[Patent Talk] The Troubling Prospect of Corporate Tax Refunds on Patent Royalties

On the 20th, the Supreme Court upheld the ruling in favor of Samsung Electronics in its suit against the Dongsuwon Tax Office seeking cancellation of a corporate tax withholding assessment. As a result, Samsung Electronics does not have to pay the additional KRW 11.3 billion in corporate tax imposed by the Dongsuwon Tax Office.

The facts are as follows. In 2011, Samsung Electronics entered into a royalty agreement with Microsoft (MS) covering Android patents used in smartphones and other devices. When paying royalties to MS, Samsung Electronics withheld 15% of the royalties as corporate tax and paid it to the tax authorities. To avoid any misunderstanding, Samsung was paying, on MS's behalf, the tax on MS's royalty income; it was not paying its own corporate tax.

In 2013 in particular, Samsung Electronics owed MS KRW 1.2815 trillion in royalties, but after setting off KRW 69 billion that MS owed Samsung, it paid only the remaining KRW 1.2125 trillion as royalties. The Dongsuwon Tax Office then demanded an additional KRW 11.3 billion, on the ground that no corporate tax had been paid on the KRW 69 billion that had been set off.

Samsung Electronics argued that most of the royalties it paid to MS were fees for the use of US patents not registered in Korea, and therefore did not constitute Korean-source income of MS. Following the first- and second-instance courts, the Supreme Court accepted Samsung's argument. The Supreme Court reasoned that the Korea-US Tax Treaty, which adopts the "place-of-use" principle, takes precedence over the Income Tax Act and the Corporate Tax Act, and that under the principle of territoriality, US patents can be used only in the United States.

To resolve the issue legislatively, the Corporate Tax Act was amended in 2008 so that fees for the use of patents not registered in Korea are treated as Korean-source income if the patents are used in manufacturing or selling products in Korea, yet the Supreme Court's position has not budged.

The problem is that, following this Supreme Court ruling, US companies are expected to file refund claims worth trillions of won for the corporate tax paid on patent royalties. MS has already sued for the return of KRW 634.4 billion of the KRW 653.7 billion in corporate tax withheld on royalties it received from Samsung Electronics between 2012 and 2015, and last month the Supreme Court, applying the same reasoning as in the ruling above, reversed and remanded the case in a manner recognizing most of the refund amount.

According to the Supreme Court's ruling, Samsung Electronics has in effect reflected in its costs royalties for patents that it does not use in Korea...