[1] The extent to which the German investment-related organization, which falls under the “foreign corporation” under the Korean Corporate Tax Act, can be subject to the Agreement between the Republic of Korea and the Federal Republic of Germany for the Avoidance of Double Taxation and the Prevention of Fisc

[2] Requirements for applying the 5% limited tax rate on dividend income pursuant to Article 10(2) of the Agreement between the Republic of Korea and the Federal Republic of Germany for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital, and the meaning of “corporation” as defined in Article 3(1)(e)

[1] Articles 1, 3(1)(d), (e), and 4(1) of the Agreement between the Republic of Korea and the Federal Republic of Germany for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital / [2] Articles 3(1)(e) and 10(2) of the Agreement between the Republic of Korea and the Federal Republic of Germany for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect

Seoul High Court Decision 201Na1448 delivered on May 2, 201

The Head of the Southern District Tax Office (Law Firm ELDB Partners, Attorney Lee Do-young, Counsel for defendant-appellant)

Seoul High Court Decision 2012Nu20832 decided March 27, 2013

The judgment below is reversed and the case is remanded to Seoul High Court.

The grounds of appeal are examined (to the extent of supplement in case of supplemental appellate briefs not timely filed).

1. Regarding ground of appeal No. 1

A. Article 2(1)2, etc. of the former Corporate Tax Act (amended by Act No. 9267, Dec. 26, 2008; hereinafter the same) provides that a foreign corporation is liable to pay corporate tax only when there is any domestic source income with respect to the foreign corporation. Articles 2(4) and 98(1) provide that a person who pays a certain amount of domestic source income to a foreign corporation, such as Article 93 subparag. 9, shall withhold the relevant corporate tax. Articles 93 subparag. 2 and 98(1)3 provide that the withholding tax rate for the dividend income that is the domestic source income of the foreign corporation shall be 25%.

Meanwhile, Article 10(1) of the Agreement between the Republic of Korea and the Federal Republic of Germany for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and on Capital (hereinafter “Korea- Germany Tax Treaty”) provides that “The dividends paid by a corporation which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other Contracting State,” and Article 10(2) provides that “However, with respect to such dividends, the corporation paying the dividends may also be taxed in the Contracting State, which is a resident, in accordance with the laws of that State: Provided, That if the beneficial owner of the dividends is a resident of the other Contracting State, the taxes imposed as above shall not exceed: (a) Item (a) provides that “5% of the total amount of the dividends shall not exceed the following:

B. citing the reasoning of the judgment of the court of first instance, the lower court: (a) established TmbH 1 GmbH&C on August 13, 2003, which is a German limited partnership company (hereinafter “TMW”), TmbH (hereinafter “GmbH 1”) and TMW GmbH (hereinafter “GmbH 2”), respectively, and held all outstanding shares; (b) acquired 50% of the Plaintiff’s outstanding shares in Seoul City TmbH 28 on August 28, 2003, on the ground that the Plaintiff’s limited tax rate of 208mbH 1 and 25mbH (hereinafter “GmbH 2”) was excluded from the corporate tax rate of 10% under the former Tax Treaty; and (c) recognized that the Defendant paid dividends to the Defendant for the purpose of 2008 GmbH 25mbH (hereinafter “the instant tax treaty”).

Furthermore, the lower court determined that the beneficial owner of the dividend income in this case should be deemed as GmbH1 and 2, the nominal owner of the instant dividend income, and that it cannot be deemed as TMW, in light of the fact that the establishment of TMbH 1 and 2 was derived from the purpose of evading acquisition tax on the Seoul TM building, even though it was established for the purpose of evading acquisition tax on the Seoul Metropolitan City TmbH 1 and 2, in view of the fact that the acquisition tax is not subject to the Korea- Germany Tax Treaty and there is a need to respect the substance of the special purpose company in relation to other taxes not subject to the avoidance purpose, and thus, the beneficial owner of the instant dividend income in this case should be deemed as GmbH 1 and 2, the nominal owner of the instant dividend income, and it is not considered as TMW, in view of the fact that it is necessary to respect the substance of the special purpose company.

C. However, the lower court’s determination is difficult to accept for the following reasons.

The substance over form principle under Article 14(1) of the former Framework Act on National Taxes (amended by Act No. 8840 of Dec. 31, 2007 and Article 14(1) of the same Act (amended by Act No. 9911 of Jan. 1, 2010; hereinafter the same) where there is a separate person to whom the actual income, profit, property, transaction, etc. belongs differently from the nominal owner, the nominal owner should be the person to whom the property belongs rather than the nominal owner. Thus, where the nominal owner is not capable of controlling and managing the property, and there is a separate person who actually controls and manages the property through the control, etc. over the nominal owner, and where the disparity between the nominal owner and the actual owner arises from the purpose of evading taxes, the income on the property shall be deemed reverted to the person who actually controls and manages the property and shall be the person to whom the property belongs (see, e.g., Supreme Court en banc Decision 2008Du84999, Jan. 19, 2012).

