AUGUST/SEPTEMBER 2003 ASIA-PACIFIC TAX BULLETIN
To be within the scope of a Chinese DTA, a foreign
investor in China must be a “resident” of the other con-
tracting state as defined in the DTA. China’s treaties pro-
vide that a person is a resident of a contracting state if the
person is subject to tax under the laws of that state by rea-
son of the person’s domicile, residence, place of general
management or any other criterion of a similar nature.
For instance, in Mauritius, a Mauritian company must be
registered as Category 1 global business licence company
in order to enjoy the DTA benefits. To qualify as a Cate-
gory 1 business licence company, a Mauritian company
must have at least two Mauritian resident directors, one
local qualified company secretary and one local qualified
corporate auditor. The company must hold its board meet-
ing in Mauritius and must have a bank account in Mauri-
tius through which the company channels fund for invest-
ment in other treaty country.
SOUTH KOREA
Withholding Tax Planning Techniques*
Dong Soo Kim
Woo, Yun, Kang, Jeong & Han, South Korea
1. WITHHOLDING TAX RATES
Under the Corporate Income Tax Act (CITA), interest pay-
ment, dividend distribution and royalty payment by a
South Korean corporation to a foreign entity having no
permanent establishment (PE) in South Korea are all sub-
ject to South Korean withholding tax at the rate of 27.5%
(including resident surtax). However, most double tax
agreements (DTA), to which South Korea is a party, pro-
vide reduced withholding tax rates on such payments or
exemptions from withholding taxes in South Korea.
Accordingly, a foreign investor may enjoy reduced rates or
exemptions from withholding taxes in South Korea on
such incomes from South Korea if the foreign investor is a
resident in a jurisdiction that has entered into a DTA with
South Korea.
2. WITHHOLDING TAX ON PAYMENTS TO A
NON-RESIDENT FOR SERVICES PROVIDED
OVERSEAS
The applicability of South Korean withholding tax on a
payment for the services provided overseas (“offshore ser-
vice fee”) depends on the character of the offshore service
fee. If the relevant DTA characterizes the offshore service
fee as personal service income, and provides that only the
country where the services are performed may tax per-
sonal service income, the offshore service fee may not be
taxed in South Korea. On the other hand, if the offshore
service fee is characterized as business income, the tax-
© 2003 International Bureau of Fiscal Documentation
Exported / Printed on 17 Oct. 2022 by WU (Wirtschaftsuniversität Wien).
291
Additional rules in the DTAs may limit the availability of
treaty benefits. A 1996 protocol to the 1984 United
States–China DTA denies treaty benefits to an entity
established in one of the DTA partner countries if residents
of the DTA partner country do not hold at least a 50%
interest in the entity.
It should be noted that the Chinese tax authorities have
issued a number of domestic documents regarding differ-
ent treaties on interpretation issues on a particular DTA
and on the procedural matters on ways to obtain treaty
benefits. These interpretation provisions may to a certain
extent limit the extent of DTA benefits to the scope of peo-
ple as clarified in these documents.
ation on the offshore service fee depends on whether or
not the relevant foreign service provider has a PE in South
Korea, i.e. the offshore service fee may be taxed in South
Korea only if the foreign service provider has a PE in
South Korea.
If there is no DTA between South Korea and the country of
residence of the provider of offshore services, the taxation
on the offshore service fee would be governed by the
CITA. Under the CITA, the offshore service fee would be
characterized as personal service income. The CITA pro-
vides that personal service income may be subject to tax in
South Korea if the service provider renders services in
South Korea or if services provided offshore are utilized in
South Korea. Therefore, under the CITA, if the services
provided offshore are utilized in South Korea, the payment
for such services may be subject to withholding tax at the
rate of 22% (including resident surtax).
It is, however, often difficult to distinguish personal ser-
vices income from royalties income. In fact, the tax
authorities have often re-characterized personal services
income as royalties where the personal services involve
the transfer of know-how, especially where the payments
for such services are considered excessive.
* © Baker & McKenzie, 2002
292 ASIA-PACIFIC TAX BULLETIN
3. WITHHOLDING TAX ON PAYMENTS
RELATING TO MANAGEMENT FEES AND
CORPORATE OVERHEAD FEES PAID TO A
NON-RESIDENT
In South Korea, payments made to a related non-resident
pursuant to an allocation of management expenses and
corporate overhead expenses are generally treated as per-
sonal service income like other offshore services fees.
