Korea’s Patent Royalty Rule Flipped. Your Contracts Didn’t.

A US software company licenses an embedded software stack and its patents to a Korean electronics manufacturer: $20 million a year, worldwide license, patents registered in the United States but not in Korea. For years, the parties have treated only the $8 million copyright and know-how share as Korean-source, and the licensee has withheld $1.32 million at 16.5%. After the Korean Supreme Court’s en banc decision of September 18, 2025, the National Tax Service (NTS) can treat the full $20 million as Korean-source once it shows the technology is used in Korean manufacturing, unless the parties can prove the share used elsewhere. Withholding goes to $3.3 million, and if the United States treats the income as US-source, much of the increase may never be credited.

A year on, the Court has applied the rule twice more, three remanded cases are pending in the High Courts with no decision yet on how to allocate, and renewals and year-end provision reviews are putting the question in front of tax teams now. The law moved. The process didn’t. Legal has the contract, the licensee has the production data, royalty accounting has the reports, and the payment goes out from the Korean payor before anyone has compared them.

The example is software, but the rule is not. If your company licenses technology to a Korean manufacturer, or to its own Korean subsidiary, and the product is made or sold in Korea, this decision applies to you.

Are you exposed? Three questions

1. Does your group receive royalty or settlement payments from a Korean company, including a Korean affiliate?
2. Is any of the licensed technology covered by patents that are not registered in Korea?
3. Is the technology used to make or sell products in Korea, even if the products are exported?

Yes to all three means the registration defense no longer protects that income, and the withholding on it should be revisited before the next payment. The exposure is largest where the royalty is a single worldwide fee with no territorial split, or where withholding has covered only the know-how or Korean-registered share.

Executive summary

• The registration defense is gone. In Decision 2021Du59908, the Supreme Court held that under the Korea-US treaty, royalties for patents not registered in Korea are Korean-source where the patented technology is actually used in Korea. In January 2026, two divisions of the Court applied it to $97 million that LG Electronics paid AMD and to royalties Samsung SDI paid a US battery-technology licensor.
• Manufacturing is the trigger. Making the product in Korea is enough, even if every unit ships to the US.
• Allocation is open, and the burden is likely yours. The Court did not say how much of a global royalty is Korean-source. A concurring opinion would presume all of it once Korean use is shown and leave the taxpayer to prove the rest.
• The cost lands now. Withholding is set by the Korean payor at payment, on contracts drafted for the old rule. Gross-up clauses can move millions between the parties, refund claims built on registration are unlikely to succeed, and Korean tax the US will not credit is a permanent cost.

If you answered yes to all three questions above, start with treaty documentation and the open-year exposure.

The courts caught up with the statute

For 33 years, the Supreme Court tied “use” of a patent to where it was registered, even after the statute said otherwise. In September 2025, it reversed itself.

Two points follow. The NTS never stopped withholding or refusing refunds, so the decision ends a long dispute rather than opening a new policy. And the current text of Article 93(8) is more explicit than the version the Court applied, referring to the manufacturing methods, technology and information embodied in an unregistered patent that are actually used in Korea. The rule applies with at least as much force to payments made today.

Where the technology is used now decides it

The treaty does not define “use,” so under Article 2(2) it takes its Korean domestic-law meaning unless the context requires otherwise. Finding nothing in the treaty’s text, negotiating history or context that required the territorial reading, the majority applied the Corporate Tax Act: “use” means use of the patented technology, not exercise of the patent right. Territoriality means only that using the technology in Korea does not infringe a foreign patent. It does not stop Korea from taxing a payment for that technology.

Software precedent supported the reasoning. The majority relied on its holding that payments for foreign-made software introduced into Korea were consideration for know-how used in Korea (Decision 97Nu11065, January 21, 2000), and noted that the treaty’s royalty definition covers registered and unregistered rights alike. One actual-use test now applies to all of them.

Allocation is open, and the burden is likely yours

Only the share of a global royalty paid for use in Korea should be Korean-source, and the decision does not say how to measure it. The three dissenting justices called the pro rata calculation a difficult follow-on problem, given that Korean licensees also manufacture abroad, and doubted the NTS could carry the burden of proof. The concurrence answered that the difficulty of allocation “would not be great” where the contract separates domestic and overseas use, and proposed a model borrowed from US practice: once the NTS shows Korean use, the whole royalty is presumed Korean-source and the taxpayer must prove the foreign share.

A license that states its territory, identifies what each payment is for and ties royalties to Korean and non-Korean production can be defended. A single worldwide fee invites the NTS to tax the whole payment.

A worked example

Return to the opening example. The agreement allocates 40% of the $20 million royalty ($8 million) to copyright and know-how and 60% ($12 million) to the patents. The licensee makes 60% of licensed units in Korea and 40% elsewhere. The combined Korean rate is 16.5% (the 15% treaty rate plus local income tax), or 22% where treaty relief is not available. The figures are illustrative and assume treaty eligibility and the stated allocations.