According to the reasoning of the judgment below and the evidence duly admitted by the court below, ① TMW established GmbH 1 and 2 with the intention of evading acquisition tax on the Seoul TM building upon consultation from the relevant agencies, and caused them to acquire 50% each of the total issued stocks of the Plaintiff holding the Seoul TM building; ② GmbH 1 and 2 were the same as TMW and location, contact address, director, and no independent member of the company, and all of the funds acquired the Plaintiff’s issued stocks were provided from TMW. From April 2006 to May 208, 2008, the entire amount of dividends received from the Plaintiff excluding German capital gains tax was immediately paid to TMW. On July 2007, 2007, the Plaintiff’s general meeting of shareholders decided to sell the Seoul City TM building and the Seoul Special Metropolitan City Mayor decided to dismiss the Plaintiff’s claim for revocation of acquisition tax on the ground that the Plaintiff’s entire issued stocks were the beneficial owner of TM and the Plaintiff’s claim for revocation of 20% on its own stocks.

In light of the circumstances and purpose of the establishment of GmbH 1 and 2, GmbH 1 and 2’s personal and physical organization and details of business activities, and the degree of control and management over TmbH 1 and 2’s income, GmbH 1 and 7’s income, GmbH 2 did not have the ability to control and manage the Plaintiff’s issued stocks or the instant dividend income, and TmbH 1 and 2 actually controlled and managed TmbH 1 and 2 by exercising the control, etc. over the Plaintiff’s issued stocks and the instant dividend income, and such disparity may be deemed to have arisen solely from the purpose of tax evasion. As such, the beneficial owner of the instant dividend income is not GmbH 1 and 2, but TMW. Moreover, insofar as GmbH 1 and 2 is merely the nominal owner, it does not mean that the instant legal act was done in its name or it was established as a specific purpose company.

Nevertheless, the lower court deemed otherwise the beneficial owner of the instant dividend income as GmbH 1 and 2. In so determining, the lower court erred by misapprehending the legal doctrine on the scope to which the principle of substantial taxation under Article 14(1) of the former Framework Act on National Taxes applies. The allegation contained in the grounds of appeal on this point is with merit.

2. As to the grounds of appeal Nos. 2 and 3

A. The lower court determined otherwise on the ground that even if the beneficial owner of the instant dividend income is deemed as TMW, it constitutes a “corporation” as the entity to whom the rights and obligations are attributed independent of the members of the organization under the private law of Korea, and furthermore, since GmbH 1 and 2 hold all the Plaintiff’s issued stocks through GmbH 1 and 2, the lower court determined that the instant disposition was unlawful on the ground that the limited tax rate of 5% under Article 10(2)(a) of the Korea- Germany Tax Treaty is applied to the instant dividend income.

B. However, the lower court’s determination on this part, which was based on the premise that TMW as a “corporation” is a “resident” under the Korea- Germany Tax Treaty, is also difficult to accept for the following reasons.

1) Article 1 of the Korea- Germany Tax Treaty provides that “This Agreement shall apply to persons who are residents of one or both of the Contracting States,” and Article 3(1)(d) and (e) provides that “person” shall mean individuals and corporations unless the context otherwise requires in this Agreement, and “corporation” shall mean any body corporate or any entity which is treated as a body corporate for tax purposes, and “resident of a Contracting State for the purposes of this Agreement” shall mean a person liable to pay taxes in that State under the law of that State in accordance with any other criteria of address, domicile, location of the head office or principal office, or any other similar nature. However, this term shall not include any person liable to pay taxes only with respect to income at the source of that State or capital located in that State.”

Inasmuch as the issue of double taxation arises when both the resident state and the source state exercise the authority to impose taxes on the income accrued in the source state, it is necessary to prevent double taxation by properly allocating and coordinating the authority to impose taxes and the authority to impose taxes on the source state. Accordingly, both Contracting States enter into a tax treaty under the premise that the authority to impose taxes on the source state is not limited to the resident state, and the resident state has the same system as the foreign tax credit under their laws to respect the right to impose taxes on the source state. As such, the tax treaty assumes that the resident state assumes the domicile, residence, location of the head office or principal office, or any other similar standard in the resident state, and thus, the tax treaty cannot be applied to the income accrued in the source state unless the resident state bears such comprehensive tax liability.

Meanwhile, whether a foreign organization that received income from the Republic of Korea as a source country constitutes a "foreign corporation" under the Corporate Tax Act of the Republic of Korea shall be determined depending on whether it can be deemed an entity to whom separate rights and obligations are attributed independent of its members under the private law of the Republic of Korea (see, e.g., Supreme Court Decision 2010Du5950, Jan. 27, 2012). However, since it is merely for the purpose of determining whether a foreign organization is a taxpayer under the Corporate Tax Act or a taxpayer under the Income Tax Act in the Republic of Korea as the source country of income, it shall be separately determined in accordance with tax treaties. Since a foreign organization that received income from the Republic of Korea as the source country is a "foreign corporation" under the Corporate Tax Act of the Republic of Korea, it shall not be deemed as a "resident" subject to the tax treaty (see Supreme Court Decision 2011Du2747, Oct. 24, 2013).

