. Inclusion of compensation for infringement of patents registered overseas into the scope of Korean-sourced other income [Articles 119 and 156(1) of the IITL, Articles 93 and 98(1) of the CITL]

As the amended income tax law seems to be inconsistent with the Supreme Court's position on such royalties, it remains to be seen whether the Court will agree that the Korean tax authority now has the ability to tax royalties for foreign patents under the amendment despite its interpretation of the Korea-U.S. Tax Treaty.

In view of these tax law changes, Korean licensees (who are responsible for Korean withholding taxes) will likely feel pressure to pay withholding taxes on all IP royalties paid to U.S. licensors, regardless of whether they are related to Korean or non-Korean patents. Any challenge to collection of withholding tax for non-Korean patents will require that a licensor or licensee file a request for tax refund to a tax office, and most likely pursue subsequent tax appeal procedures with the Tax Tribunal and in court.