Responding to Taxation and Tax Investigation Corporate Tax Issue: Repudiation of Wrongful Calculation Cases Determined Based on the Economic Rationality in Repudiation of Wrongful Calculation

 

Responding to Taxation and Tax Investigation

Corporate Tax Issue: Repudiation of Wrongful Calculation

Cases Determined Based on the Economic Rationality in Repudiation of Wrongful Calculation | Dowoo Hwasan

 

Repudiation of Wrongful Calculation, Tax Investigation Response Team, Tax Attorney | Dowoo Hwasan Attorneys & Counselors | Hokeun Yoon, Managing Partner of Dowoo Hwasan

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· Definition of Repudiation of Wrongful Calculation (Article 52 of the Corporate Tax Act)

 When it is acknowledged that the corporation has unjustly reduced the burden of taxation on corporate income from the transaction with a related party, this tax system taxes by recalculating the objectively reasonable income regardless of the corporate act or calculation of income (hereinafter, “wrongful calculation”).

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For instance, despite the company purchasing real estate at a higher price than the market price to use it for business from a related party, if the company reported the entire amount of real estate sales as deductible by considering thereof as expenses, the difference between the actual sales price and the market price will be subjected to the repudiation of wrongful calculation.

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· How Reputation of Wrongful Calculation is Determined

Determined centering on whether the type of transaction falls under the cases where it is admitted as wrongful reduction of tax burdens.

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Key Corporate Tax Issue: Reputation of Wrongful Calculation

Key Controversial Issues?

1. Purchasing assets from a related party at a price higher than the market price

2. Transferring assets to a related party at a price lower than the market price

3. Lending money to a related party without consideration or at a low-interest rate

4. Borrowing money from a related party at a high-interest rate

 

​- The Requirement of the Economic Rationality Must be Reviewed (see Supreme Court 2020. 3. 26. Decision 2018DU56459)

When a corporation unlawfully evades or reduces tax burdens by abusing and pretending various types of transactions listed under each subparagraph of Article 88(1) of the Enforcement Decree of the old Corporate Tax Act (before amended by the Presidential Decree No. 26981, 2016. 2. 12, same below) and not by reasonable methods of normal business persons in transactions with parties in a related relationship with the corporation, the repudiation of wrongful calculation prescribed under Article 52 of the old Corporate Tax Act allows the tax authority to repudiate thereof and deems there is income that is objective and reasonable under the methods prescribed under the law.

 

This applies only to cases where it is admitted that economic rationality is ignored by conducting unnatural and irrational calculations from the perspective of business persons. The determination of economic rationality is made based on whether the transaction lacks economic rationality and therefore is abnormal in light of sound social norms and business practices when various circumstances of the transaction are considered specifically, while the transaction price among persons with no related relationship and special circumstances at the time of the transaction must also be considered.

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Key Corporate Tax Issue: Reputation of Wrongful Calculation

Determined based on ‘Market Price’?

The price that applies to or determined to be applicable in normal transactions between persons without a special relationship under sound social norms and commercial practices.

 

In principle, ‘Market Price’ refers to an objective value of exchange formed under normal transactions. However, when it is difficult to confirm such a market price, a price evaluated with an objective and reasonable method can be deemed as market price. Yet, the burden of proof for the market price used as the standard for applying the repudiation of wrongful calculation shall be borne by the tax authority claiming for the repudiation of wrongful calculation (see Supreme Court 2005. 5. 12. Decision 2003DU15287).

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In the transaction among persons with a related relationship: ① there are transactions among third parties with the same or similar type of transaction à refer to the price in the third-party transactions (Article 89(1) of the Enforcement Decree of the Corporate Tax Act); ② there is no transaction among third parties with the same or similar type of transaction à follow the laws and regulations including the valuation method under the Inheritance Tax and Gift Tax Act (below Article 89(2) of the Enforcement Decree of the Corporate Tax Act).

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Repudiation of Wrongful Calculation

 

Cases Determined Based on Economic Rationality

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Supreme court 2018. 12. 18. Decision 2017DU47519

 

What is Economic Rationality?

When there is a circumstance whereby a corporation had to conduct the transaction prescribed under Article 88(1) of the Enforcement Decree of the Corporate Tax Act in transacting with a related person or it is difficult to conclude that the profit is distributed to a related person from economic perspectives, the transaction is economically rational.

 

As B, the largest shareholder and actual executive of A Corp., entered into a stock transfer agreement under the conditions of transferring stocks of A Corp. held by B and bonds with warrants that B acquired from A Corp. to C Corp. In doing so, B committed to transfer the management rights for A Corp., while 100% of the shares of D Corp. held by A Corp. would be purchased by B and it was agreed that the payment of the purchase price can be set off with the principal and interests for the bonds with warrants held by B. 

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Then, B entered into the stock purchase agreement for acquiring shares of D Corp. held by A under the agreement above, the tax authority concluded that A Corp. wrongfully transferred its shares to B in a related relationship at a low price and thereby imposed general income tax to B by adding the difference between the share price calculated under Article 63 of the old Inheritance Tax and Gift Tax Act and the above share transfer payment to the profit of the business year concerned of A Corp., thereby treating it as income as dividends to B.

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​▶In the special circumstances where B tries to forego its position as the largest shareholder of A Corp., B agreed to acquire shares of D Corp. à the purchase price indicated on the contract shall not be the sole standard to determine whether the transfer was made at a low price à it cannot be concluded the above stock transfer agreement lacks economic rationality à it cannot be concluded that the above stock transfer agreement is an abnormal transaction without economic rationality, being subject to the repudiation of wrongful calculation.

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1. B relinquished its bonds of A Corp. to resolve the contingent liabilities and maintain A Corp.’s listing.

2. After acquiring D Corp., which had been continuously incurring losses, B intended to continue to operate it without liquidating it.

3. At the time of the transaction, the share value per share of the D Corp. was only 0 won, and the net asset value of D Corp. continued to decline until the end of 2011, after the transaction date.

4. D Corp. had already received operating funds from B, and B intended to settle D Corp.’s debts via stock transfer.

5. The case to be compared as presented by the Defendant (stock exchange transactions between shareholders of D Corp. and A Corp., capital increase for shareholders of D Corp. to recover their investment) is not suitable for comparison because the case has different circumstances and purposes.

 

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