Tax Tribunal-2016-C-4191 ( October 31, 2017)

Whether the bad debt amount of a debt-equity swap is deducted

Where the whole amount of a debt-to-equity swap has been reduced without compensation according to the rehabilitation plan, the rehabilitation claim can be deemed to have been finalized as unrecoverable, but the rehabilitation claim cannot be deemed to have been finalized as unrecoverable.

Article 45 of the Value-Added Tax Act

Disposition to revoke the imposition of value-added tax by the Seoul Administrative Court 2017Guhap76302

○ Construction Corporation

○ Head of tax office

April 4, 2019

May 16, 2019

1. The Defendant’s increase in excess of KRW 0 of the value-added tax for the second period of 2015 against the Plaintiff shall be revoked.

2. The plaintiff's remaining claims are dismissed.

2. 5/6 of the costs of lawsuit is assessed against the Plaintiff, and the remainder 1/6 is assessed against the Defendant, respectively.

Cheong-gu Office

The defendant's disposition of increasing KRW 0 of the value-added tax for the second term of 2015 against the plaintiff shall be revoked.

1. Details of the disposition;

A. On January 7, 2015, the Plaintiff was decided to commence rehabilitation procedures by Seoul Central District Court 2014 Gohap000, and was decided to commence rehabilitation plans on July 3, 2015 (hereinafter “instant rehabilitation plan”).

B. According to the instant rehabilitation plan, “(i) for rehabilitation creditors with a special relationship, 85% of the principal and interest prior to commencement shall be converted into equity, and 15% shall be paid in cash, ② for other rehabilitation creditors, 50% of the principal and interest prior to commencement shall be paid in cash, and 50% of the debt shall be paid in cash, and the debt to be converted into equity shall be substituted for the repayment of the relevant rehabilitation claim on the effective date of the shares newly issued by the debtor. The amount of the face value of 5,000 won shall be converted into 5,000 won for common shares and 5,000 won for each common share and 1 share

The total amount of shares converted into investment is to be retired without compensation.

C. According to the instant rehabilitation plan, the remaining amount of the rehabilitation claim against the Plaintiff was converted into investments. Of the new shares issued through a conversion into investments, shares acquired by 00, Co., Ltd., Ltd., 00 IT, 00, 00, and consulting division (hereinafter collectively referred to as “specially related parties”), which are rehabilitation creditors having a special relationship with the Plaintiff, were all retired without compensation. Shares acquired by 00 energy, Co., Ltd., Ltd., 000, 000, Co., Ltd., Ltd., 000, 000, Co.,, Ltd., Ltd., 000, 00HS, and 00 mid-term Co., Ltd. ( collectively referred to as “non-specially related parties”) were consolidated at the rate of 5:1 on July 31, 2015.

D. A related party and a non-related party (hereinafter collectively referred to as "the rehabilitation creditor of this case") deemed that the book value of rehabilitation claims subject to conversion into investment under the rehabilitation plan of this case and the difference between the market value of stocks issued through said conversion into investment or bad debts under the Value-Added Tax Act have occurred due to default bills, and filed a report on bad debts tax deduction for the amount equivalent to value-added tax from January 2016.

E. On August 1, 2016, the Defendant denied the Plaintiff’s input tax deduction amount equivalent to the bad debt tax amount upon the instant rehabilitation creditor’s report, and made an increase or decrease in the amount of KRW 0 as the value-added tax for the second term portion on August 1, 2016 (hereinafter “the first increase or decrease disposition”). On October 4, 2016, the Defendant again made an increase or decrease in the amount of KRW 0 as the value-added tax for the second term portion on 2015 (hereinafter “the second increase or decrease disposition”). Thereafter, the Defendant rendered a reduction in the amount of bad debt tax credit amount for the bad debts of KRW 00 among the first increase or decrease in the amount of KRW 0 ex officio on November 21, 2016 by deeming that it is not subject to deduction.