However, if the payment is in respect of consideration for
the transfer of know-how to the South Korean entity, it
would be treated as a royalty. If the allocated expenses are
stewardship expenses, which have been incurred only for
the benefit of the parent corporation’s shareholders, such
expenses are disallowed for South Korean tax purposes
and taxed as dividends if the payee is a foreign shareholder
of the payor.
The tax authorities have often disallowed the deduction of
management service fees paid by a South Korean sub-
sidiary to its regional headquarters (RHQ) on the ground
that in principle, South Korean tax laws or relevant DTAs
do not clearly provide that the deduction of such expenses
allocated by a RHQ to its related company is allowable for
corporate income tax purposes.
However, in a recent case (the Rockwell case), the
Supreme Court allowed deductions by a South Korean
subsidiary of a foreign company for management service
fees where it was proven that the foreign company had
actually provided services to its subsidiaries including the
South Korean subsidiary, and where the fees were allo-
cated using proper allocation methods (e.g. fees for ser-
vices regarding human resources were allocated based on
the number of employees of each subsidiary).
4. LIMITATIONS ON THE AMOUNT OF
PAYMENTS MADE TO A NON-RESIDENT
AFFILIATE
Under the South Korean tax law, there are no specific
guidelines regarding payments made in connection with
intercompany services such as royalties, licence fees, ser-
vices, or payments made pursuant to an allocation of man-
agement expenses and corporate overhead expenses.
However, the transfer pricing rules under the International
Tax Coordination Act (ITCA) may apply to such pay-
ments.
Under the ITCA, payments between a South Korean entity
and any of its foreign related parties should be at an arm’s
length. If the South Korean entity pays royalties, licence
fees, services, or payments made pursuant to an allocation
of management expenses and corporate overhead ex-
penses which are not in accordance with the arm’s length
principle, the tax authorities may, for the purpose of calcu-
lating the taxable income of the South Korean entity, dis-
allow deductions for the portions of the payments in
excess of the arm’s length rates.
Generally, the comparable uncontrolled price (CUP)
method is the most preferred method by the tax authorities
while the ITCL allows several other methods such as the
resale pricing method, cost-plus method, profit split
© 2003 International Bureau of Fiscal Documentation
Exported / Printed on 17 Oct. 2022 by WU (Wirtschaftsuniversität Wien).
AUGUST/SEPTEMBER 2003
method, transactional net margin method, and other rea-
sonable methods.
Last year, the Supreme Court dealt with the transfer pric-
ing issue involving royalties for the first time and dis-
cussed what constituted a “comparable” (99 Du 3423, 23
October 2001). In the case, the taxpayer was a South
Korean entity engaged in distributions of movies and
videos in South Korea that were supplied by British enti-
ties. For two fiscal years, the taxpayer paid royalties and
deducted those amounts from the taxpayer’s taxable
income for the relevant fiscal years. The National Tax Ser-
vice (NTS) denied a portion of the deduction taken for the
royalties paid arguing that the royalties paid exceeded the
arm’s length prices calculated by the NTS using the CUP
method. The Supreme Court stated that an uncontrolled
transaction is comparable if the uncontrolled transaction
involves goods or services, and circumstances such as the
geographic and economic market conditions, the volume,
or the terms and conditions, which are similar with those
of the controlled transaction at issue. The Supreme Court
further stated that if the uncontrolled transaction is not pre-
cisely comparable with the controlled transaction due to
certain differences in the circumstances, reasonable
adjustments may be made to the arm’s length price derived
from the uncontrolled transaction in order to accommo-
date those differences.
In the case of interest payments, for transfer pricing pur-
poses, the interest rate prevalent in the international finan-
cial market (such as LIBOR) is generally considered as the
arm’s length interest rate.
5. RATES UNDER DTAs
5.1. Interest
Withholding tax rates on interest payments may vary
depending on the DTAs and range from 0 to 15%.
Pursuant to the respective DTAs, there is 0% withholding
rate on interest paid to residents of Hungary, Ireland and
Russia.
5.2. Dividends
The reduced rates of withholding tax on dividends may
vary depending on the DTA and range from 5 to 15%.
There is a 5% withholding rate, pursuant to DTAs, on div-
idends paid to residents of Bulgaria, China, the Czech
Republic, Greece, Hungary, Israel, Japan, Malta, Mongo-
lia, Morocco, Poland, Russia, South Africa, the United
Kingdom and Uzbekistan.
