Recently, many issues have been raised relating to license agreements and royalty payments for multinational companies doing business in Korea. More specifically, we will discuss how licenses are affected by customs duties, corporate taxes, and fair trade laws. We believe it may be helpful to keep these issues in mind as you make license agreements with Korean subsidiaries and/or 3rd party companies in Korea.

1. Customs Duty – Royalty/License Payment May be Removed from Dutiable Value of Goods

When calculating the dutiable amount, the Korean Customs Service (KCS) has generally taken the view that any royalty/license payments relating to particular goods should be added to the dutiable value of the goods. As a simple example, if an importer purchases a good for USD 100 and then pays an additional USD 50 as payment for licensing of intellectual property rights (IPR) (e.g., patents or trademarks) or as royalty payments, then the dutiable value of the goods is calculated based on USD 150.

However, in two recent Supreme Court cases, Kim & Chang was able to eliminate or reduce the royalty/license payment from the dutiable value of the goods. In the first case, Supreme Court Decision 2016Du34110, 34127 (consolidated), the importer had imported into Korea devices for manufacturing glass to be used in LCD panels and paid duties based on the sales price of the manufacturing device. Separately, the importer was also paying royalties for use of various patents and know-how. The KCS assessed duties on the total combined price of the manufacturing device and the royalty payments.

In response, the importer argued that the entire royalty payments should not be added to the value of the dutiable good. Instead, only royalty payments for certain patents directly associated with the manufacturing device should be included. The Supreme Court agreed and a large portion of the royalty payments were excluded from the dutiable value of the good.

In the second Supreme Court case, Supreme Court Decision 2018Du57599, the importer had imported videotapes containing cinematographic works such as animation into Korea. The importer paid for the videotapes and separately paid a licensing fee for the television broadcasting rights. The KCS added the licensing fee to the dutiable value of the videotapes. However, the importer was able to argue that the licensing fee was for the copyrighted broadcasting rights and was unrelated to the actual videotapes. The Supreme Court agreed and the dutiable value was limited only to the price paid for the videotapes.

From these cases, we believe that detailed technical analysis and comparisons between IP rights and the imported goods are important to better exclude certain royalty from the dutiable value of goods.

2. Corporate Tax – Tax Law Changes to Allow Taxation of Royalties Paid by Korean Licensees to US Companies for Foreign Patents

Since patent royalties are subject to Korean withholding tax, Korean licensees are required to pay withholding taxes on royalties paid to foreign licensors. Most tax treaties provide for the taxation of royalties based on the principle of "place of payment," which allows for the withholding tax on royalties for patents, regardless of whether the patents are registered in Korea (domestic patents) or outside Korea (foreign patents).

However, the Korea-U.S. tax treaty provides for the taxation of royalties based on the "place of use" principle, which raises questions about whether withholding taxes on royalties paid to U.S. licensors should be treated differently depending on whether the payments are for domestic patents or foreign patents.

According to a Supreme Court precedent (Korean Supreme Court Case No. 2012Du18356 rendered in November 2014), 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, and thus, are not subject to Korean withholding tax.

Despite the Supreme Court's decision, the Korean tax authority has been trying to impose withholding tax on royalties paid for foreign patents. In order to allow the Korean tax authority to collect taxes on such royalty payments, 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 allows Korea to tax U.S. entities' royalty income. The proposed amendment was passed and took effect on January 1, 2020.

As the amended income tax law seems to be inconsistent with the Supreme Court's previous position on such royalties, it remains to be seen whether the Courts will allow the Korean tax authority to tax royalties for foreign patents under the amendment.

3. Fair Trade – Certain Demands for Royalties May be Deemed an Unfair Exercise of Patent Rights

Normally, demand for royalties in a license agreement would be considered a fair exercise of patent rights. However, the following acts of unfairly demanding consideration for the grant of a license may be deemed outside the bounds of the fair exercise of patent rights by the Korean Fair Trade Commission (KFTC):

• Act of unfairly collaborating with other enterprises to decide, maintain, or alter the royalty rate;
• Act of unfairly imposing discriminatory royalty rates based on the counterparty involved;
• Act of unfairly demanding royalties for portions of licensed technology that are not used;
• Act of unfairly imposing a royalty on periods after the expiration of patent rights; and
• Act by patentees of unilaterally deciding or altering the method of calculating royalties without prescribing the calculation method in a contract.

Further, when standard essential patents (SEPs) are involved, acts of unfairly imposing discriminatory conditions when licensing SEPs or of imposing an unreasonable level of royalty against FRAND conditions may also be deemed to be an unfair exercise of patent rights. For non-practicing entities (NPEs), acts of imposing an unreasonable royalty amount when compared with usual trade practices may also be deemed an unfair exercise of patent rights.

If a demand for a royalty is deemed to be an unfair exercise of patent rights and to correspond to an abuse of market-dominating position, an unfair collaborative act by multiple enterprisers, or an unfair trade practice, the KFTC may assess corrective measures, penalty surcharges, and/or criminal penalties.

The KFTC established the Knowledge Industry Anti-Monopoly Division in December 2016, and subsequently set up a task force to closely monitor unfair trade practices and potential abuses of IPR in the information & communication technology (ICT) industry. A major role of the task force has been to monitor IPR owners (especially SEP owners) for acts of foreclosing competitors or causing disadvantages through, for instance, the imposition of unreasonable royalties. Therefore, we recommend closely reviewing the antitrust risks when acquiring or exercising patent rights, including license agreements.