The Korean Supreme Court has reaffirmed that even if a patent is registered only overseas, royalty income derived from that patent constitutes Korean-source income and is subject to taxation if the patented technology is substantially used in Korea. This case represents a significant intersection between global patent cross-licensing arrangements and international taxation. Its implications for corporate practice and international tax strategy are far from negligible. This article examines the outline of the decision, its legal issues, and its implications for future practice.
Case Overview: The Patent Settlement Between LG Electronics and AMD
The case originated from a patent dispute between LG Electronics and Advanced Micro Devices (AMD).
In 2017, the parties settled their litigation and entered into a cross-license agreement allowing mutual use of their respective patents. The terms were as follows:
- Patents held by LG: 4 U.S. patents
- Patents held by AMD: 12 U.S. patents (including those registered under its subsidiary ATI)
- LG paid AMD royalties of USD 97 million
LG withheld and remitted KRW 16.42 billion in corporate tax on the royalty payment. Subsequently, however, LG filed a claim for refund, arguing that the AMD patents were U.S. patents not registered in Korea and therefore did not constitute Korean-source income under the Korea–U.S. Tax Treaty.
Key Issue: Are Royalties for Unregistered Foreign Patents Korean-Source Income?
The central issue in this case can be distilled into a single question:
Can consideration for the use of a foreign patent not registered in Korea be treated as Korean-source income under the Korean Corporate Income Tax Act and the Korea–U.S. Tax Treaty?
The court of first instance and the appellate court sided with LG, holding that royalties for patents not registered in Korea do not constitute Korean-source income.
However, the Supreme Court reversed and remanded the case.
The Supreme Court’s Holding: “Substantial Place of Use” Over Formal Registration
The First Division of the Supreme Court clarified the following principles:
- The place of patent registration is not a decisive factor.
- What matters is where the patented technology is substantially used.
- If the technology is used in Korea for manufacturing, sales, or other business activities, the royalties constitute Korean-source income.
In other words, the Court adopted a “substantial place of use” doctrine rather than a strict “place of registration” approach.
This ruling aligns with the en banc decision rendered by the Supreme Court in September of the previous year, indicating that this jurisprudential principle has now been firmly established.
Legal Significance: Redefining the Source Principle in International Taxation
In international taxation, the primary issue is which country holds taxing rights. Under tax treaties, the source of royalties is generally determined by the place of use.
This decision is significant for the following reasons:
Anti–Tax Avoidance Function
If source were determined solely by place of registration, taxpayers could potentially avoid taxation by registering patents only in certain jurisdictions. By focusing on the substantial place of use, the Court’s approach helps prevent tax avoidance through formalistic structuring.
Adaptation to the Digital and Intangible Asset Era
In the modern economy, intangible assets constitute the core of corporate value. Taxation aligned with the economic reality of where value is created—rather than the formal legal location of an asset—is consistent with global BEPS (Base Erosion and Profit Shifting) initiatives.
Impact on Corporate Practice
This ruling will significantly affect:
- Multinational enterprises entering cross-license agreements
- Technology transfer and OEM agreements
- Manufacturing companies implementing global IP strategies
Going forward, companies must move beyond simply examining where patents are registered and instead analyze:
- Where the technology is integrated into manufacturing processes
- Where products are sold
- Where economic value is realized
At the time of entering royalty agreements, companies will need to conduct more sophisticated tax risk assessments.
Future Outlook
Following this decision, the “place of patent registration” standard has effectively receded in Korea, while the “substantial place of use” standard has been clearly established.
Potential future issues may include:
- Determining the place of use for non-physical applications such as software and AI technologies
- Identifying the source of income in cloud-based environments
- Allocating taxing rights where technology is simultaneously used in multiple jurisdictions
As cross-border transactions involving intangible assets continue to expand, it is likely that countries will increasingly strengthen taxation based on substantive economic use.
Conclusion
The Supreme Court’s decision makes clear that the decisive factor for taxation is not where a patent is registered, but where the technology is actually used.
This ruling extends beyond a single corporate tax dispute; it provides an important guideline at the intersection of international IP strategy and international tax practice.
Going forward, multinational enterprises can no longer separate intellectual property management from tax strategy. The principle of substance over form is becoming firmly established as the central axis of intangible asset taxation, and this decision strongly reinforces that trend.