The documented-allocation row conservatively keeps the know-how share as it was; because the actual-use test now applies to know-how too, a full production-based allocation could argue for less. No gross-up is shown. If the licensee had to gross up in row 3, the gross payment needed to deliver $20 million net would be about $23.95 million, and the tax about $3.95 million.

Three numbers stand out. Treaty paperwork alone is worth $1.1 million (row 4 against row 3), and it is the cheapest fix available. A supportable allocation is worth about $0.8 million a year (row 3 against row 2), if it can be backed with the licensee’s production data. And if foreign tax credit relief is limited, the increase over the prior position is a permanent cash cost, not a timing difference.

Who is exposed

Exposure turns on what the Korean counterparty does with the technology, not on where the licensor filed: building it into products made in Korea, running it in Korean fabs and plants, or selling products in Korea that embody it.

Semiconductors are the first and clearest case

Two of the three decided cases involve chip technology: a worldwide settlement license for about 40 US-registered patents taken by a Korean semiconductor maker after a non-practicing entity sued it in the US, and $97 million that LG Electronics paid AMD, with about $14.5 million of withholding at stake. Korean fabs license large US portfolios, often from licensors with no Korean registrations. Royalties charged per chip or per wafer of silicon processed tie payment directly to Korean output, while assembly and test sites abroad make a worldwide fee harder to split. Wafer starts, unit volumes and revenue by site are the natural allocation keys.

Exposure by sector

The test is the same everywhere: is technology protected only by non-Korean patents used to make or sell products in Korea, and is the royalty a single worldwide fee?

If your Korean subsidiary pays the royalty

For many US multinationals, the largest exposure is inside the group: a Korean manufacturing subsidiary paying its US parent under a worldwide intercompany license, often for US patents never filed in Korea. If the subsidiary withheld only on the know-how or Korean-registered share, it is the withholding agent for the shortfall in open years, plus penalties, and that liability sits inside your own group rather than with a counterparty. That reaches industrials, chemicals, medical devices, auto suppliers and consumer products.

Four things differ from the third-party case. The production data is inside the group, so there is less excuse for lacking an allocation. If the subsidiary grosses up or absorbs the extra Korean tax, its operating margin can fall below the arm’s length range its benchmarking supports, inviting an NTS adjustment. If the parent bears it, the parent’s return on the IP falls instead. Either way, the Korean-source allocation and the transfer pricing documentation must describe the same use of the technology. A gross-up cannot push the cost outside the group: it only moves that cost between the subsidiary and the parent. Whatever the parent cannot credit goes straight to the consolidated effective tax rate. And the royalty becomes a costlier way to bring cash home: groups that used royalties alongside dividends to repatriate Korean profits should rerun that comparison, and any open-year shortfall the subsidiary pays as withholding agent comes out of cash that would otherwise be distributed. A contract or toll manufacturer that pays no royalty generally falls outside the issue, which makes any royalty-bearing Korean subsidiary worth a second look.

Why the Korean tax may stick in the US

The likely result is Korean tax with no offsetting US credit. The question is not whether the Korean tax is creditable but whether there is room to credit it. Korea now treats the royalty as Korean-source. Under section 861(a)(4), the US sources patent royalties where the property is used, in practice where the patent is legally protected, so royalties for US patents are generally US-source. Article 5(2) grants the credit subject to US law, which means the section 904 limitation, and Korean tax on income the US treats as US-source finds no foreign-source income to absorb it. Practitioners should also confirm how the source-based attribution requirement for royalty withholding taxes in Treas. Reg. section 1.901-2 applies, and the relief from it under Notices 2023-55 and 2023-80.

The treaty’s remedies are the competent authority process for agreeing a common source (Article 6(9)) and the mutual agreement procedure (Article 27). The majority pointed to both, and both take time. There is no structural fix either: most of Korea’s other treaties source royalties by the payor’s residence, so moving the licensing entity to another treaty country gives up the one treaty that ever supported the registration defense.

Every fix moves the fight somewhere else

The first instinct is to rewrite the contract. Three moves come up, and none is clean:

• Allocate by territory. State the share of the royalty paid for Korean and non-Korean use, tied to production or sales reports. This gives a defensible base, but the dispute moves to the data, and the split has to match how the licensee actually uses the technology.
• Split the license. License Korean and non-Korean use under separate agreements or schedules. This can isolate the Korean-source payment, but the NTS may still look at the arrangement as a whole and compare the drafting with actual conduct.
• Reprice for the tax. Move to net-of-tax pricing, a gross-up or a shared-cost mechanism. This settles who pays the Korean tax, but it does not shrink it: the gross-up is itself taxed, and the licensor still reports the grossed-up amount as US income. A licensee facing a bigger gross-up will push for a lower headline royalty, and an intercompany gross-up moves the Korean subsidiary’s margin.

