The Supreme Court of Korea (the “SC”) has of late rendered numerous decisions on a tax-minimizing structure commonly and frequently used by foreign investment funds, where the investors first establish a limited partnership as their first-tier investment vehicle, which in turn sets up, directly or indirectly, a corporation-type entity in a jurisdiction that has a tax treaty with Korea, and this latter entity becomes the legal owner of the relevant Korean asset. Typically, the SC in its decisions upheld the tax assessments that, based on the domestic substance-over-form doctrine, disregarded the corporation-type entities which served as income-channelling conduits, and attributed the relevant income to the limited partnerships. Thus, the ensuing question became whether such a limited partnership can qualify as a “resident” for tax treaty purposes.
In a case where the term “resident” under the Korea-U.S. Tax Treaty was at issue, the SC viewed such a limited partnership itself as a “resident,” but only to the extent that the income was allocated to the partners who were U.S. residents. This outcome is referred to in this article as the theory of “divisible resident,” because it treats only a numerically divisible part of the relevant entity as a resident for tax treaty purposes. It should also be noted that this may be tantamount to denying the partners who are not U.S. residents benefits under the Korea-U.S. Tax Treaty. As this Korea-U.S. Tax Treaty, which was signed in the late-1970s, included some peculiar wordings in its text and Technical Explanations, this theory of “divisible resident” may be arguably viewed as the correct interpretation of the said treaty.
However, this interpretation of the term “resident” for the purposes of tax treaties in general is not justified in that it deters foreign investors from participating in an investment vehicle established in a jurisdiction other than their own residence states. Absent abuse, however, there is no reason to discriminate investment made through vehicles set up in a foreign jurisdiction against that made through domestic investment vehicles, and it is therefore submitted in this article that the holding of the recently rendered SC decision dated March 26, 2015 with the case identification code of 2013 du 7711, based on the same theory of “divisible resident,” cannot be viewed as a correct interpretation of the term “resident” for tax treaty purposes in general. Also, as the SC is insistent on attributing income to foreign limited partnerships, both for domestic tax law and treaty law purposes, it would rather have been a more coherent interpretation to treat the partnership itself as a resident, if not making a complete U-turn to adhere to the OECD position on attribution of income originating from its 1999 Partnership Report and confirmed, again, in its recent Final Report on Action 2 of the BEPS Project.