1. Case Introduction

On June 16, 2022, the Supreme Court of South Korea ruled on an important tax case involving the taxation of software purchased by a Korean subsidiary from its U.S. parent company.

The plaintiff is a subsidiary of the US parent company located in South Korea. It imports computer software products such as 3D engineering design software from the US parent company, and then sells the software products to local plant design companies and shipbuilding companies in South Korea, while providing them with technical consulting, training and other related services. The US parent company has no permanent establishment in South Korea.

2. Focus of the Dispute

The plaintiff believed that the price it paid to the US parent company was the consideration for the purchase of software products. According to Article 8 (Business Profit Clause) of the Korea-US Tax Agreement, this business is not a taxable item in Korea, so no tax was withheld or paid. However, the Korean National Tax Service (NTS) determined in its tax audit of the plaintiff that the US parent company’s income was royalties from Korea. In the view of the Korean National Tax Service, the plaintiff paid the corresponding consideration in order to obtain the right to use the proprietary technology.

3. Final Decision

On January 20, 2022, the Seoul High Court made a decision in favor of the taxpayer’s claim, and the Supreme Court of Korea (hereinafter referred to as the “Court”) also agreed with the above judgment. The Court held that the transaction between the plaintiff and its US parent company was an imported computer software product, and the US parent company obtained revenue from the sale of goods, which was operating profit and should not be judged as royalties from Korea. The main reasons are as follows:

First, the computer software products that are the subject of controversy in this case were developed and commercialized for the purpose of forming “final products”. The computer software products imported by the plaintiff were finished products and resold in Korea. Throughout the process, there is no evidence that the plaintiff copied or modified the above products and sold the copies to Korean customers.

Second, in this case, although the plaintiff provided consulting and training services to Korean customers to help them install, use and maintain the software, this was not sufficient to overturn the plaintiff’s sale of ordinary “final commodity” software programs. Based on this evidence alone, it is difficult to characterize the software sales as the transfer of proprietary technology rights from the US parent company to the plaintiff.

Third, unlike the claims of the Korean Tax Service, the high price of the software in this case, the plaintiff’s need to comply with the confidentiality obligations stipulated by the US parent company, and the fact that other companies would withhold and pay taxes on behalf of the recipient in similar circumstances are not sufficient to characterize the software sales as a transfer of the right to use proprietary technology.

Fourth, as a distributor of the U.S. parent company, the plaintiff imported computer software products according to the unit price set by the U.S. parent company and sold them directly to non-designated customers in South Korea. Its business process was to import and sell goods and did not involve the use of proprietary technology.

4. Implications for “Going Global” Enterprises

The Korean Taxation Bureau has always adhered to the principle of “tax when in doubt” and insisted on ensuring Korea’s right to levy taxes, interpreting the import costs of computer software used in industry and manufacturing as “royalty income from Korea.” Therefore, during the tax investigation process, the Korean Taxation Bureau and companies generally have disputes over the qualitative issues of imported computer software products.

For “going global” enterprises that export software to South Korea, first, they should preserve relevant evidence that can prove that the software products constitute “final goods” and that the South Korean subsidiary that imports the software products has no right to modify or copy the software products, so as to obtain favorable conditions for the qualitative characterization of the sales income. Second, they should understand the legal procedures for resolving tax disputes in South Korea and use legal tools to safeguard their own interests. It is worth noting that applying for mutual consultation of tax treaties is also an important channel for resolving tax disputes.