Beneficial Ownership under Tax Treaties, the Substance-over-Form Principle and Treaty Abuse: The Standards Applied in Three Supreme Court Decisions on International Taxation

Question

Drawing on three Supreme Court decisions, this brief sets out how the determination of beneficial ownership under tax treaties is combined with the substance-over-form principle of the Framework Act on National Taxes in dividend and royalty payments routed through multi-tiered foreign holding companies, and the order in which anti-treaty-abuse provisions apply.

The first issue is the question addressed in the 2018Du38376 judgment: "Is a Hungarian corporation that received dividends of approximately KRW 841.1 billion the beneficial owner under the Korea–Hungary Tax Treaty?" The second issue is the question addressed in the 2017Du33008 judgment: "Is domestic taxation barred because the beneficial owner of royalties of approximately KRW 13.5 billion is a Hungarian corporation?"

The third issue is the question addressed in the 2016Du841 judgment: "Can application of the limited tax rate under the tax treaty be denied to dividends routed through two companies established by a German fund?" All three judgments ask how the boundaries of the text and the substantive factors for determination are to be distinguished on the record.

Material to check

First (2018Du38376): the issues in this judgment are the meaning of, and the standard for determining, the beneficial owner of dividend income under the Korea–Hungary Tax Treaty, and whether, even where a person is the beneficial owner, application of the treaty may be denied as treaty abuse under the substance-over-form principle. To ascertain the relationship of use and enjoyment of the dividend income and the content and status of business activities, the materials on the circumstances of Company B's establishment and the status of its business activities, and the materials on where the dividend income was spent and how the funds were managed, must be examined. The status of Company B's human and physical resources, the record of its exercise of rights as a shareholder, the source of the capital-increase funds, its management of shareholdings and its receipt of dividends must also be examined. Whether dividends were paid out and whether any amount was transferred to others must also be ascertained from the materials on the use of funds and investments.

Second (2017Du33008): the issues in this judgment are the meaning of, and the standard for determining, the beneficial owner of royalty income under the Korea–Hungary Tax Treaty, and whether, even where a person is the beneficial owner, application of the treaty may be denied as treaty abuse under the substance-over-form principle. To ascertain the relationship of use and enjoyment of the royalties, the licence agreements, the materials on the conclusion of the agreements and the performance of related work, and the materials on receipt of the royalties, related expenditure and the management of funds must be examined. The materials on the circumstances of Corporation B's establishment and the record and status of its business activities, and the materials on the composition of its business divisions, its long-term business activities and the status of its human and physical resources, must also be examined. The record of control over, management of and disposal of the distribution rights and the royalty income must also be ascertained from the relevant materials.

Third (2016Du841): the issues in this judgment are whether the principle of taxation based on the substantive owner also applies to the interpretation and application of tax treaties, whether Article 27(2) of the Korea–Germany Tax Treaty is a special provision excluding the substance-over-form principle, and the standard for determining whether the limitations prescribed in Articles 10(2), 11(2), 12(2) and 21 of that treaty apply. To ascertain the circumstances in which rights were created and transferred and the purpose and activities of the related business, the materials on the establishment of Company B and Company C, the materials on the circumstances of the acquisition of the shares of Company D, and the records of dividend payments and payment of withholding tax must be examined. To ascertain the role of the persons concerned in operating the business and whether they controlled and managed the income in question, the materials on business activities and on the source and management of funds must also be examined.

Possible readings

In the 2018Du38376 case, the issues were the meaning of, and the standard for determining, the 'beneficial owner' of dividend income under item (a) of Article 10(2) of the Korea–Hungary Tax Treaty, and whether, even where a person is the beneficial owner, application of the treaty may be denied on the ground of treaty abuse under the substance-over-form principle.

In the 2017Du33008 case, the issues were the meaning of, and the standard for determining, the 'beneficial owner' of royalty income under Article 12(1) of the Korea–Hungary Tax Treaty, and whether, even where a person is the beneficial owner, application of the treaty may be denied on the ground of treaty abuse under the substance-over-form principle.

In the 2016Du841 case, the issues were whether the principle of taxation based on the substantive owner under Article 14(1) of the Framework Act on National Taxes also applies to the interpretation and application of tax treaties, whether Article 27(2) of the Korea–Germany Tax Treaty is a special provision excluding the substance-over-form principle, and the standard for excluding the limited tax rate under that provision.

What the decisions held

Supreme Court Decision 2018Du38376 delivered on 29 November 2018 held as follows: "Taking together the legislative history and context of the above treaty provision, a beneficial owner means a case where the person who received the dividend income in question has the right to use and enjoy it without any legal or contractual obligation, etc. to transfer it again to another person." In this judgment, the Court held that a beneficial owner means a case where the person who received the dividends has the right to use and enjoy them without any legal or contractual obligation to transfer them to another person. It established the standard that whether a person qualifies is determined by considering all the circumstances together, including the content and status of business activities and the actual use and management of the income. It stated that the substance-over-form principle in Article 14(1) of the Framework Act on National Taxes applies equally to the interpretation and application of tax treaties unless there is a special provision excluding it, so that application of a treaty may be denied in the case of treaty abuse. It held that, because the Hungarian corporation managed the dividends without any obligation to transfer them and had substance consistent with an independent restructuring purpose, so that its substantive control was recognised, application of the treaty could not be denied. The lower court's determination that the substantive owner was the US parent company, based solely on the tax-saving aspect, involved a misapprehension of the legal principles.