F. On October 28, 2016 and January 5, 2017, the Plaintiff rejected the Plaintiff’s remaining request for a re-investigation to the effect that “the market price of stocks converted into investment pursuant to the instant rehabilitation plan is re-audited on May 31, 2017,” which was the result of the re-audit to the effect that “the tax Tribunal dismissed the Plaintiff’s tax base and tax amount according to the results.”

G. The Defendant issued a subsequent disposition to reduce or increase a certain bad debt amount by each of the following rehabilitation creditors according to the aforementioned review decision, and reflected the subsequent disposition, and corrected the amount of value added tax for the second period of July 19, 2017 to the Plaintiff on July 19, 2017 (hereinafter referred to as “instant disposition, excluding KRW 00,000 reduced ex officio by the Defendant on the part corrected due to the first and second increase disposition, and excluding KRW 0,00,000 that was partially corrected by the above follow-up disposition, and hereinafter referred to as “the instant disposition”). However, in the instant rehabilitation creditors among the instant rehabilitation creditors, the first Defendant also considered a bad debt tax credit due to the debt-equity swap as the grounds for the report by the above rehabilitation creditors, but the balance between the book value of the stock subject to the debt-equity swap and the market value of the stock (hereinafter referred to as “the difference between KRW 935,93 per share”).

[Reasons for Recognition] Facts without dispute, Gap evidence Nos. 1 through 7, Eul evidence Nos. 1, 2, 3, 6 through 19 (including each number; hereinafter the same shall apply), the purport of the whole pleadings

2. Whether the instant disposition is lawful

A. The plaintiff's assertion

1) The Defendant rendered the instant disposition by deeming the instant difference to be subject to bad debt tax credit under Article 45 of the Value-Added Tax Act by deeming that the instant difference falls under “a claim confirmed to be impossible to be recovered according to the authorization of the rehabilitation plan pursuant to Article 19-2(1)5 of the former Enforcement Decree of the Corporate Tax Act (amended by Presidential Decree No. 27115, Apr. 29, 2016; hereinafter the same).”

2) However, according to the proviso of Article 72(2)4-2 and Article 15(4)1 of the former Enforcement Decree of the Corporate Tax Act, when a debt is converted into a debt according to a rehabilitation plan under the Debtor Rehabilitation Act, the acquisition value of shares arising from the conversion into a debt is the book value of the debt converted into a debt, and thus, it cannot be deemed that the amount of bad debt would accrue at the time of a conversion into a debt. ② In light of the methods and intent of the conversion into a debt under the Debtor Rehabilitation Act and the rehabilitation plan of this case, the initial debt upon a conversion into a debt can be deemed to have been repaid in full. ③ Even according to the legal principles of the issuance of new shares under the Commercial Act, the substance of the difference cannot be denied. Accordingly, the difference in this case shall be deemed to have been entirely extinguished by the repayment, and it shall not be deemed

3) Therefore, the instant disposition subject to the bad debt tax credit under the Value-Added Tax Act should be revoked as it is unlawful.

B. Relevant statutes

It is as shown in the attached Form.

C. Determination

1) The purpose and contents of the bad debt tax credit system

A) In supplying goods or services (hereinafter “goods, etc.”), an entrepreneur under the Value-Added Tax Act imposes value-added tax only on the portion corresponding to the added value created at the trading stage by paying the difference between the value-added tax collected at the time of the transaction’s supply of the goods, etc. (Article 31 of the Value-Added Tax Act) and the transactional partner’s collection of value-added tax (Article 31 of the Value-Added Tax Act). The Korea’s value-added tax, which adopts the pre-stage tax credit method, takes the form of transaction tax that imposes on the external appearance of transaction, not substantial income, unlike the income tax and corporate tax, is imposed regardless of whether the entrepreneur’s profit or loss (referring to the Constitutional Court Order 2009Hun-Ba11, Feb. 24, 201).