In the same purport, Articles 1 and 4(1) of the Korea- Germany Tax Treaty also stipulate that a tax treaty is applicable only to a resident who is liable for comprehensive tax payment in a Contracting State. However, the Korea- Germany Tax Treaty does not have any provision as to whether a resident is a resident, rather than an organization, with respect to income derived from an activity of a certain organization.

In exercising the right to impose taxes, when a source country applies a tax treaty, the source country shall comply with the domestic law of the source country unless otherwise stipulated in the tax treaty. Thus, in cases where a source country ought to be deemed a source country as the source country’s source country’s source country’s source country’s source country’s source country’s source country’s source country’s source country’s source country’s source country’s source country’s source country’s source country’s source country’s source country’s source country’s source country’s source country’s source country’s source country’s source country’s source country’s source country’s source country’s source country’s source country’s source country’s source country’s place of taxation is not subject to the application of the tax treaty. However, in full view of the fact that a source country’s country’s source country’s source country’s source country’s source country’s source country’s source country’s source country’s income and its source country’s source country’s source country’s source country’s income can be treated as a comprehensive tax treaty.

Therefore, in a case where a German organization, which constitutes a “foreign corporation” under the Corporate Tax Act of Korea, constitutes a foreign corporation-invested organization that does not bear a comprehensive tax liability in Germany with respect to the income accrued in Korea, the scope that its members are liable for comprehensive tax liability in Germany with respect to the income accrued from the said organization falls under a German resident under the tax treaty, and the Korea- Germany Tax Treaty may be applied to the extent that its members are not liable for comprehensive tax liability in Germany among the income accrued from the Republic of Korea as the source country, to the extent that

However, in order to apply the 5% limited tax rate on dividend income pursuant to Article 10(2) of the Korea-U.S. Tax Treaty, the beneficial owner of the dividend income, i.e., the beneficial owner of the dividend income, shall be the resident who is the corporation. Article 3(1)(e) of the Korea-U.S. Tax Treaty defines the corporation as “an organization corporate or an entity treated as a body corporate for tax purposes.” The term “corporation” as defined in the above provision refers to the taxable unit that bears the same comprehensive liability as corporate tax at the stage of an organization established in accordance with the law of the country where the organization is established. Therefore, if the German investment and taxation organization does not bear the same comprehensive liability as corporate tax under the German tax law, it cannot be deemed as “corporation” under the Korea-U.S. Tax Treaty. As such, with respect to dividend income derived from the Republic of Korea where the organization is the source country, the limited tax rate of 15% under Article 10(2)(b) of the Korea-U.S

2) According to the reasoning of the lower judgment and the evidence duly admitted by the lower court, WT is a human company established under the German Commercial Code, which is an entity of which the rights and obligations independent of its members are attributed to the organization. However, TPP is only a business tax liability under the Business Tax Act (Gewestestestestestest) and cannot be deemed as a comprehensive tax liability on the ground that it has no corporate tax liability under the German Corporate Tax Act and is not a place-based relationship such as address. With respect to the income attributed to TPPW, the member is a German, Austria and Luxembourg. Meanwhile, TPP is composed of Germany, Austria and Luxembourg.

Therefore, as long as TMW, which falls under the “foreign corporation” under the Korean Corporate Tax Act, is a German investment and taxation organization, so long as it does not bear a comprehensive tax liability in Germany, it cannot be deemed a “corporation” under the Korea- Germany Tax Treaty, and as to the dividend income of this case, the limited tax rate of 5% under the Korea- Germany Tax Treaty cannot be applied. Only to the extent that its members bear a comprehensive tax liability in Germany, the limited tax rate of 15% can be applied as a “resident” under the Korea- Germany Tax Treaty. Thus, the lower court should have determined the amount subject to the 15% limited tax rate out of the dividend income of this case by examining the scope of a person who bears a comprehensive tax liability as a German resident among the members of TMW, and should have determined

Nevertheless, solely for the reasons indicated in its holding, the lower court determined that the instant disposition was unlawful on the grounds that TMW constitutes “corporation” and “resident” under the Korea- Germany Tax Treaty, and that the limited tax rate of 5% may be applied to the entire dividend income of this case. In so determining, the lower court erred by misapprehending the meaning of “corporation” under the Korea- Germany Tax Treaty and “resident”, or by failing to exhaust all necessary deliberations. The allegation contained in the grounds of appeal on this point is with merit.

3. Conclusion

Therefore, without further proceeding to decide on the remaining grounds of appeal, the lower judgment is reversed, and the case is remanded to the lower court for further proceedings consistent with this Opinion. It is so decided as per Disposition by the assent of all participating Justices on the bench.

Justices Lee In-bok (Presiding Justice)