Korean Tax Newsletter - English (June 2024)

▲ Tax Authorities News

National Tax Service Declares 2024 as the First Year of 'AI Tax Administration'

The National Tax Service (NTS) has declared 2024 as the inaugural year of AI Tax Administration and announced the full-scale promotion of digital transformation in tax administration using AI. Starting with tax consultations, the NTS plans to invest a total of KRW 30 billion over the next two years to take the first steps in AI Tax Administration.

1. AI Tax Consultation Service

• During this year's comprehensive income tax filing period in May, the NTS will provide the AI Tax Consultation service using AI voice recognition technology for the first time among government agencies.
• The AI consultants have been trained with over two million past consultation records and extensive tax laws, regulations, and case precedents.
• In the last year, the provision of the AI Tax Consultation service has significantly increased the success rate of tax consultation calls from 24% to 98%.

2. Preparation for AI Hometax Launch

Over the next two years, starting in 2024, the NTS will invest KRW 30 billion in the project to upgrade Hometax, preparing for the launch of the new AI Hometax.
The AI Tax Consultation will expand its scope to encompass additional tax items, improving consultation quality through insights gained from a broader range of cases. Additionally, AI services will progressively extend into various areas such as filing and payment processes.
Complex, form-oriented screens will undergo redesign to ensure simplicity and user-friendliness, catering even to non-tax professionals.

▲ Rulings and cases 

A. [Tax Tribunal] Regarding Whether Discount Sales to Employees of Partner Companies at Employee-Only Stores Can Be Considered Entertainment Expenses (Decision No. 2023Se9469, March 29, 2024, Rejection)

Issue: Whether the discount amount provided to employees of partner companies at employee-only stores can be considered entertainment expenses.

Case Summary: The plaintiff is a domestic sales corporation of a sports goods company A Group, which imports and distributes sports apparel and other products. The company mainly engages in wholesale distribution to dealers while also operating various direct retail stores. Notably, at two locations, the A Employee Store in Gangnam, Seoul, and Haeundae, Busan, the plaintiff sells products at a discounted price to its employees, employees of related companies within A Group, employees of A Group’s shoe production partners, and employees of dispatch companies at the plaintiff's logistics center (collectively referred to as “the partner companies”).

The Tax Office conducted a comprehensive corporate tax audit on the plaintiff from May 14, 2020, to April 10, 2022, and found that the plaintiff sold products to employees of the partner companies at a 40% discount (50% discount before September 1, 2018) off the final consumer price through the employee-only stores (referred to as “the discount sales”). The Tax Office deemed these discount sales as entertainment expenses, considering such expenses as facilitating business relationship with related parties. Consequently, they informed the plaintiff of the assessment, denying the portion of the entertainment expenses exceeding the deductible limit and adjusting the corporate income tax for fiscal years 2018 to 2020. The plaintiff appealed this decision on July 20, 2023.

Decision Summary: The Tribunal ruled to dismiss the appeal, supporting the Tax Office’s decision based on the following reasons:

• According to the Corporate Tax Act, entertainment expenses are defined as expenses incurred to entertain, associate, or provide services to individuals directly or indirectly related to the business to facilitate business operations.
• The recipients of the discount sales were employees of partner companies directly or indirectly related to the plaintiff’s business, including those involved in the distribution, sale, production, and manufacturing of A Group’s products.
• There were no contractual or legal obligations for the plaintiff to offer such discount sales to the employees of the partner companies.
• The stated purpose of increasing sales and profits did not justify limiting the discount sales to employees of the partner companies if the purpose were genuinely promotional or marketing in nature.
• The products sold at a 40-50% discount included new items typically sold at full price to the general public, suggesting that the discount sales were not standard promotional activities.

Given these points, the Tribunal found it reasonable to classify the discount sales as entertainment expenses intended to maintain and facilitate business relations with the partner companies, thereby rejecting the plaintiff's claim.