B) A person liable to pay value-added tax is not the supplier of goods, etc. (Articles 2 subparag. 3 and 3 subparag. 1 of the Value-Added Tax Act), and a supplier of goods, etc. should file a return and pay value-added tax within the reporting and payment period for the taxable period to which the time of supplying goods, etc. belongs, rather than the time of actual payment. As such, where an entrepreneur supplied goods, etc. on credit and fails to pay the value for reasons of the other party’s default or bankruptcy, etc., the entrepreneur suffers economic loss as well as the value-added tax paid by the State. In such a case, Article 45 of the Value-Added Tax Act provides for a system for a bad debt tax credit that is calculated by deducting the amount equivalent to the value-added tax that the entrepreneur has not received from the other party, i.e., the bad debt tax amount, from the output tax amount to be paid later (see Supreme Court Decision 2006Du13855, Apr. 24, 2008).

C) The legislative intent of such a bad debt tax credit system is also known in its history;

The Value-Added Tax Act, enacted by Act No. 2934 on December 22, 1976, does not have any provision on bad debt tax deduction, was newly established under Article 17-2 in the Value-Added Tax Act amended by Act No. 4663 on December 31, 1993, so that bad debt tax deduction can be applied from the first portion supplied or supplied after January 1, 1994.

Article 63-2 of the Enforcement Decree of the Value-Added Tax Act (amended by Presidential Decree No. 14081, Dec. 31, 1993) provides for the grounds for bad debt tax credit for bankruptcy, compulsory execution, declaration of death, and decision of approval of a company reorganization plan. Article 63-2 of the Enforcement Decree of the Value-Added Tax Act (amended by Presidential Decree No. 15103, Jul. 1, 1996) added the grounds for bad debt tax credit when the extinctive prescription under the Commercial Act expires and six months have elapsed from the date of default on checks or bills. Since the Value-Added Tax Act provides separate grounds for bad debt tax credit for a reasonable period of bad debt tax credit under the Corporate Tax Act, Article 63-2(1) of the Enforcement Decree of the Value-Added Tax Act (amended by Presidential Decree No. 1930, Feb. 9, 2006) provides for the scope of bad debt tax credit for the purpose of expanding the scope of bad debt tax credit under Article 17(3).1).

2) Interpretation of relevant provisions and legal principles

A) The main sentence of Article 17-2(1) of the Value-Added Tax Act provides that "where an entrepreneur supplies goods or services subject to the imposition of value-added tax, and all or part of credit sales or other sales claims (referring to those which include value-added tax) cannot be recovered as bad debt due to the bankruptcy or compulsory execution of a person who receives the supply, or other causes prescribed by Presidential Decree, 10/110 of the irrecoverable amount due to bad debt (hereinafter referred to as " bad debt tax amount") may be subtracted from the output tax amount in the taxable period whereto belongs the date when the bad debt becomes final and conclusive, and the main sentence of Article 17-2(3) provides that when the entrepreneur who receives the goods or services deducts all or part of the amount equivalent to the bad debt tax amount as the input tax amount under Article 38 before the entrepreneur closes his/her business, the entrepreneur who receives the goods or services shall deduct the relevant bad debt tax amount from his/her input tax amount in the taxable period whereto belongs the date when the bad debt becomes final and conclusive."

In addition, Article 87(1) of the former Enforcement Decree of the Value-Added Tax Act (amended by Presidential Decree No. 29535, Feb. 12, 2019; hereinafter the same) provides that "any reason for recognizing bad debts as bad debts pursuant to Article 19-2(1) of the Enforcement Decree of the Corporate Tax Act" is "a reason for bankruptcy or compulsory execution or other reason prescribed by Presidential Decree" among "a reason prescribed by Presidential Decree". Article 19-2(1)5 of the Enforcement Decree of the Corporate Tax Act provides that "a claim confirmed as bad debts due to a decision to grant authorization for the rehabilitation plan under the Debtor Rehabilitation Act or a court'

