Most multinational enterprises today adopt an “intra-group service model.” Under this model, multinational enterprises either centralize or regionally consolidate business management functions such as accounting, auditing, IT services, marketing support, HR management, among others, which are critical to the operations of their affiliates, to enhance efficiency. In this regard, taxpayers and tax authorities have often been at odds due to the latter’s view that payments made by a domestic corporation to its parent company (or similar entities), constitute royalties for the know-how owned by the parent company.
A recent Supreme Court decision, which reaffirmed the legal principles distinguishing remuneration for personal services from royalty income, established that payments made as part of an intra-group service transaction should be classified as business income (remuneration for personal services), considering the intrinsic nature of the intra-group service transaction (Supreme Court Decision 2024Du39028, July 11, 2024).
In the aforementioned Supreme Court case, the plaintiff is a Korean subsidiary of a multinational enterprise group that produces and sells products across various industries in approximately 200 countries. The plaintiff entered into an agreement (the “Agreement”) with its parent company in the US and a Singaporean affiliate to receive business support services related to manufacturing, technology, research, engineering, sales, marketing, management and strategy, among others. Under the Agreement, the plaintiff agreed to pay its parent company and Singaporean affiliate an amount calculated by adding a certain mark-up to the costs incurred in the course of providing these services. When paying the consideration for the services (the “Service Fees”) to the parent company and affiliate pursuant to the Agreement, the plaintiff adopted a conservative approach, withholding and paying corporate income tax on the assumption that the Service Fees constituted royalty income under the relevant tax treaty. Later, the plaintiff filed a claim for a refund of the withheld corporate income tax, arguing that the Service Fees should be categorized as business income (remuneration for personal services), given that they are not subject to taxation in Korea under the relevant tax treaty. The tax authority denied the plaintiff’s refund claim, contending that the Service Fees represented royalties for intellectual property rights and know-how owned by the parent company, thus qualifying as royalty income under the tax treaty. The plaintiff subsequently filed a lawsuit seeking the cancellation of the tax authority’s denial of the tax refund claim.
Prior to the Supreme Court’s decision, the lower court (Seoul High Court Decision 2023Nu49785, February 27, 2024) explained as follows: “In a situation where a party (i) leverages its expertise and experience to invest substantial time and financial resources to carry out a task, and (ii) subsequently provides the resulting outcomes to another party in exchange for an amount that reimburses the actual expenses incurred, including labor costs associated with the service provision, such amounts should be classified as remuneration for personal services rather than royalties for know-how. Even if existing intellectual property rights or know-how are partially used or transferred in the course of providing these services, the same principle shall apply to cases where the usage or transfer is not the primary objective but rather an incidental purpose.” Based on the above mentioned reasoning, the Seoul High Court ruled that the Service Fees constituted business income paid as consideration for the provision of personal services in light of the terms and conditions of the Agreement.
The tax authority argued that it was lawful to deny the plaintiff’s refund claim for the following reasons: (i) the Agreement does not contain specific provisions detailing the service providers’ obligation to guarantee performance, (ii) the indirect billing method that allocates the total expenses incurred by the parent company, or similar entities, in providing business support services to the affiliates based on sales, among others, cannot be deemed as a typical method of settling service fees, and (iii) the transaction parties have classified the Service Fees as royalty income and have paid corporate (withholding) taxes accordingly over an extended period of time.
In response, the Seoul High Court rejected all of the tax authority’s arguments and ruled that the denial of the plaintiff’s refund claim, premised on the categorization of the Service Fees as royalties for know-how rather than business income (remuneration for personal services), was entirely unlawful.
The reasoning behind the Seoul High Court’s ruling is as follows:
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(i) |
Considering the nature of the Agreement, which was intended to support the integrated management of affiliates within the multinational enterprise group, and services provided thereunder, it is not unusual for the Agreement to lack specific guarantee obligation provisions beyond the stipulation of liability for non-performance. |
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(ii) |
It appears reasonable for the parent company to calculate the costs incurred in the course of providing the services through the indirect billing method and to include a normal profit margin in the amount as it is impossible to specify individual services and claim remuneration for each individual service. |
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(iii) |
The mere fact that a taxpayer initially adopts a conservative approach to avoid penalties when fulfilling its reporting and payment obligations, and subsequently files a refund claim, cannot solely be used to infer the factual basis for determining the taxpayer’s tax liability. |
Thereafter, the Seoul High Court’s decision was affirmed by the Supreme Court.
This decision is pivotal because it presented specific legal principles on the distinction between consideration for personal services and royalty income. Furthermore, it determined the nature of the payment at issue as consideration for personal services, not royalty income, taking into account the multifaceted distinctiveness of intra-group service transactions.
