Supreme Court: Losses in Specific Country Must Be Deducted from Income in Other Countries for Foreign Tax Credit Calculations

The Supreme Court has ruled that when calculating the foreign tax credit limit for domestic companies with overseas business operations in multiple countries, it is valid to proportionally distribute and deduct losses incurred in a specific country from the income generated in other countries.

The Supreme Court's Second Division, led by Justice Oh Kyung-mi, finalized the lower court rulings in June, which had ruled against LG Chem in its lawsuit filed against the head of the Yeongdeungpo Tax Office seeking the cancellation of the refusal to rectify corporate tax.

A similar lawsuit filed by Hyundai Engineering & Construction against the head of the Jongno Tax Office was also finalized in June by the Supreme Court's Third Division, led by Justice Noh Kyung-phil, ruling against Hyundai E&C.

The core issue of the lawsuit was how to handle losses incurred in a specific country when calculating the foreign tax credit limit for domestic corporations with overseas business sites in two or more countries.

The foreign tax credit refers to a system where taxes paid to foreign countries are deducted from a Korean corporation's corporate tax to resolve the issue of domestic companies being taxed twice—both abroad and in South Korea—on income earned overseas.

However, if credits were granted without limit, a company that paid hefty taxes abroad could potentially use the excess to even deduct taxes on income earned domestically. Therefore, credits are granted only to the extent corresponding to the income earned abroad.

The problem arose in situations like those of LG Chem and Hyundai E&C, which have business sites in multiple countries, when losses occur in one or more of those nations: how should the credit limits be calculated by country?

LG Chem and Hyundai E&C argued that losses in a specific country should be reflected only in that country's income and should not be reflected or deducted from foreign-source income in other countries.

LG Chem incurred a loss in the United States during the 2018 business year. If this loss is not reflected in other countries' incomes, the foreign-source income in those other countries would appear larger, thereby increasing the tax credit limit.

However, the tax authorities adopted a method of proportionally dividing and deducting the losses from the income of each country based on the ratio of income earned in each respective country.

For example, if a loss of 10 billion won occurred in Country A, while incomes of 50 billion won and 30 billion won were generated in Countries B and C respectively, and 20 billion won domestically, the 10 billion won loss from Country A would be proportionally split and deducted from Country B's and Country C's foreign-source incomes at 50% (50 billion won / 100 billion won) and 30% (30 billion won / 100 billion won) respectively.

Consequently, LG Chem filed a lawsuit seeking a refund of approximately 4.2 billion won in corporate taxes for the 2018 business year, while Hyundai E&C sought a refund of 32.5 billion won for the 2015 to 2017 business years.

However, following the first and second instances, the Supreme Court also sided with the tax authorities.

The Supreme Court explained, "The foreign tax credit system permits deductions only within the limit of the corporate tax amount to be paid to South Korea on foreign-source income," adding, "The taxation rights regarding domestic-source income must not be encroached upon by foreign tax credits."

The court explained that if losses in a specific country are not deducted from incomes in other countries at all, those losses would essentially be deducted solely from domestic-source income, thereby encroaching upon domestic taxation rights.

This is because if the 10 billion won loss in Country A is not deducted from the incomes of Countries B and C, the 10 billion won is subtracted from the total tax base while the foreign-source incomes of Countries B and C remain intact, resulting in the same effect as if the loss had been deducted from domestic income.

The Supreme Court stated, "Therefore, in order not to undermine the legislative purpose of Article 57, Paragraph 1, Item 1 of the former Corporate Tax Act, which stipulates the method for foreign tax credits, it is valid and reasonable to adopt a method of proportionally dividing and deducting losses in proportion to the degree to which income by country contributed to the calculation of domestic corporate tax amounts."

(Photo: Yonhap News)
※ Please note: This article was translated by AI and may contain errors.