The Seoul Administrative Court recently ruled that a Hungary-based subsidiary (“HungarianCo”) - set up in 2010 by a Dutch Motion Picture Licensing Entity (“Dutchco”) to hold exclusive rights in distributing motion pictures produced by the group company in Korea, Japan, Israel and Hungary - was not the beneficial owner of royalty payments made by a Korean entertainment and motion pictures distributor (“KoreaCo”) for rights to distribute motion pictures in the Korean market. Although HungarianCo had substantive physical presence in Hungary, the court held that based on an overall consideration of the purpose for setting up the entity in a certain jurisdiction, the nature of the activities performed by the employees, scope of transactions undertaken and actual flow of payments, DutchCo was the beneficial owner to the royalty payments and applied the royalty withholding tax rate of 15% pursuant to the Korea-Dutch tax treaty.


KoreaCo had a distribution agreement in place with DutchCo for rights to distribute motion pictures produced by DutchCo group entities (“GroupCo”). Pursuant to this agreement, KoreaCo had been withholding 15% on royalty payments paid out to DutchCo in accordance with the Korea-Dutch tax treaty. In 2010, DutchCo established HungarianCo as a wholly-owned subsidiary, with which it entered into a license agreement for exclusive rights to distribute to five jurisdictions, including Korea, Japan, Israel and Hungary. HungaryCo entered into a distribution agreement with KoreaCo, pursuant to which KoreaCo remitted royalty payments of approximately KRW 13.6 billion (approximately USD 12.4 million) from May 2011 through December 2013 for rights to distribute motion pictures produced by the GroupCo. Since royalty income under the Korea-Hungary tax treaty adopts residence taxation principles, KoreaCo did not withhold on royalty payments made to HungarianCo.

The Korean tax authorities argued that DutchCo, as opposed to HungarianCo, should be regarded as the beneficial owner of royalty income, in which case KoreaCo should have withheld 15% from its royalty payments in accordance with the Korea-Dutch tax treaty.

At the time of the imposition, HungarianCo had physical substance in Hungary, in the form of a large office space with approximately 46 employees and business operations involving, at least with respect to the agreement with Koreaco, certain limited rights to determine marketing and advertising, motion picture release dates, content editing as well as movie title changes pursuant to agreement or prior approval from DutchCo.

The court held that in order to determine who in fact receives the benefit of the income concerned, overall consideration should be given to circumstances surrounding the intermediary company, such as the purpose and process involved in setting up the entity in a particular jurisdiction, physical presence, decision-making authority, as well as the flow of payments involving relevant transactions of the intermediary company. In particular, the purpose behind establishing the intermediary company in a particular jurisdiction should be subject to careful scrutiny to determine whether tax avoidance is a primary objective.

For the court, the following facts were important in their determination that HungarianCo was a mere conduit set up for purposes of tax avoidance:

  • A distribution license agreement between DutchCo and HungarianCo was executed immediately following the establishment of HungarianCo, following which the Korean distribution rights were granted to KoreaCo in the next six months.
  • The number of employees initially based in HungarianCo was less than 5 persons. Thereafter, most of the employees involved with the Korean distribution rights were finance or accounting-related personnel. 
  • According to the license agreement entered into between DutchCo and HungarianCo, the two entities do not seem to operate independent motion film distribution businesses. 
  • DutchCo holds actual rights to control royalty income in consideration of the fact that DutchCo received dividend distribution from HungarianCo of 71% and 86% of net profits for 2011 and 2012 respectively.
  • Internal review was conducted to analyze the possibility that HungarianCo may not be regarded as the beneficial owner. As such, there was prior recognition internally within the company that tax avoidance was a possibility.
  • Given that the geographical location of the business is not a critical element in the movie film distribution business, it does not seem likely that Hungaryco was set up in Hungary for business reasons such as foreign investment benefits or group restructuring.

BKL Outlook:
Although this case is currently under appeal at the high court, we view that this case may serve as important precedent for many global contents distributors supplying entertainment brands in television, motion pictures, as well as online and mobile platforms through entities established in Hungary if the decision of the Administrative Court is not overturned.

Furthermore, this case may be used as an important precedent to deny treaty benefits not only to global contents distributors, but also to multinational corporations or investment companies that have holding companies with substance in their treaty jurisdiction.

We note, however, that it may be premature to deem that the Korean tax authorities will look beyond corporate governance factors, such as physical substance and decision-making authority over the use of the income, to consider treaty abuse or treaty shopping as the primary factor in determining the beneficial ownership issue. We anticipate that the ultimate decision of the Supreme Court may impact the overall landscape involving beneficial ownership and substance issues for companies with operations in treaty jurisdictions and should be carefully monitored.

* This bulletin is intended as a summary news report only, for general information. This bulletin does not represent, and should not be construed as, legal opinions or advice of Bae, Kim & Lee LLC. Information contained in this bulletin is not represented to be accurate or up-to-date. For legal advice, please inquire with Bae, Kim & Lee LLC or other qualified counsel.

Tae Kyoon KIM
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Pil Yong KIM
+82 2 3404 0489

Seung Wan CHAE
+82 2 3404 0577

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