Supreme Court rules technology know-how is not a capital asset under tax treaty

The Supreme Court on April 9 ruled that technology know-how used in business operations does not constitute a capital asset under the Korea-U.S. tax treaty, rejecting a claim for exemption from domestic withholding taxes.

In its judgment, the high court found that the lower court had misinterpreted the scope of capital assets under Article 16, Paragraph 1 of the treaty and remanded the case for retrial. The justices reasoned that because such intangible assets are subject to depreciation deductions under U.S. internal revenue laws applicable at the time of the 1976 signing, they are generally excluded from the capital asset category defined in the accord.

The ruling clarifies that undefined terms in the treaty must be interpreted by referencing the domestic laws of the contracting states as understood when the agreement was finalized. Since the term 'capital asset' is not explicitly defined in the treaty text, the court looked to the U.S. Internal Revenue Code as it stood in 1976, which excludes property used in a trade or business and subject to depreciation from the definition.

The court further distinguished these transactions from royalty income, noting that the fixed lump-sum payments lacked the contingent nature required to be classified as royalties under Article 14, Paragraph 4(b). Unlike variable consideration tied to future production or usage, the deterministic nature of the payment meant it did not fit the specific criteria for royalty taxation either.

The case centered on a U.S. corporation that transferred research and development technologies to a Korean company, which paid withholding taxes on the licensing fees. The American firm argued the income should be exempt as proceeds from the sale of a capital asset, but the tax authority refused the refund request, prompting the litigation that has now returned to the lower court.