Does Korea Look Through Your Fund?

Before Korean tax law can ask which treaty applies to a gain on Korean shares, it has to answer a prior question. Whose income is it?

For a fund that is not obvious. The fund holds the shares, executes the sale and receives the money. But a fund is a pooling vehicle, and the economic interest belongs to its investors.

If Korea treats the fund as the owner of the income, one treaty – the fund’s – governs the whole of it. If Korea looks through to the investors, each investor’s own residence treaty governs its own slice, and a single sale produces several different outcomes at once.

In cross-border investment, uncertainty is itself a cost. And this question is settled before the treaty is opened. The answer changes the unit to which a treaty applies, and in some cases leads to the conclusion that no treaty can be applied at all. If the after-tax return is only known at exit, it is known too late. That is why the question belongs in the investment review.

Article 93-2 of the Corporate Income Tax Act deals with it. The structure is simple: look-through as the rule, with three exceptions.

The rule is look-through

Where a foreign corporation receives Korean-source income through an overseas investment vehicle, that foreign corporation is treated as the beneficial owner of the income. The default direction runs past the vehicle to the investors behind it. Unless an exception applies, the vehicle is a conduit.

One of the three exceptions is punitive

The three are not of the same character. The first two treat the vehicle as the beneficial owner because the vehicle itself holds a treaty position.

The third is different. It applies where the vehicle cannot substantiate its investors. The vehicle is treated as the beneficial owner here too, but that is not a benefit. Article 93-2(2) provides that treaty exemption, non-taxation and reduced rates do not apply in that case. The vehicle is placed in the position of owner precisely so that it can be taxed under domestic law without treaty relief.

The message is unambiguous. A fund that cannot produce its investor schedule does not get to fall back on its own treaty position.

What changes when the fund is looked through

Outcomes divide within a single transaction. Investors resident in treaty jurisdictions may be exempt while investors in non-treaty jurisdictions are fully taxable, on the same gain, in the same sale. The closing withholding has to be computed investor by investor.

Thresholds are measured at investor level. A treaty’s ownership test is applied to the person who is the beneficial owner. Whether the fund’s overall stake or an investor’s proportionate slice is the relevant measure follows from the look-through conclusion.

Documentation multiplies. A residence certificate is needed for every investor claiming relief, collated through the fund. Where an investor in the fund is itself a conduit, the analysis repeats at that tier. Feeder and fund-of-funds arrangements lengthen the timetable noticeably and should be identified early.

Substantiation is where it is decided

Because the third exception turns entirely on whether investors can be substantiated, the whole structure rests on evidence.

The standard applied when substantiation is tested after the fact is demanding. Treaty exemption has been denied where investment history, the basis of the interest calculations, schedules showing the disposition of investment returns and financial evidence were not produced in objective and concrete form (Tax Tribunal, Jo-sim 2021-Jeon-3192, 31 October 2022).

There is only one practical answer. Build the file during the fund’s life, while the information is still easy to obtain, rather than in the closing window of an exit. Investor schedules, contribution and fund-flow records, allocation calculations and residence certificates all become harder to assemble as time passes and investors change.

How settled is this

Article 93-2 is a relatively recent codification of the look-through approach, and the body of rulings, tribunal decisions and case law applying it directly is still thin. The analytical framework is clear on the face of the statute; how a particular set of facts will be treated in practice is less so.

Where a structure’s outcome depends on a point that has not been settled, an advance ruling is worth considering rather than relying on a view that has not been tested.

Worth checking

Can you state, in writing, who the beneficial owner of the gain is in your structure, and on what basis?

If the investor schedule and the contribution evidence were requested today, could you produce them within days?

Was that determination made at the investment review, or has it been left until the exit begins?

For a review of your position, please contact Star Tax & Legal at heebong@star-tax.kr.

Topics: Beneficial Ownership · Overseas Investment Vehicles · Fund Exit · Tax Treaties · Substantiation · Foreign Investors