None is a safe harbor, and under the concurrence’s model each still needs evidence behind it. Two moves carry less risk: get treaty documentation right before every payment (Korea’s reduced-rate application and IRS Form 6166), and agree in the contract how the parties will cooperate in an audit or a mutual agreement case.

Then decide who carries the tax that is not relieved: the licensor, through its foreign tax credit position, or the licensee, through a gross-up. Where the licensee is your own Korean subsidiary, that choice runs through transfer pricing. Either way, it belongs in the effective tax rate forecast now.

The decisions this changes

• Settling US patent suits against Korean manufacturers. Korean withholding is now part of the settlement value. Price it, allocate it and assign it before agreeing a headline number.
• License renewals and royalty true-ups. Expect licensees to reopen the economics. Go in with your own allocation and data proposal rather than reacting to theirs.
• M&A diligence. For targets with Korean royalty income or Korean licensees, past withholding, refund claims and tax indemnities are live exposures that belong in purchase price and the indemnity package. A Korean target that pays royalties to foreign licensors is itself the withholding agent: in a share deal, any shortfall in open years, plus penalties, stays with it after closing, and any license the buyer’s group grants it after the deal falls under the new rule from day one.
• Manufacturing footprint. Korean manufacturers are building major US capacity: Samsung in Taylor, Texas, SK hynix in Indiana, and battery plants run by LG Energy Solution, Samsung SDI and SK On. As licensed production moves to the US, the Korean-use share of a royalty should fall, but only if the contract ties royalties to where production happens, so the clause needs to be in place before those plants ramp up.

What to do now

Each payment now needs a source position, a contract position, a foreign tax credit position and a payment control, usually owned by different people.

The decision reaches past payments in open years (generally seven in Korea for cross-border transactions) as well as future ones. None of this should wait for the remanded cases.

The CFO’s first question will be what this costs and whether it is a one-off. Answering it takes a list of every Korean royalty stream, the patents behind each one and where the technology is used, and most groups do not have that list in one place.

Before the next payment

• Create one record for each Korean license, settlement, cross-license and intercompany royalty, shared by legal, tax, transfer pricing, royalty accounting and treasury, and by the payables team of any Korean subsidiary that pays.
• Confirm treaty documentation is current, identify agreements that assumed the patent share was free of Korean tax, and set escalation and approval rules for Korean royalties.

This quarter

• Establish where the licensed technology is actually used: which products are made or sold in Korea, and which plants elsewhere use the same technology.
• Quantify withholding, gross-up and foreign tax credit exposure for open years, and reflect it in the effective tax rate forecast and, where relief is uncertain, the provision.
• Reassess any refund claim, receivable or dispute that relies on the registration test, and decide how you would respond if the NTS challenges a past payment.

At renewal and beyond

• Redraft allocation, gross-up, indemnity and cooperation clauses, and agree with the licensee what production data supports the allocation and how often it is shared. If that data does not exist in usable form, it is a systems project with a long lead time.
• Track the three remands. How they allocate royalties and assign the burden of proof will shape the evidence needed, so rerun any position once that guidance emerges.

Where TaxRay fits

Until allocation and burden of proof are settled, this exposure is managed payment by payment. Under the concurrence’s model, once the NTS shows Korean use, the taxpayer must prove the foreign share, and the NTS will test whether the license, the royalty reports and the licensee’s actual use tell one story. If tax assembles that evidence only after payment, incremental Korean withholding on royalties the US treats as US-source may become permanent foreign tax credit leakage.

TaxRay is an enterprise withholding tax operating system. Its AI agents ingest agreements and payment requests, assemble the relevant facts from ERP, legal, treasury and transfer pricing systems, evaluate characterization, source and treaty eligibility, and model withholding, gross-up and US foreign tax credit consequences. In the $20 million example, TaxRay compares the prior $1.32 million withholding with a documented allocation, full Korean-source treatment and undocumented treaty relief, before payment.

The output is a preventive payment control: release, hold or escalate. TaxRay routes exceptions to the accountable owner, records approvals, and preserves the governing agreement, supporting facts, calculation and decision trail, which is the evidence a Korean-source allocation has to rest on. Tax leaders gain a current view of upcoming payments, unresolved withholding exposures and potential permanent cash-tax costs.

The distinction is execution: TaxRay converts legal change and transaction facts into governed payment decisions before cash leaves the company, so the position the tax team has taken is the one applied to every payment.

This article is general commentary on a Korean Supreme Court decision and related Korean and US tax rules, parts of which remain subject to further litigation, and is not tax, legal or accounting advice. No conclusions should be drawn for particular facts without advice on those facts.

Hagit OrenFounder and CEO, TaxRay

Built and ran the global tax function at monday.com through the 2021 IPO, after a decade advising US multinationals on cross‑border structure as a Tax Partner at Herzog Fox & Neeman and Tax Director at Deloitte Israel.

Katie TuckerHead of Tax, TaxRay

Ran the tax department of a listed multinational operating in 17 countries, owning worldwide transfer pricing strategy, ASC 740 and SEC disclosure.