[1] The meaning of "subscriber" under Article 40 (1) of the former Inheritance Tax and Gift Tax Act, and whether a person acquiring convertible bonds, etc. for simple investment purposes falls under such meaning (negative in principle)

[2] In a case where Company A acquired both bonds with warrants issued by Company B and transferred them to Company B, who is the largest shareholder of Company B, and thereafter Company C received Company B’s stocks by exercising the preemptive right, and the tax authority determined and notified gift tax to Company C on the ground that Company C was benefiting from exercising the preemptive right, the case holding that Company A cannot be deemed to constitute an underwriter under Article 40(1) of the former Inheritance Tax and Gift Tax Act, and thus, gift tax cannot be imposed on Company C in light of all the circumstances

[1] Article 40(1) of the former Inheritance Tax and Gift Tax Act (amended by Act No. 11130, Dec. 31, 2011; hereinafter “former Inheritance Tax Act”) provides that “In cases where the largest shareholder of a corporation that has issued convertible bonds, etc. or any other person who has a special relationship with him/her acquires, acquires, or exchanges convertible bonds, bonds with warrant (referring to warrant certificates where preemptive rights are separated) or bonds entitled to take over stocks (hereinafter “convertible bonds, etc.”) with other stocks, or obtains profits falling under any of the following subparagraphs by converting, exchanging, or taking over stocks with convertible bonds, etc. by acquiring, exchanging, or taking over stocks, an amount equivalent to such profits shall be deemed the value of property donated to the person who has acquired such profits, as a result of acquiring, exchanging, etc. stocks from the corporation [including cases where the largest shareholder of a corporation that has issued convertible bonds, etc. or a person who has acquired stocks with a special relationship with him/her by acquiring, exchanging, etc. stocks from the corporation in excess of the market value of stocks].

In addition, Article 9 of the former Financial Investment Services and Capital Markets Act (amended by Act No. 11845, May 28, 2013) provides that the public offering of securities is “inviting 50 or more investors to make an offer to acquire new securities” under Article 9(7) of the former Financial Investment Services and Capital Markets Act; Article 9(8) of the same Act provides that “in the event that 50 or more investors make an offer to acquire securities newly issued, and do not fall under public offering”; Article 9(9) of the same Act provides that “in the event that 50 or more investors make an offer to sell or invite an offer to purchase securities already issued,” and Article 9(11)1 provides that “in the event of public offering, private placement, or public sale of securities, acquiring all or part of the securities for the purpose of acquiring such securities to a third party” and Article 9(12) of the same Act provides that “in the event that an underwriter publicly offering, or private placement is conducted, an act falling under any subparagraph of paragraph (11).”

In light of the contents of the aforementioned relevant statutes, an underwriter under Article 40(1) of the former Inheritance and Gift Tax Act merely refers to a person who acquires convertible bonds, etc. for the purpose of acquiring them by soliciting a third party to acquire subscription for acquiring convertible bonds, etc. for a corporation issuing convertible bonds, etc., and it is reasonable to view that the person who acquires them for the purpose of simple investment without such purpose does not constitute an underwriter

[2] In a case where Company A acquired both bonds with warrants issued by Company B and transferred them to Company B, who is the largest shareholder of Company B, and thereafter Company B received Company B’s stocks by exercising the preemptive right, and the tax authority deemed that Company C obtained profits by exercising the preemptive right, the case holding that the lower court erred by misapprehending the legal principles on the grounds that the aforementioned disposition was lawful, in light of all the circumstances, inasmuch as it is reasonable to view that Company A purchased bonds with warrants for the purpose of acquiring bonds or preemptive right on behalf of Company B by soliciting a third party to acquire bonds with warrants, and rather, it was reasonable to deem that Company A acquired them for the purpose of obtaining interest profits and investment profits, such as sales profits, etc. in the status of investors, and thus, it cannot be deemed that Company B cannot be deemed as an underwriter under Article 40(1) of the former Inheritance Tax and Gift Tax Act (amended by Act No. 11130, Dec. 31, 201) and thus, C cannot be imposed gift tax on Company B.

[1] Article 40(1)1(b) and 2(b) of the former Inheritance Tax and Gift Tax Act (Amended by Act No. 11130, Dec. 31, 201); Article 9(7), (8), (9), (11)1 (see current Article 9(11) and (12) of the former Financial Investment Services and Capital Markets Act (Amended by Act No. 11845, May 28, 2013); Article 40(1) of the former Inheritance Tax and Gift Tax Act (Amended by Act No. 11130, Dec. 31, 201); Article 9(12) of the former Financial Investment Services and Capital Markets Act (Amended by Act No. 11845, May 28, 2013)

Plaintiff (Law Firm LLC, Attorneys Yellow-man et al., Counsel for the plaintiff-appellant)

The Head of Gangnam District Tax Office (Attorney Cho Jae-ho, Counsel for the plaintiff-appellant)

Seoul High Court Decision 2016Nu64823 decided May 24, 2017

The judgment below is reversed and the case is remanded to Seoul High Court.

