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Recent Supreme Court Decision on Permanent Establishment

2020.07.02

Korea’s Supreme Court has recently rendered an important decision on the determination of Corporate Income Tax (“CIT”) and Value Added Tax (“VAT”) imposed on a permanent establishment (“PE”) of a foreign enterprise (Supreme Court Decision 2017Du72935, June 25, 2020).

In this case, an overseas company (“A”) recruited casino gamers outside Korea, who would gamble at a casino in Korea operated by a Korean corporation (“B”) and received commission for such recruitment services, including providing guidance to local casinos, exchange of chips, etc. in Korea.  The Korean tax authorities concluded that A’s performance of activities related to the gamers, including provision of above-mentioned services at an office located at the casino in Korea constitutes A’s PE, and imposed CIT and VAT on all of the commission (based on the view that the commission in its entirety is attributed to the PE).

The Supreme Court first held that where a foreign enterprise carries on business through a PE in Korea, only profits that the PE would have derived from transactions that it had independently engaged with the foreign enterprise, as a distinct and separate enterprise, would be attributed to the PE and taxable in Korea, and that the tax authorities would bear the burden of proof on the amount of profits attributable to a PE. 

Based on the above conclusions, the Supreme Court found that (i) even if activities performed by A’s employees at A’s office in Korea constitute A’s essential and significant activities, A’s more essential and significant work took place outside Korea and the costs of such work were mostly incurred outside Korea, (ii) the revenues attributable to A’s PE are limited to the consideration that A received for work it had performed at its office in Korea, and it cannot be concluded that the attributable revenues include the consideration for A’s activities performed outside Korea, and (iii) the revenues attributable to A’s head office are clearly part of the commission that A received, and such attributable revenues would also be significant.  Accordingly, the Supreme Court determined that the tax authorities’ assessment of CIT and VAT would have to be canceled in its entirety because there were no materials upon which the profits and revenues attributable to the PE may be calculated in order to compute the justifiable tax amount.

The Supreme Court’s decision represents a significant development, as the Supreme Court has set forth a specific standard on determination of CIT and VAT amount for a PE.  The Supreme Court confirmed that CIT may only be imposed on profits attributable to a PE in accordance with the tax treaty; in particular, even if a PE is found, the Supreme Court concluded that VAT is not due on all revenues earned from Korea.  Under the premise that the profits attributable to A’s PE are limited to A’s commission for work performed at A’s fixed place of business in Korea and that consideration for A’s activities performed outside of Korea does not constitute a part of the attributable profits, the Supreme Court ruled illegal the VAT assessment, which was based on the authorities’ position that A has an obligation to pay VAT on all of its commission. 

In this case, Kim & Chang made the following arguments: (i) even if a PE is recognized, the commission in its entirety cannot be taxed as income attributable to the PE, (ii) the tax authorities bear the burden of proof on the amount of attributable profits, and have failed to meet that burden, (iii) since the PE’s function is to merely provide services in Korea, taxation in Korea should be limited to that function, and (iv) VAT cannot be imposed because the services were provided from outside Korea, where more essential and significant activities took place.  We succeeded in persuading the Supreme Court to hold as follows and cancel the assessment of CIT and VAT in its entirety based on such holdings: (i) even if A’s PE exists in Korea, more essential and significant work took place outside Korea and the costs of such work were also expended outside Korea, (ii) it is clear that part of the commission that A received from B constitutes profits attributable to A’s head office, and (iii) even though the tax authorities bear the burden of proof on the grounds of assessment and reasonableness of the method of assessment, the authorities failed to calculate the profits attributable to the Korean PE. 

However, as the assessment of CIT and VAT was canceled in its entirety in this case, the Supreme Court did not reach a clear conclusion on whether the same amount of income should be attributed to the PE for purposes of CIT and VAT (i.e., whether attributable revenues for CIT purposes constitute the tax base for VAT purposes).  The Supreme Court’s decision permits the view that where a PE is found, VAT liability exists for income attributable to the PE.  Accordingly, it is necessary to closely monitor future assessments and the court’s decisions on such assessments regarding specific determination of VAT liability attributable to a PE.

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