The Supreme Court has ruled that Korea cannot levy corporate tax under the Korea-U.S. tax treaty on payments made by a domestic drugmaker for using a U.S. pharmaceutical company's technology. The court analyzed U.S. tax law to determine the precise meaning of the treaty before issuing its decision.
The Supreme Court's Third Division, presided over by Justice Oh Seok-jun, said on the 18th that on Apr. 9 it overturned an appellate ruling that had ordered the Dongjak Tax Office chief to refund corporate tax to the U.S. drugmaker Genosco in a suit to revoke a denial of withholding corporate tax refunds, and remanded the case to the Seoul High Court.
In Oct. 2016, Genosco signed a contract to transfer technology and know-how for a compound targeting liver cancer to Yuhan. Under the terms, Yuhan would pay Genosco a fixed royalty and a running royalty equal to a set percentage of drug sales until the patent expired.
In Nov. 2016, Yuhan paid 500 million won to Genosco as the down payment portion of the fixed royalty and withheld and remitted 75 million won in corporate tax. Genosco sought a refund, arguing that under the Korea-U.S. tax treaty, royalty income is not domestic-source income subject to Korean taxation.
The Dongjak Tax Office denied the refund claim, and Genosco filed an administrative suit. The tax authorities argued that Yuhan used the know-how provided by Genosco in Korea to develop a new drug, and there was no basis to find that consideration for foreign use was included, so the royalty constituted domestic-source income.
The first and second instance courts ruled that corporate tax could not be imposed on the royalties Genosco received. Article 16, Section 1 of the Korea-U.S. tax treaty provides that income arising from the sale, exchange, or disposition of a capital asset is exempt from tax. The appellate court found that the royalties were capital gains and therefore exempt from Korean taxation.
By contrast, the Supreme Court said, "Genosco's know-how can be regarded as property used in business for which depreciation deductions are allowed," and held that "it cannot be viewed as falling under a capital asset under Article 16, Section 1 of the Korea-U.S. tax treaty."
Before reaching its conclusion, the Supreme Court examined what exactly "capital asset" means. Because Korean law has no concept of a capital asset and the Korea-U.S. tax treaty does not define it separately, the court said it had no choice but to understand it according to the treaty's "context."
It added that "under the Korea-U.S. tax treaty, a capital asset can be understood as all of a taxpayer's property other than the property enumerated in the Internal Revenue Code as of the 1976 conclusion of the treaty."
It further noted that the Internal Revenue Code allows depreciation deductions for property used in trade or business, and determined that know-how can be considered subject to depreciation. In that case, know-how is not a capital asset under the Korea-U.S. tax treaty, and royalties may be taxable.
In line with the Supreme Court's decision, the Seoul High Court must, on remand, reexamine whether corporate tax can be imposed on the royalties Genosco received for providing its know-how.