B. [Tax Tribunal] Claim Regarding Re-Deducting Loss Carryforwards in Calculating Accumulated Earnings for the Current Year Due to the Deduction Limit in Prior Years (Decision No. 2023Se7744, April 11, 2024, Rejection)

Issue: Whether loss carryforwards, previously deducted in calculating accumulated earnings for the prior year but not fully utilized due to the deduction limit, can it be re-deducted when accumulated earnings for the current year.

Case Summary: The plaintiff claimed that the Tax Office had excessively assessed corporate tax for accumulated income under Article 100-32(1) of the Special Tax Treatment Control Act from the 2017 to 2021 fiscal years by not allowing repeated deduction of accumulated loss carryforwards. The plaintiff sought the refund of corporate tax paid on October 20, 2022, through a claim filed based on this issue. The Tax Office rejected this claim on January 31, 2023. Consequently, the plaintiff appealed this decision on April 25, 2023.

Decision Summary: The Tribunal decided to reject the appeal, stating the following:

• The plaintiff argued that accumulated loss carryforwards could again be deducted when calculating corporate tax related to accumulated earnings. However, Article 100-32(4)(2) of the Special Tax Treatment Control Act (before its amendment on February 15, 2022, by Presidential Decree No. 32413) stipulates that only "losses deductible for the applicable fiscal year" can be deducted in calculating corporate income under Article 13(1)(1) of the Corporate Tax Act. There is no explicit provision allowing repeated deduction of accumulated loss carryforwards in calculating accumulated earnings tax related to unreturned income.
• Although the amendment in 2022 changed the corporate income calculation for accumulated earnings by eliminating the carryforward deduction limit applicable to "losses that can be deducted in the applicable fiscal year," this amendment alone does not justify re-deducting accumulated loss carryforwards for fiscal years before 2021 when calculating corporate tax related to accumulated earnings.

Considering these factors, the Tribunal found no error in the Tax Office's decision to reject the plaintiff's claim.

C. [Tax Tribunal] Claim Regarding Imposition of Acquisition Tax Due to Post-Merger Management of Decrease in Number of Employees in a Qualified Merger Between Parent and Its Wholly Owned Subsidiary (Decision No. 2023JI3474, April 15, 2024, Reversal)

Issue: In the case of a qualified merger between a parent company and its  wholly owned subsidiary, whether the imposition of acquisition tax due to a decrease in the number of employees, falling under Article 44-3(3)(3) of the Corporate Tax Law, qualifies as a reason for imposing tax under Article 57-2(1) of the Local Tax Law.

Case Summary: The plaintiff acquired a parcel of land (hereinafter referred to as the "subject property") through a merger with its wholly owned subsidiary (hereinafter referred to as the "merged company") on March 3, 2020. Subsequently, on April 16, 2020, the plaintiff declared and paid acquisition tax based on the assessed value of the subject property as the taxable base, receiving a reduction in the tax amount according to the relevant reduction provisions. However, the Tax Office, citing the post-merger management rule, concluded that the plaintiff's number of employees fell below 80% of the total number of employees of both the merged company and the plaintiff at the time one month before the merger registration date (March 5, 2020). Consequently, on January 10, 2023, the Tax Office issued a tax assessment for the previously reduced acquisition tax amount. The plaintiff filed an appeal on March 23, 2023.

Decision Summary: The Tribunal decided to reverse the decision, stating the following:

• The Tax Office's opinion that there is no separate provision expressly excluding qualified mergers from the scope of imposition does not hold, as the imposition decision is distinct from the original acquisition tax assessment and pertains to situations where the recipient of the tax reduction did not use it in line with its intended purpose.
• While Article 44-3(3) of the Corporate Tax Law outlines scenarios for imposing tax within three years from the merger registration date, the post-merger management rule expressly excludes cases where a domestic corporation merges with another corporation it owns in full, thus negating the basis for imposing tax under Article 57-2(1) of the Local Tax Law, as per a previous decision (Reference: Decision No. 2022JI1342, October 25, 2023).

