The Supreme Court ruled that when Korea-based corporations operating in multiple countries incur a loss in a particular country, they must first allocate and deduct that loss amount from profits earned in other countries and then pay corporate tax in Korea. Otherwise, losses incurred in a particular country would be offset only against profits generated at domestic business sites, which could prevent the tax authorities from properly collecting corporate taxes.
The Supreme Court's Second Division (presiding Justice Oh Kyung-mi) said on the 10th that it finalized the lower court ruling that dismissed the plaintiff's claim in the suit filed by LG Chem to cancel the refusal of a corporate tax adjustment by the head of the Yeongdeungpo Tax Office, on June 25.
◇ Court notes that calculating as LG Chem argued could lead to "domestic corporate taxes flowing overseas"
LG Chem incurred a loss at its U.S. business site in 2018. It paid corporate tax after calculating the loss amount by allocating it in proportion to the income share by country against total foreign-source income generated in other countries such as China, and deducting that allocated amount.
This was calculated according to the method presented in the National Tax Service's form titled "country-by-country foreign tax credit statement." For example, if A and C and Korea each recorded profits of 5 million won, 3 million won, and 2 million won, and B recorded a loss of 6 million won, the loss in B is first deducted from the profits in A and C. Then, the domestic and foreign business sites are combined to calculate the corporate tax payable to our government.
In 2022, however, LG Chem filed an adjustment request, saying, "The limit on the foreign tax credit should be calculated without deducting the loss incurred in the United States from foreign-source income generated in other countries such as China," and sought a refund of 4.2 billion won in 2018 corporate tax. The Yeongdeungpo Tax Office rejected the request, and the Tax Tribunal also dismissed the appeal, prompting this lawsuit.
In the first trial, the court dismissed LG Chem's claim, saying, "Considering the text and purpose of the Corporate Tax Act and related regulations, losses incurred in a particular country need to be reflected in foreign-source income (of other countries) in accordance with the calculation method on which the disposition was based."
The first trial court explained that the tax authorities presented this calculation method in line with the purpose of the foreign tax credit system, which is intended to prevent "double taxation," where corporations operating in multiple countries pay taxes both to the country concerned and to our government.
Under this system, the tax authorities grant a full or partial credit when the amount of foreign tax paid is less than the domestic corporate tax. The first trial court said, "It is not designed as a system to refund the excess when the foreign tax paid exceeds the domestic corporate tax."
The first trial court also noted that if, as LG Chem argued, losses incurred in a particular country are not allocated and reflected against profits from other foreign business sites, then the losses from that country would be deducted only from profits generated in Korea. It added that linking such a calculation method with the system for crediting taxes paid overseas "would not achieve the purpose of the foreign tax credit system, which is to prevent domestic corporate taxes from flowing to countries with higher corporate tax rates than ours."
LG Chem appealed, but the second trial also dismissed the appeal. During the proceedings, LG Chem argued that tax treaties Korea has concluded with the United States, China, and others provide for the avoidance of double taxation, and that the National Tax Service is effectively allowing double taxation by restricting tax credits based only on internal guidelines, not the law.
After reviewing the Korea-U.S. and Korea-China tax treaties, the second trial court rejected LG Chem's argument, saying, "It appears they reserve to Korean law the determination of the specific method for calculating the credit limit related to the avoidance of double taxation for Korean residents."
The Supreme Court found the current calculation method "reasonable and rational." It said, "If the loss incurred at one foreign business site of a domestic corporation is not deducted at all from the income amounts of other foreign business sites, it will in substance be deducted only from domestic-source income," and "this results in an erosion of the taxing rights over domestic-source income."
◇ Supreme Court: Taxing rights over domestic-source income must not be eroded
Hyundai Engineering & Construction also filed a suit in 2023 to cancel a refusal of a corporate tax adjustment against the head of the Jongno Tax Office on similar grounds. Hyundai Engineering & Construction has branches in the United States, the United Kingdom, Japan, Indonesia, and Saudi Arabia, and when filing corporate taxes from 2015 to 2017, it paid corporate tax after allocating losses incurred in particular countries against profits in other countries and deducting them.
Hyundai Engineering & Construction argued that this calculation method was improper and filed suit seeking a refund of 32.5 billion won in corporate tax, but lost in the first and second trials and at the Supreme Court. The Supreme Court's Third Division (presiding Justice Noh Kyung-pil) said on June 24, "To prevent the erosion of taxing rights over domestic-source income, it is reasonable and rational to adopt a method of allocating and deducting losses in proportion to the extent to which each country's income contributed to the calculation of domestic corporate tax," and dismissed Hyundai Engineering & Construction's appeal.