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Korean Supreme Court Issues Several Rulings on Whether a Foreign Company Doing Business in Korea May Be Found to Have a Permanent Establishment
In 2016, the Korean Supreme Court issued several rulings shedding light on its approach when analyzing whether a foreign company conducting business in Korea may be found to have a permanent establishment (“PE”).
These recent cases highlight some of the PE issues on which the Korean tax authorities are currently focusing.
1. In one recent case, a Canadian company provided project management services to a Korean subsidiary, a project owner for the building of a bridge in Korea. Employees of the Canadian company performed their services at the office of the subsidiary. The Supreme Court, affirming the lower court’s decision, held that such space should be regarded as a PE of the Canadian company, citing the “6-month rule” and the “2-year rule” under the Korean corporate income tax law1. Accordingly, the Court effectively found that the 6-month rule and the 2-year rule under the Korean tax law can be applied in the context of a tax treaty.
2. On the same day, the Supreme Court also rendered a decision in another, but related case2. A U.K. affiliate of the Canadian company subsequently took over the above project management services under separate agreements for onshore and offshore services. The U.K. company registered a branch (PE) in Korea, and complied with income taxes and VAT on the onshore services portion. However, the Korean tax authority challenged and also assessed corporate income tax and VAT on the offshore portion. The Supreme Court found that the onshore and offshore services were by nature a combined provision of one service. Since the onshore services were important and essential to the provision of the entire services, the offshore services were effectively also provided through the PE and subject to the Korean tax.
This case appears to depart from the “attribution principle” for a PE under domestic law as well as treaties, taxing income from services not performed in Korea. The Supreme Court appears to have applied a substance-over-form principle, determining that form did not agree with substance, and that there was no justifiable reason to split the contract into two.
3. In another case, a Korean casino paid commission to a service provider based in the Philippines to solicit foreign customers pursuant to a services agreement3. Under the agreement, the foreign service provider had the right to use a certain area within the casino’s office, provided rent-free by the casino. Employees of the service provider carried out: (i) hotel, airport, and casino business-related services to foreign customers; and (ii) casino chip exchange services to foreign gamblers at the casino site.
The Supreme Court ultimately ruled that the provided space constituted a PE of the foreign service provider on the ground that the services provided at that space were essential and important parts of the foreign company’s business. Thus, the space provided at the casino constituted a PE of the Philippines-based company.
Significance / Potential Impact:
In recent years, the Korean tax authorities have again focused their attention on whether a foreign company’s operations in Korea should give rise to a PE. This trend is noteworthy in light of the OECD’s BEPS Action 7, which strengthens taxation of PEs. Once a foreign company is regarded as having a PE in Korea, such a finding potentially triggers the imposition of corporate income taxes and VAT. Further, since the statute of limitations in case of non-filing of returns is extended to seven years, finding a PE can result in significant amount of taxes, penalties, and interest. While not common and depending on the facts, criminal tax charges can be made as well.
Accordingly, it is important for foreign companies conducting business activities in Korea without or with any registered presence to analyze potential PE risks. This should be done by closely examining all facts and circumstances, including the roles and functions of all parties involved, to develop and establish a persuasive defense against a possible future PE challenge. In addition, when employees of a Korean subsidiary of a multinational enterprise (“MNE”) visit foreign affiliates to provide services, there may be a PE risk in the foreign country. This overseas PE risk of a Korean subsidiary of an MNE is particularly notable in China, where the Chinese tax authorities have aggressively raised PE issues.
1 Supreme Court Decision 2014Du13812, February 18, 2016
2 Supreme Court Decision 2014Du13829, February 18, 2016
3 Supreme Court Decision 2015Du51415, July 14, 2016