Treaty Exemption at Closing, Not Through a Refund Claim

Assume the analysis was done properly. The gain on your Korean share sale is Korean-source income under domestic law, but the capital gains article of the applicable treaty allocates the taxing right exclusively to your residence state. You hold the residence certificate. On the merits, you are exempt.

None of that stops the buyer from withholding.

This is the point at which foreign sellers are most often caught out in a Korean exit. It is not the misfortune of meeting a difficult buyer. It is a predictable consequence of how the Korean withholding rules allocate risk.

The risk sits with the buyer

Under Korean law the person who pays the consideration is the withholding agent. And where the determination turns out to be wrong, the party that ultimately carries it is the buyer.

If the buyer applies a treaty exemption and the tax office later concludes the conditions were not met, the tax is collected from the buyer (Corporate Income Tax Act Article 98(4)). The buyer is then left to pursue the seller under whatever indemnity the share purchase agreement contains, by which time the seller has distributed the proceeds.

Look at it from the buyer’s side. Withholding costs the buyer nothing; it is the seller’s money. Not withholding exposes the buyer to a later assessment and penalty tax. Facing any residual doubt, a rational buyer withholds and leaves the seller to sort it out afterwards.

So the seller’s real objective is not to be exempt. It is to leave the buyer with no defensible reason to withhold. That is a matter of documents and persuasion, and it has to be finished before the payment date.

And the legislation supplies that reason

An exemption is claimed by filing, not by assertion. And the legislation sets out the cases in which a payer that has received the filing must withhold regardless. One of them is where the beneficial owner cannot be identified from the documents submitted.

That is the widest of them, and the person who makes the judgment is the buyer. A buyer inclined to withhold does not have to work hard to reach it on a thin file.

There is a second review at the tax office, and where the conditions are not met the tax is again collected from the buyer. This is what drives buyer behaviour. The back end puts the buyer’s money at risk; the front end gives the buyer a lawful means of removing that risk. Sellers should assume buyers understand the structure.

And the legislation contemplates what comes next. Once tax has been withheld, the position is to be corrected by a refund claim. That is usually the buyer’s justification as well – let it be withheld, and recover it later if there was nothing in it.

A refund claim is a poor alternative

The position can indeed be corrected afterwards. Three things follow.

The evidential burden becomes heavier. Claiming relief up front is a forward-looking filing. Claiming it afterwards asks the tax office to reverse a completed collection, and the file is examined accordingly.

The processing period is set by statute, but how long it takes in practice is difficult to predict.

And the cash is locked up throughout. For a fund approaching the end of its life, part of the proceeds immobilised for an indefinite period is not a technicality. It delays distributions to investors and can outlast the fund’s own timetable.

There is a documented case. Treaty exemption was 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). The point is not that the standard cannot be met. It is that documents assembled after the fact often do not meet it.

Lead time is what actually derails transactions

Among the documents, the one that governs the timetable is the residence certificate issued by the competent authority of each beneficial owner’s residence jurisdiction. Foreign tax authorities do not issue them on request. In some jurisdictions it takes weeks, and a certificate covering the wrong period or naming the wrong entity is worthless.

Where payment runs through a fund, a collation step is added. Where an investor in the fund is itself a conduit vehicle, it repeats at each tier.

This work begins when the exit process starts, not when it concludes.

Worth checking

Was withholding treatment discussed at term-sheet stage? It belongs alongside price and conditions precedent. Discovering the buyer’s position after signing leaves you without leverage.

Are you prepared to give the buyer the reasoning rather than the conclusion? No buyer releases withholding because the seller says it is exempt. It has to be in a form the buyer can hand to its own advisers and, later, to the tax office.

When did the residence certificates start? That item has the longest lead time and the least flexibility.

If you can answer all three, you are prepared. For a review of your position, please contact Star Tax & Legal at heebong@star-tax.kr.

Topics: Treaty Relief · Withholding Tax · Fund Exit · Beneficial Ownership · Residence Certificates · Foreign Investors