Seocho 2013west 1104 ( October 23, 2014)

Interest paid on borrowings from the head office of a foreign corporation in excess of six times the amount invested in the head office of the foreign corporation shall be disposed of as dividends.

In full view of the structure and contents of the Korea-U.S. Tax Treaty and the provisions of the Korean Corporate Tax Act, interest paid on loans from the head office exceeding six times the amount invested by the head office of a foreign corporation can be recognized as dividends under the Korea-U.S. Tax Treaty

Article 25 (Calculation Method of Non-deductible Expenses)

2013Guhap61845 Notice of Change in Income Amount

호주◎◎◎◎은행

◉◉지방국세청장

August 13, 2015

November 19, 2015

1. All of the plaintiff's claims are dismissed.

2. The costs of lawsuit shall be borne by the Plaintiff.

Cheong-gu Office

Notice of each change in the amount of income stated in the separate sheet issued by the Defendant against the Plaintiff on October 22, 2012

The cancellation shall be revoked.

1. Details of the disposition;

A. The Plaintiff, a legal entity whose head office is located in Australia, establishes a branch office in the Republic of Korea (hereinafter referred to as “Plaintiff branch”) and operates financial business.

B. The Plaintiff branch held that the sum of the interest paid on the loan exceeding six times the amount of the Plaintiff’s investment in the Plaintiff branch during the business year from 2007 to 2009 (from October 1, 2006 to September 30, 2009) and the business year from 2011 (from October 1, 201 to September 30, 201) exceeds six times the amount of the Plaintiff branch’s investment in the Plaintiff branch (= KRW 00,000,000 + KRW 00,000,000 for the business year from 207 + KRW 200,000 for the business year from 209 + KRW 00,000,000 for the business year from 209 + KRW 00,000,000 for the business year from 20,000,000 in total, and KRW 200 for the pertinent business year).

C. On October 22, 2012, pursuant to Article 14 of the former Adjustment of International Taxes Act (amended by Act No. 9914, Jan. 1, 2010); Article 14 of the former Adjustment of International Taxes Act (amended by Act No. 11606, Jan. 1, 2013; hereinafter referred to as the “International Tax Adjustment Act” in the former Adjustment of International Taxes Act (amended by Act No. 11606, Jan. 1, 2010); Article 25(6) of the Enforcement Decree of the same Act, the Defendant disposed of the instant income as dividends of each pertinent business year, and notified the Plaintiff of changes in the amount of income as shown in the attached disposition list (hereinafter referred to as the “instant disposition”).

D. Accordingly, the Plaintiff paid 0,000,000 won (including resident tax) in total as follows, by applying the limited tax rate of 15% (including resident tax) stipulated in Article 10(2) of the Convention between the Government of the Republic of Korea and the Government of the Australia for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to the Taxes on Income in the instant case (hereinafter “Korea-U.S. Tax Treaty”).

[Reasons for Recognition] Facts without dispute, entry of Gap evidence 1 to 4 (including each number), the purport of the whole pleadings

2. Whether the disposition is lawful;

A. The plaintiff's assertion

The plaintiff asserts that the disposition of this case is unlawful for the following reasons.

1) The disposition of income with respect to interest excluded from deductible expenses pursuant to Article 14(1) of the International Tax Adjustment Act shall also be interpreted in compliance with the contents stipulated in Article 67 of the Corporate Tax Act. According to Article 67 of the Corporate Tax Act and Article 106(1)3(j) of the Enforcement Decree of the same Act, the “income to which the amount included in gross income belongs to the foreign corporation in return, or determination or correction of the corporate tax base on the income for each business year of the domestic business place of the foreign corporation” stipulates that the income included in gross income shall be disposed of as other outflow of income. The instant income falls under the amount included in gross income of the domestic business place for each business year, which belongs to the foreign corporation, and should be disposed of as

2) The instant income is merely an internal transfer of funds between a foreign corporation and its domestic place of business, and does not constitute the corporate income itself, and thus, the corporate income cannot be established under the Corporate Tax Act (section 2).