5.3. Royalties
The reduced rates of withholding tax on royalties may
vary depending on the DTAs and range from 0 to 15%.The
DTAs with Hungary, Ireland, and Malta prescribe a 0%
withholding rate on royalties.
AUGUST/SEPTEMBER 2003 ASIA-PACIFIC TAX BULLETIN
6. FAVOURABLE DTAs WITH RESPECT TO
SERVICE PAYMENTS
Payments for services rendered overseas are generally
treated as personal service income in South Korea. Some
DTAs to which South Korea is a party treat personal ser-
vices income earned by a corporation as business income.
These DTAs could work favourably because service
providers may avoid taxation in South Korea using these
DTAs provided they do not have a PE in South Korea.
DTAs that have been concluded and deemed favorable
include those with Australia, Brazil, Germany, India,
Indonesia, Pakistan, Russia, South Africa, Sri Lanka and
the United States.
7. TREATY SHOPPING
In a tax ruling (Jaekukjo 46017-61 dated 20 April 2000),
the Ministry of Finance and Economy clearly showed its
intention to deny the application of DTA benefits on inter-
est payments, if the recipient of interest payments is not
the “beneficial owner” of the interest payments. Accord-
ingly, for example, where a foreign investor that is not
itself eligible for DTA benefits extends a loan to its South
Korean subsidiary through its Irish financial intermediary
based on a back-to-back loan arrangement, the South
Korean tax authorities may deny the application of the 0%
withholding tax rate under the South Korea–Ireland DTA
to the interest paid on the loan by the South Korean sub-
sidiary to the Irish financial intermediary.
In another ruling (Jaekukjo 46017-106 dated 10 August
2000) by the Ministry of Finance and Economy, a taxpayer
in a transaction was denied a DTA benefit. Relying on the
“substance over form” principle, the Ministry ruled that
TAIWAN
Withholding Tax Planning Techniques*
Keye S. Wu
Baker & McKenzie, Taiwan
1. THE WITHHOLDING PRINCIPLE
The withholding obligor is required to withhold tax from
payments of Taiwan-sourced income made to foreign
profit-seeking enterprises, which do not have a fixed place
of business or business agent in Taiwan.
Withholding obligor
A withholding obligor refers to the chief accountant or
responsible person, e.g. chairman of the board of a com-
pany or general manager of a branch office, of any institu-
tion, organization or professional firm. A business agent,
© 2003 International Bureau of Fiscal Documentation
Exported / Printed on 17 Oct. 2022 by WU (Wirtschaftsuniversität Wien).
293
treaty shopping was the main reason the transaction was
entered into.
The NTS also relied on a similar beneficial ownership test
in a recent tax ruling which was issued by the NTS (Seoe
46017-10281 dated 20 February 2002). The ruling in-
volved a foreign licensor which transferred to another for-
eign entity the right to sub-license a certain intangible. A
South Korean entity was then given the licence to use the
intangible from the foreign sub-licensor. The NTS ruled
that the beneficial owner of the royalty payments in the
series of transactions was the entity which owned the right
to dispose of the royalty payments.
8. OTHER VIABLE TECHNIQUES TO REDUCE
OR AVOID WITHHOLDING TAXES
DTAs may be relied upon to reduce or avoid withholding
taxes on payments made by a South Korean resident to a
non-resident subject to the beneficial ownership test and
the treaty shopping.
In addition to the reliance on DTAs, a capital reduction
technique may be considered to reduce or avoid dividends
withholding tax to the extent. A foreign investor can avoid
dividends withholding in South Korea by implementing a
capital reduction instead of distributing dividends. How-
ever, this return of investment is limited to the originally
invested amount, and a capital reduction in excess of the
originally invested amount will be deemed as dividends
and taxed as such. Under the CITA, if the amount paid to
an equity holder through a capital reduction is greater than
the aggregate par value of the equity instruments subject to
redemption, the excess is deemed as dividends subject to
South Korean withholding tax.
collection agent and payer may also be required to with-
hold taxes for certain payment.
Permanent establishment (PE)
A PE refers to a foreign enterprise, which has a fixed place
of business or business agent in Taiwan. A fixed place
refers to fixed places for operation of business, including
administrative offices, branch or sub-branch offices, busi-
ness offices, factories, workshops, warehouses, mining
fields, and construction sites, however, this shall exclude
warehouses or storage sites used exclusively for purchase
* © Baker & McKenzie, 2002