Therefore, the Tax Office's decision to impose acquisition tax based on the provisions of the reduction clause is deemed unreasonable.

D. [Tax Tribunal] Imposition of Corporate Tax on Dividends Paid to Foreign Investors in Connection with the Sale of Total Return Swap (TRS) Products Based on Domestic Corporation Listed Shares (Decision No. 2021SEO2050, April 18, 2024, Reversal)

Issue: Whether corporate tax (withholding tax) can be imposed on dividends paid to foreign investors in connection with the sale of total return swap (TRS) products, where domestic corporation listed shares serve as the underlying asset, by considering foreign investors as beneficial owners of dividend income and the domestic corporation as the actual payer.

Case Summary: The plaintiff sold total return swap (TRS) products to foreign corporations (hereinafter referred to as "foreign investors"), with domestic corporation listed shares (hereinafter referred to as "domestic shares") as the underlying asset. Pursuant to the TRS contracts, the plaintiff paid foreign corporations, without collecting withholding tax, "all profits derived from domestic shares, including price fluctuations, interest, dividends, and all related profits" (of which the profit paid to foreign investors, derived from dividends received from domestic shares, is referred to as the "disputed amount"). The Tax Office, during the period from May 7, 2020, to August 4, 2020, conducted a comprehensive corporate tax audit of the plaintiff and concluded that since the plaintiff had an obligation under the TRS contracts to pay foreign investors all dividends derived from domestic shares, foreign investors should be considered as beneficial owners of dividend income, and the plaintiff, as the entity actu
ally paying dividends to foreign investors, should be subject to withholding tax. Consequently, corporate tax (withholding tax) for the business years 2016 to 2020 was assessed and notified to the plaintiff. Disagreeing with this, the plaintiff filed an appeal on February 9, 2021.

Decision Summary: The Tribunal decided to reverse the decision, stating the following:

• The plaintiff not only acquires shares with its own funds but also exercises all rights related to the domestic shares directly. Furthermore, the plaintiff can hedge its position by selling the acquired domestic shares and entering separate TRS contracts again, thereby facing no restrictions on the disposal of domestic shares. In contrast, foreign investors cannot exercise any rights as shareholders of domestic shares, as per the Commercial Act. They only have the right (or obligation to preserve capital gains) to receive the amount agreed upon in the TRS contracts (equivalent to capital gains from share transfers, dividends, etc.). Moreover, it is difficult to argue that foreign investors effectively control or manage the plaintiff. Thus, while all rights and obligations regarding domestic shares belong to the plaintiff, foreign investors cannot exercise any rights concerning domestic shares, making it difficult to assert a discrepancy between the nominal and substantive ownership of domestic shares by the plaintiff.
• Foreign investors may choose between i) directly purchasing domestic shares and ii) investing in domestic shares' capital gains through TRS contracts. The latter method allows them to invest in more domestic shares with the same amount of capital. Therefore, foreign investors have sufficient economic reasons to enter TRS contracts, not only for tax avoidance purposes but also for rational economic purposes (Supreme Court Decision No. 2021Du51973, January 14, 2022).

Therefore, considering the lack of discrepancy between the nominal and substantive ownership of domestic shares by the plaintiff and the sufficient economic motives for foreign investors to enter into TRS contracts, not only for tax avoidance purposes but also for rational economic purposes, the decision in this case to impose withholding tax on foreign investors under the assumption of applying the substantive taxation principle is deemed unreasonable.

E. [National Tax Service] Whether Increased Valuation is Excludable When There Are Continuous Losses Under Article 14(2) of the Corporate Tax Act in the Last Three Years (Seomyeon 2023-Bupgyujaesan 3414, 2024.3.14.)