3) The Korea-U.S. Tax Treaty shall apply to the Plaintiff’s domestic source income, and the contents of the tax treaty shall take precedence over the domestic tax law as a special law. However, the instant income paid by the Plaintiff cannot be deemed as dividend income pursuant to Article 10 of the Korea-U.S. Tax Treaty, and only constitutes interest income as prescribed in Article 11 of the said Treaty as interest on the loan. Therefore, imposing the instant income as dividend income pursuant to the domestic tax law is in violation of Article 28 of the Korea-U.S. Tax Adjustment Act and the Korea-U.S. Tax Treaty (section

4) The reason why Article 14(1) of the International Tax Adjustment Act considers the interest excluded from deductible expenses as a dividend is aimed at preventing double taxation by allowing a foreign corporation’s resident state to easily apply the tax credit for indirect payments in the case of interest paid on excess loans between the head office and the branch office of the foreign corporation that is not subject to the tax credit for indirect payments. Furthermore, it does not mean that the interest paid on the excess loans between the head office and the branch office of the foreign corporation that is not subject to the tax credit for indirect payments is excluded from deductible expenses, but rather, disposal of the interest paid on dividends and withholding taxes are more severe than the case where the domestic branch raises funds from the head office to the capital that is not

B. Relevant statutes

The entries in the attached Table-related statutes are as follows.

C. Determination

1) The nature of the instant income (determination as to the claim 1 and 2)

A) Article 14(1) of the International Tax Adjustment Act, and Articles 25(6) and 26 of the Enforcement Decree of the same Act provide that a foreign corporation’s domestic place of business shall be deemed to have disposed of as a dividend, not including in deductible expenses, the interest paid on a loan exceeding six times the equity share among the amount borrowed from a foreign controlling shareholder. In the event that the person to whom the interest accrued is a shareholder, the substance of the interest accrued as deductible expenses shall be treated as a dividend and the disposal of income is carried out on such premise. The instant income is the interest paid on a loan exceeding six times the equity share among the amount borrowed by the Plaintiff’s branch that falls under a domestic place of business from the Plaintiff, a foreign controlling shareholder, and thus, it is apparent that the instant income is treated as a dividend other than interest pursuant

B) On the other hand, the plaintiff asserts that the income of this case should be disposed of as other outflow from the company under Article 67 of the Corporate Tax Act and Article 106 (1) 3 (j) of the Enforcement Decree of the same Act (Chapter 1). However, in applying Article 25 (6) of the Enforcement Decree of the International Tax Adjustment Act, the interest on the amount borrowed from a foreign controlling shareholder shall be deemed to have been disposed of as dividend under Article 67 of the Corporate Tax Act, and the amount not included in deductible expenses among the interest on the amount borrowed from a foreign controlling shareholder shall be deemed to have been disposed of as dividend under Article 67 of the Corporate Tax Act, and the interest on the amount borrowed from a third party under a payment guarantee by a foreign controlling shareholder shall be deemed to have been disposed of as a outflow from the company under Article 67 of the Corporate Tax Act, and Article 14 (1) of the International Tax Adjustment Act shall not be deemed to have been disposed as a dividend or other outflow from the company under Article 67 of the Corporate Tax Act.

C) In addition, the Plaintiff asserts that the instant income is merely a domestic business place that does not vary with the Plaintiff’s domestic legal personality and does not constitute corporate income itself, and that it cannot be established under the Corporate Tax Act (Chapter II). However, the International Tax Adjustment Act defines “the head office and branch office of a foreign corporation that substantially controls the domestic business place of a foreign corporation” as “foreign controlling shareholder,” and states “foreign corporation’s domestic business place” in Article 14(1) as “domestic corporation’s domestic business place” in the concept of Article 93 subparag. 2 and Article 98(1)3 of the Corporate Tax Act, and Article 137(1) of the Enforcement Decree of the same Act provides that the said income is not subject to the application of the taxation system for insufficient capital in the domestic business place of a foreign corporation. In light of Article 2(1)14(a) of the International Tax Adjustment Act and Article 25(6) of the Enforcement Decree of the same Act, the amount disposed of as dividend income of the foreign corporation is subject to the said domestic business place.

