Supreme Court Overturns Three Decades of Precedent on Royalties Paid to U.S. Licensors - U.S. Companies Should Reassess Their Tax Strategies
As cross-border licensing and settlement agreements become increasingly common and tax authorities intensify scrutiny of license fees, royalty payments, and other similar consideration (“Royalties”), understanding how Royalty payments are sourced for tax purposes is critical.
This article highlights the Korean Supreme Court’s surprising decision recently issued, which redefines the sourcing rules for Royalties for registered patents under the Korea-U.S. tax treaty (“Treaty”), and outlines the potential implications for U.S. licensors receiving such Royalties from Korean payors/entities.
Supreme Court Shifts Its Position on Sourcing of Royalties for Unregistered Patents in Korea
On September 18, 2025, the Supreme Court (en banc) issued a landmark ruling (Supreme Court Decision 2021Du59908, September 18, 2025; hereinafter, the “Decision”) overturning long-standing case law on whether Royalties for patents not registered in Korea constitute Korean-source income under the Treaty. This Decision represents a significant departure from more than 3 decades of case law and may have major implications for U.S. licensors.
From “Place of Patent Registration” to “Place of Use of Patent Technology”
As a bit of background, the Decision arose out of a patent infringement dispute in the U.S. between a non-practicing entity (the “NPE”) holding patents related to semiconductor manufacturing and a Korean semiconductor manufacturer (the “Korean Company”). To resolve the dispute, the parties settled out of court, and the Korean Company and the NPE entered into a settlement and license agreement. The NPE agreed to drop the lawsuit in consideration of Royalties payments. The Korean Company, as the withholding agent, deducted 16.5% Royalties withholding tax (“WHT”) from the payment, pursuant to the Treaty.
The NPE subsequently sought a refund of this WHT on the basis that the Royalties were not Korean-source income because none of the patents were registered in Korea. The tax authorities denied the refund, prompting the NPE to appeal to the Korean courts.
At issue was the interpretation of “use” and how to determine the “place of use” under Article 6(3) of the Treaty. Under the Treaty, Royalty payments made by a Korean entity to a U.S. licensor are characterized as Korean-source income if the “use” occurs in Korea.
Since 1992, the Supreme Court had consistently applied a “territorial approach” to patent rights, holding that patents not registered in Korea have no effect in Korea, and thus their “use” cannot occur in Korea under the Treaty (See, e.g., Supreme Court Decision 91Nu6887, May 12, 1992; Supreme Court Decision 2005Du8641, September 7, 2007; Supreme Court Decision 2012Du18356, November 27, 2014; Supreme Court Decision 2013Du9670, December 11, 2014; Supreme Court Decision 2016Du42883, December 27, 2018; Supreme Court Decision 2018Du36592, February 10, 2022; Supreme Court Decision 2019Du50946, February 10, 2022; Supreme Court Decision 2019Du47100, February 24, 2022) (collectively, the “Prior Precedents”).
In this Decision, however, the Supreme Court (in a 10-3 decision) revisited and changed the interpretation of “use” to mean not the use of the patent right itself, but the use of the underlying technology protected by the patent. Accordingly, the Supreme Court held that even if a patent is not registered in Korea, Royalties paid for the patent technology used in manufacturing or sales activities in Korea constitute Korean-source income. Based on this reasoning, the Supreme Court expressly overturned the Prior Precedents. The Supreme Court remanded the case back to the Suwon High Court (the
“Appellate Court”) for further review and proceedings consistent with this new legal principle, and it instructed the Appellate Court to review the place of use and determine the amount of Korean-source income, which should be subject to WHT.
In light of the Decision, we expect that the primary disputes in the lower courts now will center on how to determine “use”—an issue on which the Decision unfortunately offered little concrete guidance—and on the appropriate methodology or allocation key to bifurcate the Royalty payments.
However, the Decision also raises new questions, as it is not exactly clear on how to determine “use” when the place of patent registration is no longer solely determinative. For example, the Supreme Court indicated that if the underlying technology embodied in such patents is used by the Korean Company in manufacturing and sales in Korea, such income should be regarded as Korean-source income. But what if the underly technology were used in manufacturing in Korea, but the products were then sold in the U.S., where the patents are registered and thus have patent protections? How should the Royalty payments be apportioned?
Observations and Possible Implications for U.S. Licensors
How to determine place of “use” based on the Decision. We believe the Decision introduces more uncertainty by no longer treating the place of patent registration as dispositive under the Treaty. In cases involving actual licensing and use of patented technology, Royalty payments might be allocated based on methodology like manufacturing or sales location. However, applying this framework broadly becomes challenging when payments stem from U.S. patent litigation settlements.
Korean companies often settle with U.S. NPEs to avoid litigation and injunctions that could block U.S. sales. These settlements typically do not involve actual use of licensed technology, making it hard to determine a “place of use.” From the taxpayer’s perspective, we believe such payments should all be characterized as U.S.-source income, as they relate to resolving patent infringement claims in the U.S. While the Korean tax authorities may attempt to argue that the underlying technology was “used” in Korea, courts would not be able to deny that the Royalty payments in such case should be primarily attributable to the Korean company’s (or its U.S. affiliate’s) sales in the U.S.
Contract terms. Although the Decision does not formally place the burden of proving “place of use” on the U.S. licensor, in practice, such proof may be necessary to claim treaty benefits or a refund of WHT. Since relevant information may only be known by the Korean entity, we recommend that U.S. licensors include, in consideration for future tax withholding by the Korean entity, more robust provisions in future agreements prescribing that the Korean entity must provide substantive assistance and support to the U.S. licensor in seeking refund of WHT, including (to the extent commercially reasonable) detailed information on sales and use of products using the underlying technology. The alternative would be for U.S. licensor to insist on gross-up provisions for any Royalty WHT in the license agreements.
Monitoring the case on Remand. In the Decision, the Supreme Court remanded the case back to the Appellate Court to determine place of use of patents and apportion the Royalty payments between Korean and foreign source-income. But if manufacturing facilities and sales are spread across multiple jurisdictions, it is unclear which metrics or methodology (e.g., gross sales, cost of goods manufactured, production volume, etc.) will be recognized by the Appellate Court, or even how to split lump-sum Royalty payments between manufacturing and sales. Therefore, close monitoring of these developments on remand will be essential to determine the next steps and future strategies for U.S. licensors seeking to claim refund of WHT.
If you have any questions regarding this article, please contact below:
Tom KWON ([email protected])
Jung Ho RYU ([email protected])
Steve Minhoo KIM ([email protected])
Philje CHO ([email protected])
Ye Jin OH ([email protected])
Kyu Bin KANG ([email protected])
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