YOON&YANG

On January 28, 2026, the Suwon High Court addressed the issue of characterizing payments arising from a software and services agreement between a foreign IT company and a Korean conglomerate. The court held that even where payments include elements attributable to software usage, such consideration should be treated as business income, rather than royalty income, if its essential nature is the provision of services.

The decision addresses the income characterization of payments made under a services agreement between a U.S. IT company and a Korean electronics manufacturer and has significant implications for tax practice involving digital services, software, and database-based business models.

1. Background and Issues

2. Court’s Analysis

A. First-Instance Court Decision: Ruling in Favor of the National Tax Service

B. Appellate Court Decision: Ruling in Favor of the Plaintiff (a U.S. Company)

3. Implications for Tax Practice

1. Background and Issues

A U.S. corporation (Company A) entered into an agreement with a Korean electronics manufacturer (Company B) under which Company A’s services, including caller identification and spam filtering, were integrated into the native applications of Company B’s smartphone models, and Company B distributed smartphones through which such services could be used. Company A received contractual consideration from Company B pursuant to the agreement. In making the payments, Company B treated the consideration as royalty income and withheld tax at the 15 percent reduced rate under the Korea–U.S. tax treaty.

Company A took the position that the consideration constituted business income rather than royalty income and filed a claim for refund. The relevant district tax office denied the claim, and, following administrative tax appeals, Company A commenced litigation against the National Tax Services seeking revocation of the denial of its corporate income tax refund claim.

The dispute concerned whether payments made by a Korean company to a U.S. company for software-related services should be classified as royalty income or business income for Korean tax purposes.

2. Court’s Analysis

A. First-Instance Court Decision: Ruling in Favor of the National Tax Service

The trial court dismissed Company A’s claim, holding that the payments constituted Korean-source royalty income subject to withholding tax. The court concluded that the payments represented consideration for Company B’s use of Company A’s know-how and technology (i.e., Whitepages Technology), rather than compensation for services.  Among other reasons, the court relied on the fact that (i) agreement expressly referred to the payments as “License Fees,” (ii) software was specifically developed and customized for Company B’s smartphones rather than being general-purpose software, (iii) Company A continuously provided technical support, including testing, modification, and maintenance, and (iv) technology was used domestically in the manufacture and operation of the smartphones, notwithstanding partial overseas production.

B. Appellate Court Decision: Ruling in Favor of the Plaintiff (a U.S. Company)

The appellate court reached a contrary conclusion, holding that the payments at issue should be classified as business income rather than royalty income. In support of its conclusion, the court emphasized that:

I. Company B did not itself acquire or exploit the plaintiff’s technology, but merely acted as an intermediary enabling end users to access the plaintiff’s spam filtering and caller identification services;

II. Company A remained the entity that actually operated the database and performed the relevant services;

III. the software embedded in the smartphones did not constitute a standalone commercial product with independent value, but functioned solely as an interface for accessing the plaintiff’s services;

IV. modifications made at Company B’s request were limited to technical integration and could not be regarded as the creation of new software;

V. although Company A possessed proprietary databases and technology (know-how), such know-how was not transferred or licensed to Company B;

VI. Company A directly performed the services using its own technology, such that the payments could not be characterized as consideration for the use of know-how;

VII. the installation of the application on the smartphones constituted a technical step necessary for service provision and did not amount to commercial exploitation of copyrights; and

VIII. the consideration was paid as a fixed annual fee rather than on a running royalty basis. Based on these considerations, the court concluded that the payments were, in substance, consideration for services and should be treated as business income.

3. Implications for Tax Practice

In transactions involving payments from a Korean company to a U.S. company, the proper characterization of such payments is essential for Korean tax purposes. Where the payments are treated as royalty income, they are subject to Korean withholding tax at the reduced rate of 15 percent under the Korea–U.S. tax treaty. Conversely, where the payments are characterized as business income and the U.S. company does not maintain a permanent establishment in Korea, such payments are not taxable in Korea.

The decision further clarifies the principle that, even in transactions involving software, payments should be characterized as business income where their predominant substance is the provision of services, and as royalty income only where they constitute consideration for the transfer or use of technology. The court underscored that the presence of licensing terminology in an agreement is not determinative, and that where software serves merely as a technical means of accessing services, such payments cannot be treated as royalties under the substance-over-form doctrine. In this respect, the ruling provides guidance on the proper distinction between service income and royalty income for tax purposes.

More broadly, this decision suggests that, in structuring agreements between foreign IT or platform companies and Korean counterparties, the tax characterization of payments and the resulting tax consequences may vary materially depending on the contractual language, the method of determining consideration, and the scope of technology provided.

Therefore, in cases where Korean companies have made payments to U.S. corporations and treated such payments as royalty income subject to withholding tax, U.S. companies should consider reassessing whether the income could instead be classified as business income. Where Korean companies have customarily treated such payment to constitute royalty payments and withheld taxes, it may be appropriate to examine the possibility of seeking a refund through an amended tax filing, as well as to carefully review whether withholding tax can be avoided for future payments.

The Tax Group of Yoon & Yang LLC provides comprehensive, one-stop tax services across tax advisory and tax controversy matters. The group advises clients on a broad range of transactions and business activities, including mergers and acquisitions, corporate restructurings, financial transactions, investments and development projects, cross-border transactions, business succession planning, and inheritance and gift taxation. By combining proactive tax planning with effective risk management strategies, the Tax Group assists clients in maximizing tax efficiency while minimizing tax risk in a rapidly evolving regulatory environment.