Ji-Hyun Yoon, Is Income Tax Levied on Interest Paid and Received by Enterprises Resident in the Same State, but Attributed to a Permanent Establishment in Korea Creditable under the Korean Corporate Income Tax Act?, Journal of IFA, Korea,Vol.39, No.1(2023), pp.1-42.
<Abstract>
This article tackles the issue of whether foreign tax credit (“FTC”) under the Korean Corporate Income Tax Act should be granted to a permanent establishment (“PE”) of a bank resident in China on its interest income (“Interest”) paid by another Chinese resident enterprise. This issue is disputed at a court case now pending at the Supreme Court of Korea after the Seoul High Court decision that denied the aforesaid FTC.
The Korean tax authorities based their tax assessment on the argument that the Interest should be characterized as “other income” under the Korea - China tax treaty and that, thus, the primary right to tax such Interest be accorded to Korea, where the PE is situated. They rely heavily on a paragraph in the OECD Commentaries on Model Tax Convention, which seems to support the foregoing argument asserted by the tax authorities directly. As Korea is the country that is entitled to tax primarily the Interest under the said treaty, the argument goes that there is no reason for Korea to grant FTC on the Chinese tax levied on the Interest.
Although this argument cites the OECD Commentaries as its main source of authority, this article boldly claims that this argument is indeed flawed. First, this article argues that even if the Interest is characterized as “other income” under a tax treaty, the relevant treaty provision does not give the PE country a so-called primary right to levy tax. This article submits that, in this particular fact pattern, the relevant tax treaty provision (i.e. Article 21, Paragraph 2 of the OECD Model Treaty) dictates merely that the residence country should prevent double taxation concerning whatever tax has been levied in the PE country, but says nothing of how the PE country may or should tax the Interest. This is because, as the resident country in this case is simultaneously the source country of the Interest, the provision that the PE country “may” tax the Interest is not identical to stating that the PE country has the primary right to tax. Such is precisely so in a so-called “triangular case” situation, where the source country (and not the PE country) is accorded the primary right to tax thanks to the non-discrimination principle embedded in a typical tax treaty. This article goes on to argue that, as already noted by a few other commentators, the fact that the residence country also has the status of the source country cannot deprive it of its right to the “first bite of [the] apple.” This is tantamount to saying that the relevant OECD Commentary is flawed and, thus, should not be consulted in interpreting a tax treaty.
Once one is out of the reach of a tax treaty, it becomes a simple question of interpreting a domestic law provision. This article argues that the FTC should also be granted at this dimension because the text of the relevant provision does not exclude the foregoing situation from the scope of the FTC. This conclusion is supported also because denying of the FTC would lead us to an erroneous outcome that unjustifiably discriminates the source-residence country against all other countries, and the legal form of a branch against a subsidiary, thus violating tax neutrality. Suppose an interpretation of law is not clearly based on the text of the statutory provision, and still leads to an outcome that cannot be justified from policy perspectives. It goes without saying that this interpretation cannot be supported. There is no reason to believe that this simple theory should be altered because the issue belongs to the arena of international taxation.
In brief, apart from the OECD position, this tax assessment is outright against common sense. On the other hand, the relevant legal provisions of the Korea-China tax treaty and the Korean Corporate Income Tax Act are flexible enough to entail a conclusion that can block such an unsensible outcome. There is no reason not to avail of this flexibility.
<Keywords>
permanent establishment, foreign tax credit, tax treaty, other income, source taxation, resident taxation, triangular case
Ji-Hyun Yoon, Is Income Tax Levied on Interest Paid and Received by Enterprises Resident in the Same State, but Attributed to a Permanent Establishment in Korea Creditable under the Korean Corporate Income Tax Act?, Journal of IFA, Korea,Vol.39, No.1(2023), pp.1-42.
<Abstract>
This article tackles the issue of whether foreign tax credit (“FTC”) under the Korean Corporate Income Tax Act should be granted to a permanent establishment (“PE”) of a bank resident in China on its interest income (“Interest”) paid by another Chinese resident enterprise. This issue is disputed at a court case now pending at the Supreme Court of Korea after the Seoul High Court decision that denied the aforesaid FTC.
The Korean tax authorities based their tax assessment on the argument that the Interest should be characterized as “other income” under the Korea - China tax treaty and that, thus, the primary right to tax such Interest be accorded to Korea, where the PE is situated. They rely heavily on a paragraph in the OECD Commentaries on Model Tax Convention, which seems to support the foregoing argument asserted by the tax authorities directly. As Korea is the country that is entitled to tax primarily the Interest under the said treaty, the argument goes that there is no reason for Korea to grant FTC on the Chinese tax levied on the Interest.
Although this argument cites the OECD Commentaries as its main source of authority, this article boldly claims that this argument is indeed flawed. First, this article argues that even if the Interest is characterized as “other income” under a tax treaty, the relevant treaty provision does not give the PE country a so-called primary right to levy tax. This article submits that, in this particular fact pattern, the relevant tax treaty provision (i.e. Article 21, Paragraph 2 of the OECD Model Treaty) dictates merely that the residence country should prevent double taxation concerning whatever tax has been levied in the PE country, but says nothing of how the PE country may or should tax the Interest. This is because, as the resident country in this case is simultaneously the source country of the Interest, the provision that the PE country “may” tax the Interest is not identical to stating that the PE country has the primary right to tax. Such is precisely so in a so-called “triangular case” situation, where the source country (and not the PE country) is accorded the primary right to tax thanks to the non-discrimination principle embedded in a typical tax treaty. This article goes on to argue that, as already noted by a few other commentators, the fact that the residence country also has the status of the source country cannot deprive it of its right to the “first bite of [the] apple.” This is tantamount to saying that the relevant OECD Commentary is flawed and, thus, should not be consulted in interpreting a tax treaty.
Once one is out of the reach of a tax treaty, it becomes a simple question of interpreting a domestic law provision. This article argues that the FTC should also be granted at this dimension because the text of the relevant provision does not exclude the foregoing situation from the scope of the FTC. This conclusion is supported also because denying of the FTC would lead us to an erroneous outcome that unjustifiably discriminates the source-residence country against all other countries, and the legal form of a branch against a subsidiary, thus violating tax neutrality. Suppose an interpretation of law is not clearly based on the text of the statutory provision, and still leads to an outcome that cannot be justified from policy perspectives. It goes without saying that this interpretation cannot be supported. There is no reason to believe that this simple theory should be altered because the issue belongs to the arena of international taxation.
In brief, apart from the OECD position, this tax assessment is outright against common sense. On the other hand, the relevant legal provisions of the Korea-China tax treaty and the Korean Corporate Income Tax Act are flexible enough to entail a conclusion that can block such an unsensible outcome. There is no reason not to avail of this flexibility.
<Keywords>
permanent establishment, foreign tax credit, tax treaty, other income, source taxation, resident taxation, triangular case