2) Whether the Korea-U.S. Tax Treaty has been violated (see Articles 3 and 4)

Article 28 of the International Tax Adjustment Act provides that, in cases where the classification of income under the tax treaty and the classification of income under the domestic tax law are different in terms of the classification of foreign corporations’ domestic source income, the tax treaty should be applied preferentially. Thus, notwithstanding the provisions of Article 14(1) of the International Tax Adjustment Act, the instant income ought to be recognized as a dividend under the Korea-U.S. Tax Treaty. However, considering the following factors, comprehensively taking into account the structure and content of the Korea-U.S. Tax Treaty and the Corporate Tax Act, the instant income can be recognized as a dividend under the Korea-U.S. Tax Adjustment Act, and thus, the instant disposition cannot be deemed as a violation of Article 28 or the Korea-U.S. Tax Adjustment Act, and it cannot be said that the Plaintiff’s assertion is without merit.

(1) Article 10(3) of the Korea-U.S. Tax Treaty provides that "the income from stocks and other income which a corporation distributing dividends receives the same taxation as income from stocks under the laws of the Contracting State, which is a resident," and Article 11(4) provides that "interest" includes interest from government-issued securities or bonds or bonds and interest from all other income which is treated the same as income from money loans under the taxation laws of the Contracting State, regardless of whether or not there is any right to participate in the security and any profit-making, and interest from other forms of debt as well as all other income which is treated as equal as income from money loans, regardless of whether or not there is any right to participate in the security and any other right to participate in the profit."

② According to Article 3(1)(e) of the Korea-U.S. Tax Treaty, the term “corporation” means a corporate body or an entity similar to a corporate body for tax purposes. In light of the intent of the Korea-U.S. Tax Adjustment Act to apply the Korea-U.S. Tax System to a domestic place of business of a foreign corporation, the Plaintiff’s branch can be fully recognized as having “a entity similar to a corporate body for tax purposes.”

③ The definition of the Korea-U.S. Tax Treaty defines dividends as a juristic person and sets forth the subject of income distribution as a juristic person, unlike interest income, is deemed to be due to the fact that the dividend income is paid to the shareholders by a juristic person, and it is difficult to view it to the purport that it is intended to exclude other forms of distribution under the said provisions (Article 3(1) of the said Treaty provides that each term may be interpreted differently, notwithstanding the definition of the terms in the said provisions, such as a juristic person).

④ The Plaintiff asserts to the effect that, in accordance with the Korea-U.S. Tax Treaty, the transfer of funds within a corporation cannot be deemed as a dividend. However, Article 96 of the Corporate Tax Act and Article 10(6) of the Korea-U.S. Tax Treaty recognize the so-called branch tax to coordinate the imbalance of tax burden arising from the difference in the form of law regarding the method of domestic entry into the Republic of Korea, such as the form of a subsidiary or a branch, and allow a foreign corporation to impose corporate tax on the amount remitted by a domestic branch of a foreign corporation to its head office as in the same manner as the dividend it

⑤ The OECD Model Treaty note also provides that interest on loans may be treated as dividend income in accordance with the domestic law that applies to insufficient capital (see Article 10(3) of the OECD Model Tax Treaty and Article 10 subparag. 25 of the Notes).

(6) The purport of deeming the provisions of Article 14(1) of the International Tax Adjustment Act as a dividend of interest that is not included in deductible expenses lies in preventing the act of evading taxation (an abuse of a tax treaty) by abusing the situation in which a large number of tax treaties reduces the taxation of interest (excluding the abuse of a tax treaty) and securing the effectiveness of the taxation of under-capital, even in addition to allowing the application of the indirect tax credit in the resident state. Therefore, it cannot be readily concluded that there is no practical benefit to treat the interest paid to the head office as a dividend. Moreover, since the withholding tax amount is subject to the direct tax credit, it cannot be readily concluded that the overall tax burden of a foreign corporation increases.

3. Conclusion

Therefore, the plaintiff's claim of this case is dismissed as it is without merit. It is so decided as per Disposition.