Key Provisions of the Korea-US Tax Treaty

The United States and the Republic of Korea have an income tax treaty, signed in 1976, to address cross-border taxation. Its primary goals are to prevent double taxation and to establish cooperation between tax authorities to stop tax evasion. The treaty sets rules for taxing income from employment, business, and investments, which encourages international trade by providing tax certainty.

Determining Residency for Treaty Purposes

Using the U.S.-Korea tax treaty requires being a “resident of a Contracting State.” An individual can be a resident of both countries under their domestic laws, creating a “dual resident” situation. To resolve this, the treaty uses a sequence of four “tie-breaker” rules to assign residency to a single country for treaty purposes:

• Permanent Home: Residency is assigned to the country where the individual has a permanent home.
• Center of Vital Interests: If a permanent home exists in both countries or neither, residency is determined by where personal and economic ties are closer.
• Habitual Abode: If the center of vital interests is unclear, residency is based on where the individual spends more time.
• Competent Authority: If still unresolved, the tax authorities of the U.S. and Korea will mutually agree on the individual’s residence.

Taxation of Individual Income

The treaty assigns taxing rights for various types of individual income, which simplifies obligations and prevents double taxation.

Income from Employment

Employment income is taxed where the work is performed. The treaty’s “183-day rule” provides an exception, making the income taxable only in the individual’s country of residence if all the following conditions are met:

• The individual is in the host country for 183 days or less during the tax year.
• Remuneration does not exceed $3,000.
• The employer is not a resident of the host country.
• The pay is not borne by a “permanent establishment” the employer has in the host country.

Pensions and Annuities

Pensions and life annuities are taxable only in the recipient’s country of residence. A U.S. resident receiving a pension from a Korean source, for instance, would only pay U.S. tax on it.

Government Service

Pay, including pensions, for government service is taxable only by the paying country. For example, a salary from the Korean government for official duties in the U.S. is exempt from U.S. tax. This exemption does not apply if the services are related to a government-run business.

Students and Trainees

A resident of one country visiting the other for full-time education or professional training is exempt from tax in the host country on certain payments. This exemption applies to remittances received from abroad for their maintenance, education, or training.

Teachers and Researchers

A resident of one country invited to another for up to two years to teach or research at an educational institution is exempt from host-country tax on that income. The exemption is void if the research is for the private benefit of a specific person or entity.

Taxation of Business and Investment Income

The treaty also guides the taxation of corporate and investment income. It links taxing rights to a significant economic presence, distinguishing between business profits and passive income.

Business Profits and Permanent Establishment

A business’s profits can be taxed by the other country only if it operates through a “Permanent Establishment” (PE) there, and only on profits attributable to that PE. A PE is a fixed place of business, such as:

• A branch
• An office
• A factory
• A workshop
• A place of management

A construction project lasting over six months is also a PE. Preparatory or auxiliary activities, like storing goods, do not create a PE.

Dividends, Interest, and Royalties

The treaty limits the withholding tax the source country can charge on passive income. The maximum rate on dividends is 15%, reduced to 10% if the recipient is a corporation owning at least 10% of the paying corporation. The maximum tax on interest is 12%.

For royalties, the rate is 10% for copyrights of literary, artistic, or scientific works, and 15% for other royalties like patents and trademarks. These rates are significantly lower than the standard 30% U.S. withholding tax on such payments to foreign persons.

How to Claim Treaty Benefits

Specific procedures are required to claim treaty benefits. The process differs for Korean residents earning U.S. income and U.S. residents claiming benefits on an American tax return.

A Korean resident earning U.S.-source income, such as dividends, provides a completed Form W-8BEN to the U.S. payer. This form certifies their Korean residency and instructs the payer to apply the lower treaty withholding rate.

U.S. citizens or residents claiming a treaty benefit that alters the U.S. Internal Revenue Code must file Form 8833 with their tax return. This form discloses the treaty-based position to the IRS, and failure to file can lead to penalties. Form 8833 is not required for claiming reduced withholding rates on income like dividends, as Form W-8BEN handles that.

Relief from Double Taxation and the Saving Clause

Two articles are central to the treaty’s framework. The “Relief from Double Taxation” article provides the method for eliminating duplicate taxes. The “Saving Clause” preserves each country’s right to tax its own citizens and residents.

The “Relief from Double Taxation” article obligates the residence country to prevent double taxation, usually through a foreign tax credit. A U.S. citizen in Korea, for example, can claim a credit on their U.S. return for income taxes paid to Korea.

The “Saving Clause” allows both the U.S. and Korea to tax their citizens and residents as if the treaty didn’t exist, meaning the U.S. can tax the worldwide income of its citizens abroad. However, the Saving Clause has exceptions. The most important one for U.S. citizens is the “Relief from Double Taxation” article itself, which ensures that the U.S. must provide a foreign tax credit for taxes paid to Korea.