Supreme Court Decision 2017Du33008 delivered on 15 November 2018 held as follows: "Taking together the legislative history and context of the above treaty provision, a beneficial owner means a case where the person who received the royalty income in question has the right to use and enjoy it without any legal or contractual obligation, etc. to transfer it again to another person." In this judgment, the Court held that Article 12(1) of the Korea–Hungary Tax Treaty provides that, where a resident of the other Contracting State is the beneficial owner of the royalties, they are taxable only in that other Contracting State. A beneficial owner means a case where the person has the right to use and enjoy the income without any legal or contractual obligation to transfer it to another person, and this is determined in light of all the circumstances. The Court held that the substance-over-form principle in Article 14(1) of the Framework Act on National Taxes also applies to treaties, but that where there is no discrepancy between form and substance, the income is attributed to the nominal recipient. Taking together the group's business history in Hungary, VIH's personnel and facilities, its performance of the agreements and its management of funds, the Court found considerable room to regard VIH as a beneficial owner with substance, and accordingly reversed the judgment below and remanded the case. It held that a lack of capacity to control and manage cannot be concluded solely from the size of the dividends and the circumstances of the transfer of the distribution rights.

Supreme Court Decision 2016Du841 delivered on 27 June 2019 held as follows: "Taking together the wording, content, structure and purpose of the relevant laws and regulations as above, Article 27(2) of the Korea–Germany Tax Treaty should not be regarded as a special provision excluding the substance-over-form principle in the interpretation and application of the Korea–Germany Tax Treaty." In this judgment, the Supreme Court held that the substance-over-form principle in Article 14(1) of the Framework Act on National Taxes applies equally to the interpretation and application of tax treaties unless there is a special provision excluding it. Article 27(2) of the Korea–Germany Tax Treaty is a provision that denies benefits to abuse whose main purpose is to create the appearance of satisfying the requirements for the limited tax rate by creating rights without a proper economic reason. Whether it applies is determined by considering together the circumstances in which the rights were created, the business purpose and activities, the roles of those involved, and whether they controlled and managed the income. It was established that GmbH 1 and GmbH 2 had no business activities of note other than holding shares, received all the funds needed to acquire the shares from TMW, and passed the dividends straight on to TMW. The Court held that the 5% rate under item (a) of Article 10(2) is not available to the nominee companies, but that the 15% rate under item (b) of Article 10(2) for the substantive owner cannot be excluded, because it is difficult to regard obtaining that rate as having been the main purpose.

Practical checklist

First, is the Hungarian corporation that received dividends of approximately KRW 841.1 billion the beneficial owner under the Korea–Hungary Tax Treaty? On the record, ascertain from the materials on the circumstances of establishment and the management of funds whether there is a "right to use and enjoy without any legal or contractual obligation, etc. to transfer it again to another person" and "all the circumstances, including the content and status of business activities related to the income in question and the actual use and management of the income", and at the same time check whether any discrepancy between form and substance arose from a purpose of tax avoidance.

Second, is domestic taxation barred because the beneficial owner of royalties of approximately KRW 13.5 billion is a Hungarian corporation? On the record, ascertain from the licence agreements and the materials on the management of funds whether there is a "right to use and enjoy without any legal or contractual obligation, etc. to transfer it again to another person" and "all the circumstances, including the content and status of business activities related to the income in question and the actual use and management of the income", and at the same time check whether any discrepancy between form and substance arose from a purpose of tax avoidance.

Third, can application of the limited tax rate under the tax treaty be denied to dividends routed through two companies established by a German fund? On the record, ascertain from the materials on the circumstances of the share acquisition and on business activities "the circumstances in which rights, etc. relating to the payment of dividends, interest, royalties or other income were created or transferred" and "the purpose and activities of the related business, the role of the persons concerned in operating the business, and whether they controlled and managed the income in question", and at the same time check whether the rights were created "without a proper economic reason relating to the operation of the related business".

Glossary

Beneficial ownership under tax treaties and the framework for determining treaty abuse under the substance-over-form principle (2018Du38376): The Court held that a beneficial owner means a case where the person who received the dividends has the right to use and enjoy them without any legal or contractual obligation to transfer them to another person. It established the standard that whether a person qualifies is determined by considering all the circumstances together, including the content and status of business activities and the actual use and management of the income. It stated that the substance-over-form principle in Article 14(1) of the Framework Act on National Taxes applies equally to the interpretation and application of tax treaties unless there is a special provision excluding it, so that application of a treaty may be denied in the case of treaty abuse. It held that, because the Hungarian corporation managed the dividends without any obligation to transfer them and had substance consistent with an independent restructuring purpose, so that its substantive control was recognised, application of the treaty could not be denied. The lower court's determination that the substantive owner was the US parent company, based solely on the tax-saving aspect, involved a misapprehension of the legal principles. The factors for determination identified include the content and status of business activities, the actual use and management of the income, and the relationship of use and enjoyment.

