Korea: Payments treated as expenses under cost sharing agreement and not royalties (Administrative Court decision)

Administrative Court decision concerning payments treated as expenses under cost sharing agreement and not royalties

Payments treated as expenses under cost sharing agreement and not royalties

The Seoul Administrative Court held (2022 Nu 36010, 14 December 2022) that the taxpayer’s payments to an affiliate under a purported cost sharing agreement were, in fact, cost sharing expenses and not royalties. 


The taxpayer paid royalties to affiliates for use of intangibles under a license agreement. The taxpayer also entered into a cost sharing agreement with an affiliate located in France for research and development (R&D) with respect to glass manufacturing technology. In accordance with the cost sharing agreement, the French affiliate charged the taxpayer allocated R&D costs. The taxpayer initially treated the payment of such R&D costs as royalties and withheld a 10% withholding tax in accordance with Article 12(2) of the Korea-France income tax treaty.

However, the taxpayer subsequently filed an amended tax return treating the payment of the R&D costs as expenses under a cost sharing agreement rather than royalties and sought a refund of the withholding tax. The tax authority denied the refund request, and the taxpayer filed an appeal with the Tax Tribunal, which also denied the taxpayer’s request. The taxpayer then filed a claim with the Seoul Administrative Court.

The tax authority argued that the taxpayer’s agreement with the French affiliate could not be considered a cost sharing agreement because it applied an allocation key based on “net sales” rather than “expected benefits,” such as “decreased costs” or “increased sales.” In addition, to the extent the taxpayer used the existing intangibles that the French affiliate already owned for R&D purposes, the R&D payments were royalties excludable from the arm’s length cost sharing amount. Moreover, to the extent the taxpayer used the intangibles in its current business operations, the R&D payments were not related to the development of new intangibles and ought to be treated as royalties.

The taxpayer responded that the “net sales” allocation key was applied as a measure of “expected benefits” and appropriately calculated the cost sharing amount to be allocated to the taxpayer. Further, the R&D payments were for the joint development of intangibles, not for the use of intangibles.

The Administrative Court held that the R&D payments were cost sharing expenses rather than royalties, finding that the taxpayer’s “net sales” allocation key was an appropriate measure for expected benefits considering that the economic benefits of using the intangibles developed under the R&D agreement will be reflected in the overall sales and the taxpayer continued to use such patents under the license agreement in their glass manufacturing business operation. The fact that the taxpayer did not pay a royalty to the French affiliate for use of its existing intangibles as part of entering into the cost sharing agreement, which would normally be required, does not mean that the cost sharing agreement was not, in fact, a cost sharing agreement.

Read a July 2023 report [PDF 963 KB] prepared by the KPMG member firm in Korea


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