B) Meanwhile, when it is decided to authorize the rehabilitation plan, the rights of rehabilitation creditors, rehabilitation secured creditors, shareholders and equity right holders are altered according to the rehabilitation plan (Article 252(1) of the Debtor Rehabilitation Act); and the court may, by prescribing the rehabilitation plan on matters, such as the amount of liabilities that are to be decreased by the issuance of new shares, etc., require the debtor, who is a stock company, to issue new shares without having rehabilitation creditors, rehabilitation secured creditors or shareholders make new payments or make investments in kind (Article 206(1) of the Debtor Rehabilitation Act). When the court prescribes the amount of capital to be reduced and the methods of reducing capital are prescribed in the rehabilitation plan, the debtor’s capital to be a stock company according to the rehabilitation plan may be reduced. In such cases, the provisions of Articles 343(2), 439(2) and (3), 440, 441, 445 and 446 of the Commercial Act shall not apply (Article 205(1), 26(1) and (2) of the Debtor Rehabilitation Act).

C) Ultimately, in a case where shares issued through a debt-equity swap without requiring payment, etc. in the rehabilitation plan are determined to be substituted for repayment of existing rehabilitation claims, etc. through a debt-equity swap without requiring payment, but the shares newly issued through such debt-equity swap pursuant to the validity of the authorized rehabilitation plan are unlikely to be exercised as shareholders, and it is evident that they will be retired without any other consideration. As such, it is reasonable to deem that rehabilitation claims, etc., which are the premise for such debt-equity swap as above, have become impossible to recover according to the authorization of the rehabilitation plan (see, e.g., Supreme Court Decisions 2017Du68295, Jun. 28, 2018; 2016Du6565, Jul. 11, 2018).

D) However, under the principle of no taxation without law, the interpretation of tax laws and regulations shall be interpreted in accordance with the text of the law, barring any special circumstance, and it shall not be extensively interpreted or analogically interpreted without any justifiable reason. In particular, it is also consistent with the principle of fair taxation with the principle of fair taxation to strictly interpret the provisions that can be seen as clearly preferential provisions among the requirements for reduction and exemption (see, e.g., Supreme Court Decision 2008Du11372, Aug. 20, 2009). In addition, in light of the fact that value-added tax has the nature of transaction tax, construing the reason that the Corporate Tax Act regulating the taxation of corporate income as early bad debt in the case of value-added tax should be allowed only in exceptional cases where there are special circumstances, such as where it can be deemed that it was impossible to recover according to the authorization of the rehabilitation plan

3) Whether the difference in this case constitutes "a claim for which recovery due to the rehabilitation claim of a person with a special relationship is confirmed" and is subject to a bad debt tax credit.

Based on the aforementioned relevant legal principles, it is reasonable to view that rehabilitation claims against the plaintiff by a specially related person constituted "a claim confirmed as impossible to be recovered according to the authorization of the rehabilitation plan" under Article 19-2 (1) 5 of the former Enforcement Decree of the Corporate Tax Act, since the fact that the remaining amount of the rehabilitation claims against the plaintiff except for the cash repayment portion among the rehabilitation claims against the plaintiff by a specially related person was converted into equity and that the shares acquired by the specially related person were entirely retired without compensation as seen earlier. Therefore, the amount equivalent to the amount of the rehabilitation claims by a specially related person out of the difference in the difference in the case of this case calculated by deducting the amount equivalent to the amount of the rehabilitation claims by the plaintiff from the input tax amount for the second half-year period of 2015, is lawful, and this part of the plaintiff'

4) Whether the portion arising from the rehabilitation claim of a non-specially related person among the difference in the instant case constitutes equally subject to a bad debt tax credit

In light of the purport and content of the system of bad debt tax deduction as seen earlier and the relevant provisions, comprehensively taking account of the following circumstances revealed by adding the purport of the entire pleadings to the facts acknowledged earlier, it is difficult to view the rehabilitation claim against the Plaintiff of a non-specially related person as a bad debt pursuant to Article 19-2(1)5 of the former Enforcement Decree of the Corporate Tax Act or the court’s immunity. Therefore, it is unlawful to deem that the rehabilitation claim against the Plaintiff of a non-specially related person constitutes “a claim confirmed to be impossible to be recovered due to the decision to grant authorization for the rehabilitation plan or the court’s immunity.” Therefore, the part relating to the rehabilitation claim of a non-specially related person out of the difference in this case constitutes bad debt under Article 19-2(1)5 of the former Enforcement Decree of the Corporate Tax

