A non-resident or foreign corporation that is the beneficial owner of Korean-source income must submit an application for the reduced rate and proof of beneficial ownership to the withholding agent to obtain a treaty rate (Income Tax Act Art. 156-6(1); Corporate Tax Act Art. 98-6(1)). Without them, or where the beneficial owner cannot be identified, tax is withheld at the domestic rate — 20 per cent of the payment for dividends and royalties — and a correction may be claimed within five years.
The tax sits with the payer
When a Korean company pays a dividend to its foreign parent, or sends royalties or loan interest to an overseas counterparty, the procedure centres on the payer rather than the recipient. Income Tax Act Article 156(1) and Corporate Tax Act Article 98(1) require anyone paying a non-resident or foreign corporation domestic-source income that is not effectively connected with, or attributable to, a domestic place of business to withhold tax at the time of payment and remit it by the 10th day of the month following withholding. The Income Tax Act applies where the recipient is an individual and the Corporate Tax Act where it is a company, but the structure is the same. Corporate Tax Act Article 93 classifies a foreign corporation’s domestic-source income into interest, dividends, royalties and other heads, and the rate depends on the head, so the substance of the payment matters more than the label in the contract. Money sent as a “service fee” may be classed as a royalty if it is in fact consideration for using technology or rights. The Corporate Tax Act also provides that where tax is not withheld or not remitted on time, the district tax office collects it from the withholding agent with an addition, so the finance staff handling remittances need to know the procedure.
Domestic rates come before the treaty
The domestic rate is the starting point before any treaty. Income Tax Act Article 156(1) and Corporate Tax Act Article 98(1) set the amount to be withheld as a percentage of the payment: 20 per cent for dividends and 20 per cent for royalties; for interest, 14 per cent on bonds issued by the State, local governments or domestic corporations and 20 per cent on other interest. What matters is that these rates are the default applied whenever treaty relief is not obtained. Korea’s tax treaties often cap the tax the source country may charge on dividends, interest and royalties, and that cap is the reduced treaty rate. The rates and conditions, however, differ from treaty to treaty, and may vary within a single treaty depending on the conditions met. So rather than relying on remembered figures, check the recipient’s country of residence and the type of income for each payment and read the relevant treaty article. Working out the gap between the domestic and treaty rates at this stage also lets you tell the counterparty in advance what the difference will be if the documents arrive late.
The application and proof of beneficial ownership
A lower treaty rate does not apply automatically. Income Tax Act Article 156-6(1) provides that a non-resident who is the beneficial owner of Korean-source income and wishes to apply a treaty rate must submit an application for the reduced rate and documents proving beneficial ownership to the withholding agent; Corporate Tax Act Article 98-6(1) does the same for foreign corporations. The key term is “beneficial owner”. It is not enough that the company nominally receiving the money is located in the treaty partner; what counts is who the income is actually attributable to. Where income is paid through an overseas investment vehicle, the vehicle collects the documents from the beneficial owners and passes them to the withholding agent with an overseas investment vehicle report listing the details. Because tax is withheld on payment, in practice the documents must be in hand before the payment date for the reduced rate to be applied. Papers that have to be obtained abroad, such as a certificate of residence, often take time, so ask the counterparty as soon as a dividend resolution or royalty settlement date is fixed. The forms and filing method are set by Presidential Decree.
No documents means the domestic rate — and forms go to the tax office by February
Income Tax Act Article 156-6(3) allows the withholding agent to ask for missing or deficient items to be supplied, and requires it to withhold the amounts in Article 156(1) without the reduced rate where the documents are not received or the beneficial owner cannot be identified from them, among other grounds set by Decree. In other words, the payer cannot apply a lower rate at its own discretion on incomplete papers. Even if the counterparty asks for the treaty rate, where the documents are not complete the right course for the payer is to withhold at the domestic rate and explain how it can be corrected later. The withholding agent that does receive documents still has a task: the same article requires it to submit them to the district tax office by the last day of February of the year following the year of payment, or, if it suspends or closes its business, by the end of the second month after the month of suspension or closure. Keeping a list per payment helps ensure forms collected are not left unfiled.
Already withheld at the domestic rate? Claim within five years
If documents arrived late and tax was withheld at the domestic rate, or the reduced rate applied was wrong, there is a way to correct it afterwards. Income Tax Act Article 156-6(5) allows the beneficial owner or the withholding agent, where the beneficial owner did not receive the reduced rate and wishes to, to claim a correction from the district tax office with jurisdiction over the agent within five years from the 11th day of the month following the month in which tax was withheld. Corporate Tax Act Article 98-6 contains a claim procedure of the same structure for foreign corporations. It is useful in practice that the withholding agent, not only the beneficial owner, may claim; where the overseas party finds it hard to deal with a Korean tax office, the payer may consider handling the procedure. A claim does not decide the outcome by itself, however; whether beneficial ownership is adequately proven is examined again. The essential point is therefore to assemble properly at this stage the documents that were missing at withholding. Five years sounds long, but given the time needed to obtain and translate foreign documents, it is better to prepare early.