The purport of Article 93 subparag. 11(b) of the former Corporate Tax Act and Article 132(10) of the former Enforcement Decree of the Corporate Tax Act / Where a foreign corporation receives money as compensation for penalty or compensation in the Republic of Korea due to a breach or cancellation of a contract within the scope of compensation for actual losses that may cause a decrease in net assets in connection with the contract, whether the said provision constitutes “money received in excess of compensation for payment itself under the original contract” (negative)

Article 93 subparag. 11 (b) of the former Corporate Tax Act (Amended by Act No. 10423, Dec. 30, 2010; see Article 93 subparag. 10 (b) of the current Corporate Tax Act); Article 93 subparag. 10 (b) of the Corporate Tax Act; Article 132(10) of the former Enforcement Decree of the Corporate Tax Act (Amended by Presidential Decree No. 22577, Dec. 30, 2010)

Han Bank Co., Ltd. (Law Firm LLC, Attorneys Kang Han-hun et al., Counsel for the plaintiff-appellant)

The Head of Nam-gu Tax Office (Law Firm Namsan, Attorneys Lee Chang-soo et al., Counsel for the plaintiff-appellant

Seoul High Court Decision 2017Nu46365 decided January 17, 2018

The appeal is dismissed. The costs of appeal are assessed against the defendant.

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

1. Case summary

A. During the period from June 9, 2006 to October 27, 2006, new SELS Co., Ltd. (hereinafter “SELS Shipbuilding”) and one shipbuilding company (hereinafter “domestic shipbuilding company”) entered into a contract with the Pomos SP Co., Ltd., Ltd. and two foreign corporations (hereinafter “foreign vessel owners”) for shipbuilding a total of four vessels (hereinafter “each shipbuilding contract”).

B. Under each shipbuilding contract of this case, foreign vessel owners shall first pay part of the vessel price to domestic shipbuilding officers prior to the completion of shipbuilding, and where each shipbuilding contract of this case is terminated due to reasons such as termination or termination, the domestic shipbuilding officers shall refund to foreign vessel owners the vessel price already received (hereinafter “Advance payment”) and the interest calculated at the rate of 7% per annum from the date of receipt to the date of refund, but the refund of advance payment and interest shall be exempted from all obligations, duties and legal liability to both parties, and shall be governed by English law as the governing law of the contract.

C. Meanwhile, between August 24, 2006 and March 31, 2008, the Plaintiff concluded a contract with a foreign vessel owner to guarantee an advance payment and an obligation to refund interest to the foreign vessel owners under each shipbuilding contract of this case (hereinafter “each of the instant guarantee contracts”).

D. However, foreign vessel owners rescinded each of the instant shipbuilding contracts with domestic shipbuilding owners for reasons such as delay in delivery of the vessel, and filed a claim with the Plaintiff for the payment of the advance payment and interest that the domestic shipbuilding owners received based on each of the instant insurance contracts.

E. Accordingly, between August 17, 2010 and September 16, 2010, the Plaintiff paid each advance payment and its interest (hereinafter “interest at issue”) to the foreign vessel owners (hereinafter “interest at issue”).

F. The Defendant issued the instant disposition that collects and imposes corporate tax withheld for the business year 2010 on the Plaintiff on the ground that the interest at issue was not withheld even if the other income pursuant to Article 93 subparag. 11(b) of the former Corporate Tax Act (amended by Act No. 10423, Dec. 30, 2010; hereinafter “former Corporate Tax Act”) constituted a foreign corporation’s domestic source income.

2. As to the ground of appeal

A. Article 93 Subparag. 11(b) of the former Corporate Tax Act provides that “income prescribed by the Presidential Decree, which is penalty or compensation paid in the Republic of Korea, is one of the domestic source income of a foreign corporation,” and Article 132(10) of the former Enforcement Decree of the Corporate Tax Act (amended by Presidential Decree No. 22577, Dec. 30, 2010; hereinafter “instant provision”) pursuant to the delegation, “income prescribed by the Presidential Decree” under the said provision means the amount of damages paid due to a breach or termination of a contract on the right to property, which exceeds the damages on the payment itself under the original contract, regardless of the title thereof.”

The purport of the instant provision is to: (a) a penalty or compensation paid in Korea by a foreign corporation due to a breach or termination of a property right contract is compensation for the actual decrease in assets incurred due to a counterparty’s default, etc.; and (b) a net asset increase is not deemed as other income in the event there is no net asset increase; (c) however, if penalty or compensation has been paid in excess of the aforementioned compensation, it constitutes other income, which is a domestic source income of a foreign corporation, due to the occurrence of a new income or income beyond the compensatory damages, and thus, is subject to taxation.

In light of the contents and purport of the foregoing provision, even if a foreign corporation received money as a penalty or compensation in the Republic of Korea due to a breach or termination of a contract, if it is within the scope of compensation for actual losses that may cause a decrease in net assets in connection with the contract, it does not constitute “money received in excess of compensation for payment under the original contract” as referred to in the instant provision.

B. Examining the reasoning of the lower judgment in light of the aforementioned legal principles and records, the lower court is justifiable to have determined that the interest at issue cannot be deemed to constitute a foreign corporation’s domestic source income under Article 93 subparag. 11(b) of the former Corporate Tax Act, based on the circumstances stated in its reasoning. In so doing, it did not err by misapprehending the legal doctrine on penalty or indemnity under Article 93 subparag. 11(b) of the former Corporate Tax Act, burden of proof of special damage, etc.

3. Conclusion

Therefore, the appeal is dismissed, and the costs of appeal are assessed against the losing party. It is so decided as per Disposition by the assent of all participating Justices on the bench.

Justices Kim Jae-hyung (Presiding Justice)