(1) In order to fully or partially repay obligations, a debt-equity swap is a type of debt adjustment for claims and obligations that are issued by the debtor to the creditor, which results in the adjustment of obligations through the alteration of the capital structure converted into equity capital. As can be seen, in cases where the debt-equity swap is to substitute for repayment of existing claims through the method of issuing new shares, the agreement or agreement between the creditor and the debtor on the value of the existing claims extinguished by the debt-equity swap shall govern, and in cases where there is no agreement thereon, it is reasonable to view that the value of new shares assessed as of the effective date of issuing new shares as of the date of issuance of new shares and the amount of existing claims equivalent to the appraised amount have been repaid (see Supreme Court Decision 2008Da18376, Jul. 24, 2008). However, in cases of rehabilitation creditors, it is reasonable to deem that an agreement on debt-equity swap exists between the interested parties as well as the value of the existing claims that were extinguished by the rehabilitation plan as stipulated in the rehabilitation plan.

② According to Articles 421(1) and 423(1) and (2) of the Commercial Act, in the case of issuance of new shares, the underwriter of new shares is obligated to pay the total amount of the subscription price with respect to his/her shares subscribed on the date of payment. If the underwriter of new shares fails to pay or make an investment in kind on the date of payment, his/her rights are lost, and the effect of issuance of new shares is limited to the shares paid on the date of payment with respect to the shares to be issued. In light of the legal relationship of issuance of new shares, in the case of issuance of shares through a debt-to-equity swap, the whole debt to be converted into a debt-to-equity swap is deemed to have been paid with the subscription price with respect to the shares to be issued, but the effect of issuance of new shares takes effect with respect to the whole shares to be issued. As such, the part exceeding the market price of the shares issued on the ground of economic effect revealed as a result thereof cannot be denied (see Supreme Court en banc Decision 20

③ Articles 72(2)4(2)2(proviso) and 15(4)1(1) of the former Enforcement Decree of the Corporate Tax Act refer to “stocks acquired through debt-to-equity swap with respect to the acquisition value of assets.” However, in cases where a corporation whose rehabilitation plan including the content of conversion of liabilities into investment is decided pursuant to the Debtor Rehabilitation Act conducts debt-to-equity swap, the book value of the debt-to-equity swap should be the acquisition value of stocks, and thus, it should be considered that the profits from debt-to-equity swap should not be taxed at the time of debt-to-equity swap. The above provision is difficult to regard only as a provision to exclude profits from debt-to-equity swap, and it is also applicable in principle to determine whether the debt-to-equity swap under the Value-Added Tax Act falls under a cause for a bad debt tax credit under the Value-Added Tax Act.

④ The Defendant asserts that the legal doctrine, such as Supreme Court Decision 2017Du68295 Decided June 28, 2018 and Supreme Court Decision 2016Du6565 Decided July 11, 2018, applies to the portion arising from rehabilitation claims of non-specially related persons out of the difference in the instant case. As such, the Plaintiff’s instant disposition, excluding the Plaintiff’s amount equivalent thereto, is lawful. However, the foregoing Supreme Court precedents, supra, state that: (a) there is no room for the previous creditors to exercise rights as shareholders; (b) there is no exceptional case where the rehabilitation plan prescribed in the rehabilitation plan to retire all equity shares together with the debt-to-equity swap as in the rehabilitation claim of a non-specially related person; and (c) it is difficult to view that the remaining shares become a share after a debt-to-equity swap as in the non-specially related person’s rehabilitation claim to be converted to the value of the shares remaining after a debt-to-equity swap without consideration.