The grounds of appeal are examined (to the extent of supplement in case of supplemental appellate briefs not timely filed).

1. Case summary

A. On October 23, 2009, UND Co., Ltd. (hereinafter “END”) entered into a contract with Solomon Investment Securities Co., Ltd. (hereinafter “ Solomon”) to issue bonds with warrants worth KRW 4 billion in total face value (hereinafter “instant bonds with warrants”) (hereinafter “instant contract”). Solomon acquired all of the instant bonds with warrants under the instant contract.

B. On November 23, 2009, Solomon transferred the Plaintiff, who is the largest shareholder of Allodi, the right to subscribe to KRW 1 billion in face value, separated from the instant bonds with warrants (hereinafter “instant preemptive right”).

C. On September 16, 201, the Plaintiff exercised the instant preemptive right at KRW 986 per share and received delivery of KRW 1,014,198 of DNA shares by exercising the instant preemptive right.

D. Under the premise that Solomon falls under “takeover” under Article 9(12)2(b) of the former Inheritance Tax and Gift Tax Act (amended by Act No. 11130, Dec. 31, 201; hereinafter “former Inheritance Tax Act”), the Defendant applied Article 40(1)1(b) of the former Inheritance Tax and Gift Tax Act (amended by Act No. 11845, May 28, 2013; hereinafter “former Capital Markets Act”), based on the premise that the Plaintiff’s exercise of the preemptive right to new shares and obtained profits from KRW 976,00,752, and thus, determined and notified the Plaintiff of gift tax amounting to KRW 347,454,330 (including additional tax) (hereinafter “instant disposition”).

2. The judgment of the court below

The lower court, on the following grounds, determined that Solomon constituted an underwriter, dismissed the Plaintiff’s claim of this case.

A. The fact that Solomon acquired the instant bonds with warrants from Allod on October 23, 2009 is that the Plaintiff would again purchase 50% of the preemptive right to new stocks on the part of the Plaintiff.

B. According to the instant contract, the term “the instant contract” refers to a clause under which DNA shall pay Solomon a fee of KRW 160 million, and a clause under which Solomon shall freely transfer the instant bonds with warrants or separate only the preemptive right and transfer them to a third party without consent of DNA.

C. Solomon sold the remainder of DNA preemptive rights except the instant preemptive rights to new stocks to a third party.

D. Ultimately, Solomon may be deemed to have acquired the instant preemptive right for the purpose of having a third party acquire the instant preemptive right, and thus constitutes an underwriter under Article 9(12) of the former Capital Markets Act. On the premise of such fact, the instant disposition applying Article 40(1)2(b) of the former Inheritance and Gift Tax Act is lawful.

3. Judgment of the Supreme Court

A. Article 40(1) of the former Inheritance and Gift Tax Act provides that "where a person acquires any of the following profits by converting or exchanging convertible bonds, bonds with warrant (referring to warrant certificates if they are separated), or bonds entitled to take over stocks (hereinafter referred to as "convertible bonds, etc.") into, acquiring, or transferring convertible bonds, etc., or by converting, exchanging, or taking over stocks with convertible bonds, etc., he/she shall refer to the amount equivalent to such profits as the value of the donated property of the person who has acquired such profits, if he/she or a person specially related to the largest shareholder of the corporation which issued convertible bonds, etc. or such person acquires or acquires stocks, etc. from an underwriter under Article 9(12) of the Financial Investment Services and Capital Markets Act (hereinafter referred to as "acquisition, etc.") in excess of the number entitled to receive convertible bonds, etc. under subparagraph 1(b) and subparagraph 2(b) of the same Article, he/she shall be deemed the value of the stocks acquired by acquiring or exchanging them with the stocks at a price lower than the market price of the convertible bonds, etc."

In addition, Article 9(7) of the former Financial Investment Services and Capital Markets Act provides that “the solicitation of an offer to acquire securities newly issued to not less than 50 investors,” Article 9(8) of the same Act provides that “the solicitation of an offer to acquire securities newly issued shall not fall under public offering,” and Article 9(9) of the same Act provides that “the solicitation of an offer to sell or invite an offer to purchase securities already issued to not less than 50 investors.” Further, Article 9(11) of the same Act provides that “the solicitation of an offer to acquire all or part of the securities with a view to acquiring the securities by a third party,” and Article 9(12) of the same Act provides that “the underwriter shall be a person who performs an act falling under any subparagraph of paragraph (11) in cases of public offering, private placement, or public sale of securities.”

