Taxation on the Deemed Dividend Income of Foreign Corporations

I.    Overview

The foreign corporation has tax liability when it has domestic source income which is prescribed in Article 93 of Corporate Tax Act in Korea.  It will be reviewed here whether the deemed dividend income of foreign corporation prior to the revision of the relative provision is taxable or not according to the tax law after the revision.

II.   Fact Relevance

(1)  The plaintiff is a foreign corporation based in Singapore, and has established a Branch in Korea (Branch of Plaintiff) for financial business operation on Oct. 1, 1981.  

(2)  The Branch of Plaintiff has paid the interest expenses of total KRW3,237,559,039 (KRW1,144,008,381 for  business year 2003, KRW265,499,959 for 2004 and KRW1,828,050,699 for 2005) on borrowings which exceed 6 times as the amount invested by it's Head office which is regarded as ‘foreign controlling shareholder' according to the Article 2 (1) 11 of Adjustment of International Taxes Act (former Act amended by Act no. 9914, Jan. 1, 2010) in Korea under the Article 14 (2) of the same Act and Article 26 of Enforcement Decree of the same Act (former Act, amended by Act no. 19650, Aug. 24, 2006) and this has been disposed as an ‘outflow of income' and treated as not to be included in deductible expenses as prescribed in the Article 14 (1) of Adjustment of International Taxes Act.

(3)  As a result of the tax audit on the Branch of Plaintiff, the Defendant has made the ‘income amount alteration notice' (hereafter, Disposition of this case) to the Branch of Plaintiff on Feb. 25, 2010, disposing the amount of total KRW2,093,550,658 (KRW265,499,959 for the business year of 2004 and KRW1,828,050,699 for 2005) as ‘Dividend' income as prescribed in the Article 25 (5) of Enforcement Decree of the Adjustment of International Taxes Act

(4)  The Plaintiff has filed and paid the KRW23,136,360 (withholding corporate tax for the business year 2004) and KRW166,186,427 (withholding corporate tax for the business year 2005) as per the ‘income amount alteration notice', and filed an appeal to a Tax Tribunal on May 12, 2010, but it was dismissed by Tax Tribunal on Dec. 31, 2010.  

III.  Review Points

Article 93 of Corporate Tax Act (Domestic Source Income)

IV. Case Review

(1)  Having the issue amount of this case included in the earning in reporting, determining or correcting the tax base of corporate tax on the revenues in each business year at the domestic business places of foreign corporations and reverted to the foreign corporation as prescribed in the Article 14 (1) of Adjustment of International Taxes Act, Article 106 (1) 3 j of Enforcement Decree of the Corporate Tax Act, it should have been disposed as an ‘outflow of income', but it is premised that the disposition of this case is to take it as income disposition as ‘Dividend'.

(2)  The domestic source income of a foreign corporation is taxable only when it is prescribed in Article 93 of Corporate Tax Act in Korea.  The clause taking the ‘amount disposed as dividend' to the domestic source income as prescribed in the Article 14 of Adjustment of International Taxes Act, had been newly added after the revision of the Article 93 (2) (hereafter, Revision Clause of this Case) of Corporate Tax Act (Act before it was amended by Act No.7838, Dec. 31, 2005 and amended by Act No. 8831, Dec. 31, 2007), the issue of this case having the dividend of business year of 2004, 2005 as income disposition is against the principle of the prohibition on retroactive legislation as prescribed in the Article 13 (2) of Constitution of the Republic of Korea, as it takes the  Dividend income disposition retroactively applied upon the prior business years even after the revision made.  Accordingly, the issue amount of this case is not regarded as domestic source income as prescribed in Corporate Tax Act, as the Article 93 (2) of former Corporate Tax Act (Act before it was amended by Act No.7838, Dec. 31, 2005) is applicable for this case.    

(3)  Also, as it is prescribed that the provision of tax treaty should be preferentially applied regarding the domestic source income of a foreign corporation under the Article 28 in the Adjustment of International Taxes Act, it is not taxable when the tax treaty does not take domestic source income despite it is prescribed as domestic source income in Corporate Tax Act.  But as the issue amount of this case of having a deemed dividend as prescribed in the Article 14 (1) of Adjustment of International Taxes Act and Article 25 (5) of Enforcement Decree of same Act is not applicable to both in the Article 10 (Dividends) and Article 11 (Interest) of Tax Treaty between Korea and Singapore, it could not be regarded as domestic source income under the Tax Treaty.    