The inquiry concerns whether the exemption from increased valuation under the Enforcement Decree of Inheritance and Gift Tax Act §53(8)(1) applies when there have been continuous losses as defined by Article 14(2) of the Corporate Tax Act in the past three years before the valuation date. The question seeks clarification on whether this refers to losses under the Corporate Tax Act or cases where net profit and loss amounts under §56(4) of the Inheritance and Gift Tax Act Enforcement Decree are all losses.

Individual A, a major shareholder of Corporation A (a listed company), sold shares to related Corporation B in May 2022 through an off-hours block deal at the closing market price. Both parties are considered major shareholders under the Inheritance and Gift Tax Act, and the transaction, which involved a more than 1% change in shareholding, was deemed to transfer management rights. Thus, Individual A reported the transfer income tax based on the sale price plus a 20% premium. According to Article 89(1) of the Enforcement Decree of the Corporate Tax Act, if the shares meet any conditions under §53(8) of the Inheritance and Gift Tax Act Enforcement Decree, the increased valuation does not apply. Since Corporation A has experienced losses as defined by Article 14(2) of the Corporate Tax Act for the past three years, it falls under this exemption.

F. [National Tax Service] Treatment of Losses from Conversion of Overseas Subsidiary Loans into Equity (Seomyeon-2023-Bupgyugukjo-2595, 2024.4.18.)

The inquiry concerns the tax treatment of a domestic corporation that lends money to its overseas wholly owned subsidiary (Company A) and subsequently converts the loan into equity, resulting in a loss from the conversion. Specifically, the inquiry questions whether this conversion falls under the cancellation of debt obligation outlined in Article 4(2) of the International Tax Coordination Law and Article 4(1) of its Enforcement Decree, thus making the domestic corporation subject to disaffirmation of calculation by wrongful acts of related party transactions under Article 52 of the Corporate Income Tax Act.

When a domestic corporation converts loans to equity in its overseas wholly owned subsidiary, and the fair market value of the acquired shares is less than the loan amount, the difference falls under the cancellation of debt obligation towards the subsidiary under Article 4(2) of the International Tax Coordination Law and Article 4(1) of its Enforcement Decree. The cancellation of debt obligation makes the transaction subject to the disaffirmation of calculation by wrongful acts under Article 52 of the Corporate Income Tax Act, contingent on factual judgment. If the disaffirmation of calculation by wrongful acts does not apply, the loss should be treated according to Article 19-2...5 of the Framework Act on National Taxes, which addresses the treatment of losses from the relinquishment of claims by agreement.

G. [National Tax Service] Application of the Personnel Expense Limitation Regulation (§56(11) of the Corporate Tax Enforcement Decree) When Only 50% of the Income from Profit-making Activities is Deducted for Reserved Funds for Original Purpose Projects (Seomyeon-2023-Bupgyubupin-0003, 2024.5.16.)

The inquiry concerns whether the Personnel Expense Limitation Regulation (§56(11) of the Corporate Tax Enforcement Decree) applies to a social welfare corporation that includes 50% of the income from profit-making activities as deductions for reserved funds for original purpose projects. Specifically, it asks if this regulation applies to personnel expenses paid by the social welfare corporation. The corporation in question plans to pay personnel expenses exceeding KRW 80 million per year without obtaining approval from the competent authority.

According to the Ministry of Economy and Finance's interpretation, when a social welfare corporation includes 50% of the income from profit-making activities as deductions for reserved funds for original purpose projects, the Personnel Expense Limitation Regulation does not apply to the personnel expenses paid by the corporation. Therefore, the corporation's planned personnel expenses exceeding KRW 80 million would not be subject to this limitation, provided they meet the specified condition of including only 50% of the income as deductions.

Contacts

If you have any questions regarding the above information, please contact the provided contact information below, and we will be happy to assist you with a response.

Tax Partner, Scott Oleson | scoleson@deloitte.com
Tax Partner, Young Pil Kim | youngpkim@deloitte.com