In light of the contents of the aforementioned relevant laws and regulations, an underwriter under Article 40(1) of the former Inheritance and Gift Tax Act merely refers to a person who acquires convertible bonds, etc. for the purpose of acquiring them by soliciting a third party to acquire them for the purpose of issuing convertible bonds, etc., and it is reasonable to deem that a person who acquires them for the purpose of simple investment without such purpose does not constitute an underwriter, barring special circumstances.

B. Examining the following circumstances revealed through the reasoning and record of the lower judgment in light of the legal doctrine as seen earlier, solomon cannot be deemed as an underwriter under Article 40(1) of the former Inheritance and Gift Tax Act.

1) At the time of October 23, 2009, UNDD issued the instant bonds with warrants, due to the cumulative business losses, the former representative director’s suspicion of embezzlement and breach of trust, and dispute over management rights, etc., in the crisis of default.

2) In order to raise operating funds, DNA entered into the instant contract with Solomon. The instant contract did not contain a prospectus, a private placement, or a sale of the instant bonds with warrants or preemptive rights to new stocks, or a prospectus and a report on issuance of securities, necessary to entrust solomon with or invite subscription to the instant bonds with warrants or preemptive rights.

3) The original Solomon sold immediately the preemptive right of KRW 2 billion equivalent to 50 billion of the instant bonds with warrants to the Plaintiff or a third party arranged by the Plaintiff for the purpose of investment, and the remaining preemptive rights were owned and disposed of for the purpose of investment. In other words, since Allomon is anticipated to have limited demand for such preemptive rights because it is in difficult management situation at the time of Allomon, it was anticipated that the demand for such preemptive rights would be limited. Therefore, as solomon, it was necessary for the Plaintiff to have the Plaintiff purchase the preemptive right compulsorily, and it was intended to realize profits early by immediately selling the preemptive right separate from the instant bonds with warrants.

4) Solomon presented such investment conditions to the Plaintiff, and the Nonparty, upon introduction by the Plaintiff, decided to purchase the preemptive right of KRW 2 billion on October 23, 2009, the instant bonds with warrants could have been issued.

5) Solomon acquired the instant bonds with warrants as equity capital by the department in charge of asset management headquarters, which performs the business of acquiring, publicly offering, private placement, and sale of domestic and foreign securities, not by the department in charge of the acquisition of the instant bonds with warrants, but by the department in charge of the asset management headquarters, which performs the business of investing in equity capital for the purpose of investment returns. Under the instant contract, solomon created a pledge right on the bonds with warrants, shares, and shares owned by the Plaintiff (including their spouse), and a collateral security right on real estate owned by the Plaintiff.

6) However, as the United Nations was subject to a de facto examination on November 23, 2009, when the sale and purchase of DNA shares was suspended, so Solomon demanded the Plaintiff to immediately purchase the remainder of the preemptive rights owned by Solomon. On the same day, the Plaintiff and any third party other than the Plaintiff acquired the remainder of the preemptive rights, including the instant preemptive rights, upon the said request. This was aimed at disposing of solomon’s remaining preemptive rights prior to the delisting of DNA shares, prior to the significant decline in the value of the preemptive rights. Furthermore, according to the instant contract, so, if the transaction was suspended on the securities market established by the Korea Exchange, or is subject to significant restriction on the transaction, the solomon may claim against solomon for all expenses incurred in connection with the instant contract, and thus, the Plaintiff could not accept the solomon’s demand.

7) The agreement of this case provides that Solomon may freely transfer the instant bonds with warrants without the consent of aldididi and that only the preemptive right may be transferred to a third party by separating only the preemptive right is to obtain profits from the sale of the instant bonds with warrants and the preemptive right in the status of investors. It seems that Solomon would have obtained profits from the sale of the instant bonds with warrants and the preemptive right, and that it would have been to obtain 160 million won payment to Solomon according to the agreement of this case.

8) In full view of the above circumstances, it is difficult to view that Solomon acquired the instant bonds with warrants for the purpose of acquiring the instant bonds with warrants or preemptive rights by soliciting a third party to acquire them for aldidy, and rather, it is reasonable to view that it acquired them for the purpose of obtaining investment profits, such as interest profits and sales profits, in the status of investors.

Therefore, gift tax cannot be levied on the Plaintiff on the premise that the Solomon falls under the underwriter as provided by Article 40(1) of the former Inheritance and Gift Tax Act.

C. Nevertheless, the lower court determined otherwise on the ground stated in its reasoning that the instant disposition was lawful. In so doing, it erred by misapprehending the legal doctrine on the underwriter under Article 40(1) of the former Inheritance and Gift Tax Act, thereby failing to exhaust all necessary deliberations, thereby adversely affecting the conclusion of the judgment.

4. Conclusion

Therefore, the lower judgment is reversed, and the case is remanded to the lower court for further proceedings consistent with this Opinion. It is so decided as per Disposition by the assent of all participating Justices on the bench.

Justices Kwon Soon-il (Presiding Justice)