Determination of the beneficial owner of royalty income and the standard for applying the substance-over-form principle (2017Du33008): The Court held that Article 12(1) of the Korea–Hungary Tax Treaty provides that, where a resident of the other Contracting State is the beneficial owner of the royalties, they are taxable only in that other Contracting State. A beneficial owner means a case where the person has the right to use and enjoy the income without any legal or contractual obligation to transfer it to another person, and this is determined in light of all the circumstances. The Court held that the substance-over-form principle in Article 14(1) of the Framework Act on National Taxes also applies to treaties, but that where there is no discrepancy between form and substance, the income is attributed to the nominal recipient. Taking together the group's business history in Hungary, VIH's personnel and facilities, its performance of the agreements and its management of funds, the Court found considerable room to regard VIH as a beneficial owner with substance, and accordingly reversed the judgment below and remanded the case. It held that a lack of capacity to control and manage cannot be concluded solely from the size of the dividends and the circumstances of the transfer of the distribution rights. The factors for determination identified include the content and status of business activities, the actual use and management of the income, and the relationship of use and enjoyment.

The order in which the anti-treaty-abuse provision and the substance-over-form principle apply together (2016Du841): The Supreme Court held that the substance-over-form principle in Article 14(1) of the Framework Act on National Taxes applies equally to the interpretation and application of tax treaties unless there is a special provision excluding it. Article 27(2) of the Korea–Germany Tax Treaty is a provision that denies benefits to abuse whose main purpose is to create the appearance of satisfying the requirements for the limited tax rate by creating rights without a proper economic reason. Whether it applies is determined by considering together the circumstances in which the rights were created, the business purpose and activities, the roles of those involved, and whether they controlled and managed the income. It was established that GmbH 1 and GmbH 2 had no business activities of note other than holding shares, received all the funds needed to acquire the shares from TMW, and passed the dividends straight on to TMW. The Court held that the 5% rate under item (a) of Article 10(2) is not available to the nominee companies, but that the 15% rate under item (b) of Article 10(2) for the substantive owner cannot be excluded, because it is difficult to regard obtaining that rate as having been the main purpose. The factors for determination identified include the circumstances in which rights were created and transferred, the purpose and activities of the related business, and the role of the persons concerned and whether they controlled and managed the income.

Sources and limitations

This brief is based solely on the original texts, published on the National Law Information Center, of Article 14(1) of the Framework Act on National Taxes, Articles 4(1) and 4(3), 93 and 98 of the Corporate Tax Act, and Article 3 of the Adjustment of International Taxes Act, and on the texts of Supreme Court Decision 2018Du38376 delivered on 29 November 2018, Supreme Court Decision 2017Du33008 delivered on 15 November 2018, and Supreme Court Decision 2016Du841 delivered on 27 June 2019.

This is academic research material setting out general legal principles and standards for reviewing the record; it is not legal advice on any individual case or an opinion for submission to a court.

Points left open

2018Du38376: Even after the substance of an intermediate holding company and the independence of its management of funds have been established, what kind of record could unsettle the determination of treaty abuse again?

2017Du33008: Can business substance preserve the application of a treaty even in a structure that has a tax-saving aspect?

2016Du841: Even where companies were established in a way that created an appearance, how far should the benefit be preserved where an economic reason is also present?

When to reconsider

2018Du38376: This determination will be revisited if contracts or fund flows are identified that show an obligation to transfer the dividends or a gap in control and management.

2017Du33008: There is room to revisit this if the record reveals VIH's control and management of the distribution rights or its management of funds differently. A different picture of the size of the dividends or the terms of the loans would also be a condition for revisiting.

2016Du841: This may be revisited if different facts emerge concerning the circumstances in which the rights were created, the business purpose, or control and management.

Statutes referred to

• 국세기본법 제14조 제1항
• 법인세법 제4조 제1항·제3항, 제93조, 제98조
• 국제조세조정에 관한 법률 제3조

Decisions referred to

• 대법원 2018. 11. 29. 선고 2018두38376 판결 · Decision ledger
• 대법원 2018. 11. 15. 선고 2017두33008 판결 · Decision ledger
• 대법원 2019. 6. 27. 선고 2016두841 판결 · Decision ledger

Verification status

The provisions cited (Article 14(1) of the Framework Act on National Taxes; Articles 4(1) and 4(3), 93 and 98 of the Corporate Tax Act) and the decisions discussed (Supreme Court Decision 2018Du38376 delivered on 29 November 2018, Supreme Court Decision 2017Du33008 delivered on 15 November 2018, and Supreme Court Decision 2016Du841 delivered on 27 June 2019) were checked as at 15 October 2026 against the current legislation on the National Law Information Center and the original texts of the Supreme Court judgments. Because the legislative history of Article 2-2 of the former Adjustment of International Taxes Act cannot be confirmed from the materials provided, the original text of Article 3 (Substantive Taxation of International Transactions) of the current Adjustment of International Taxes Act was checked as at 21 October 2026. This brief cites only the three decisions listed among the decisions discussed.