V.   Judgment 사례판단

(1)  Whether the Issue amount of this case is of domestic source income under the Corporate Tax Act

1)   The domestic source income of a foreign corporation is taxable only when it is prescribed in Article 93 of Corporate Tax Act in Korea.  The amount disposed as dividend as prescribed in the Article 17 (1) of Income Tax Act and Article 9 in Adjustment of International Taxes Act is prescribed as the domestic source income by ‘the former clause of this case' and is not prescribed in Article 14 of Adjustment of International Taxes Act.  And the, clause taking the ‘amount disposed as dividend' to the domestic source income had been newly added after the revision as prescribed in the Article 14 of Adjustment of International Taxes Act,  The Revision Clause of this Case is new clause of taking the deemed dividend income as taxable source income, and newly effective, the deemed dividend as prescribed in the Article 14 in Adjustment of International Taxes Act could not be taxable as dividend income (reference for the similar case: Supreme Court Decision 2008Du13415)

2)   It is prescribed in Article 1 of the Addenda of Corporate Tax Act that the effective date as Jan. 1, 2006 and  also prescribed as ‘this Act shall apply from the first business year that begins after this Act enters into force' in the Article 2 of the Addenda of same Act.  Meanwhile, it is prescribed in the Article 18 (1) of same Act (hereinafter, Addenda Clause of this case) as ‘the amended provisions of subparagraph 2 of Article 93 shall apply from the first portion disposes of as dividends after this Act enters into force'.  The relevant business year for Issue amount of this case is the business year 2004 and 2005, and those are prior to the enforcement date of the amended Corporate Tax Act.  So, what matters is whether the provision in addenda are applicable to ‘true retroactive legislation' which make it taxable only when the income disposition for the period of completion of tax requisition with tax right and liability relation which was already fixed before the  enforcement date of revision.  Normally, the withholding liability is fixed at the time of the receipt the ‘income amount alternation notice', but the liability for withholding tax payment of the taxpayer is occurred when the taxation period closes for the income of the business year reverted (reference Supreme Court sentence 92Nu12483, Jun 8, 1993 etc.).  So, the liability of the Corporate (withholding) tax payment for the Issue Amount of this case which is a deemed dividend is supposed to be occurred only until the closing date of the business year of 2004 and 2005.  But the Addenda clause of this case is applicable to ‘true retroactive legislation' as the liability of Corporate tax payment is newly occurred which has not been existed originally by having the Revision Clause of this Case  effective on the business years after the taxation period is closed.    

3)   But it is against the Article 13 (2) of Constitution of the Republic of Korea to accept the ‘true retroactive legislation'.  It could be exceptionally accepted when it is considered as special circumstances, such as foreseeability by the public of retroactive legislation, the weakness or absence of the need to protect reliance due to legal uncertainty and disorder, justification of retroactive legislation by means of the existence of public concerns grave enough to supersede the protection of reliance (reference Constitutional Court sentence 97Heonba76, etc.).  It is contradictory to the principle of the prohibition on retroactive legislation to interpret and apply the Addenda clause of this case as it is stated, as no justification grounds are found in special circumstances specified above for this case.

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(2)  Conclusion

The domestic source income of a foreign corporation is taxable only when it is prescribed in Article 93 of Corporate Tax Act in Korea.  As the income disposition of the dividend prescribed in the Article 14 of Adjustment of International Taxes Act was not prescribed before the revision on Dec. 31, 2005 and the clause taking the ‘amount disposed as dividend' as the domestic source income had been newly added according to the Article 14 of Adjustment of International Taxes Act, the deemed dividend according to the Article 14 of Adjustment of International Taxes Act before the implementation of the revision clause should not be regarded as taxable income.

[Decision Type] Decision against the Defendant

Trial history

Josik2010Seo1863 ▶ SeoulAdministrativeCourt2011Guhap10676  ▶ SeoulHighCourt2011Nu40327 ▶ SupremeCourt2012Du11737

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