⑤ A rehabilitation plan may be approved only when rehabilitation creditors pass a resolution, and any rehabilitation creditor may freely pass a resolution on whether to substitute for repayment or only a part of the remaining rehabilitation claims after converting the whole amount of the rehabilitation claims, other than the portion of the rehabilitation claims repaid in cash on the premise that the rehabilitation claims are modified according to the rehabilitation plan. As such, it is difficult to deem that it is unreasonable to acknowledge a change of the rehabilitation claim according to the rehabilitation plan. Although a certain ratio of the rehabilitation claims are determined in the rehabilitation plan to be substituted for repayment through conversion into equity, if the rehabilitation claim is subsequently denied and only the amount equivalent to the actual market price of the shares is actually repaid and the remainder is deemed to be a claim that has become final and conclusive due to impossibility of recovery, the rehabilitation company bears an unforeseeable debt, and some rehabilitation creditors take advantage of the equity relationship with other rehabilitation creditors, thus going against the purport of the rehabilitation procedure system that intends to efficiently recover the debtor or his/her business. Considering these circumstances, it is difficult to deem the need to apply the scope of the rehabilitation claim as an exception to the principle of taxation of value-added tax, which is imposed on the external appearance of transaction.

5) Whether the rehabilitation claim of a non-specially related person is a credit account receivable of a small and medium enterprise for which six months have passed since the date of default

The defendant asserts that since the credit account receivable credit account receivable of small and medium enterprises for which six months have passed from the date of the plaintiff's default (on January 2, 2015), excluding 000 corporations, satisfies the bad debt requirement under the main sentence of Article 19-2 (1) 9 of the former Enforcement Decree of the Corporate Tax Act, it is reasonable to deny the plaintiff's input tax deduction corresponding to the bad debt tax

Article 19-2 (2) of the former Enforcement Decree of the Corporate Tax Act provides that "The date of default under paragraph (1) 9 of the same Article refers to the date of payment of default checks or default bills held by the financial company, etc., which presented the relevant checks or bills before the payment date and received confirmation of default from the financial company, etc."

On January 2, 2015, the mere fact that the Plaintiff issued a bill (see subparagraph 27) and the Plaintiff’s application for disposition of property preservation and general prohibition order on January 2, 2015 cannot be deemed to have passed the due date for the check or bill issued by the Plaintiff or to have been verified by the financial company, etc. Therefore, it is difficult to view that the rehabilitation claim of certain non-related parties constitutes the credit account receivables of small and medium enterprises for which six months have passed since the due date for the Plaintiff’s default.

Furthermore, inasmuch as the rehabilitation plan of this case provides that 50% of the principal and interest prior to the commencement of a debt-equity swap shall be paid in cash and 50% of the debt to be paid in cash shall substitute for the repayment of the rehabilitation claim concerned on the effective date of the shares newly issued by the Plaintiff, it is reasonable to view that the remaining rehabilitation claims, excluding the portion for which non-specially related persons would have been paid in cash, are extinguished through a debt-equity swap in lieu of the repayment of the rehabilitation claim concerned, and that the acquisition value of the shares to be acquired in this case shall be the book value of the bonds converted into a debt-equity swap pursuant to Article 72(2)4-2 of the Enforcement Decree of the Corporate Tax Act (the defendant's argument that it is reasonable to regard the recovered amount as the market value of the new shares that were issued through a debt-equity swap as the book value of the new shares that were issued, not the book value of the bonds converted into a debt-equity swap, and thus, it does not constitute an exception

Therefore, the defendant's above assertion does not seem to have any mother or reason.

6) Sub-decisions

Therefore, the part of the instant disposition, which increases the tax amount of KRW 0,00, is legitimate, and the part of the value-added tax imposed on the Plaintiff for the second period of February 2015, as the Plaintiff denies the Plaintiff’s input tax deduction on the premise that the remaining difference is subject to the bad debt tax deduction under the Value-Added Tax Act, is unlawful. Accordingly, the part of the increased tax amount exceeding KRW 0,00

3. Conclusion

Therefore, the plaintiff's claim is accepted within the scope of the above recognition, and the remaining claims are dismissed as it is without merit. It is so decided as per Disposition.