[1] Legislative intent of Article 2(4) of the former Inheritance Tax and Gift Tax Act that provides that where gift tax is unjustly reduced by two or more acts or transactions, such acts or transactions shall be deemed a single act or transaction which is conducted consecutively according to the economic substance / Whether a taxpayer may be subject to gift tax pursuant to the said Article solely on the basis of the result that such transactions have been conducted in several stages (negative)

[2] In a case where there is a reasonable ground to believe that a transaction partner is making a transaction by appropriately reflecting the objective exchange value, or there is a ground to deem a transaction by such terms and conditions as normal from a reasonable economic standpoint, whether there is a justifiable ground under Articles 35(2) and 42(3) of the former Inheritance Tax and Gift Tax Act (affirmative), and whether gift tax may be imposed on the basis of the aforementioned provisions (negative in principle)

[3] In a case where Gap corporation issued bonds with warrants in the form of private placement; Eul corporation acquired bonds with warrants from Eul corporation on the same day and sold them immediately to Byung who is the representative director and the largest shareholder of Eul corporation immediately; Byung reported and paid gift tax on profits acquired from the acquisition and exercise of preemptive rights; and requested correction of gift tax upon Byung to refund gift tax paid, but the tax authority rejected such request, the case affirming the judgment below holding that gift tax cannot be imposed by applying Article 40 of the former Inheritance Tax and Gift Tax Act in light of all the circumstances, and furthermore, it cannot be imposed even on Article 35 (2) and Article 42 (1) 3 of the same Act

[1] Article 2(4) of the former Inheritance Tax and Gift Tax Act (amended by Act No. 11609, Jan. 1, 2013) provides that gift tax shall be imposed by deeming it as a continuous act or transaction according to economic substance in cases where it is deemed that an act or transaction subject to gift tax has been unjustly reduced by means of two or more acts or transactions. This provides that gift tax shall be imposed bypassing or changing the transaction subject to gift tax, thereby achieving the effect of gift while coping with the tax evasion that unfairly reduces gift tax, the said act or transaction is deemed to be one act or transaction subject to gift tax, and thus, the said act or transaction should be deemed as one act or transaction subject to gift tax. However, a taxpayer may choose one of the various legal relations in order to achieve the same economic purpose in the course of economic activities, and the tax authority as the party’s chosen legal relationship should respect the legal relationship, barring special circumstances. Moreover, the outcome of the transaction after multiple stages of transactions should not be readily concluded as a result of a gift tax act or any other external act.

[2] The legislative intent of Articles 35(2) and 42(1) of the former Inheritance and Gift Tax Act (amended by Act No. 11609, Jan. 1, 2013; hereinafter “former Inheritance and Gift Tax Act”) lies in coping with modified gift acts and promoting fairness in taxation by imposing gift tax on the profits earned by the trading partner when a transaction partner transfers profits in fact free of charge through abnormal means. However, in the case of transactions between unrelated parties, the difference between interests is general and easy in terms of giving up an opportunity to gain profits by himself/herself. As such, Articles 35(2) and 42(3) of the former Inheritance and Gift Tax Act stipulate that “any transactions between unrelated parties, unlike those between unrelated parties, should not have justifiable grounds for customs duty” should be added to the taxation requirement of “where there is no justifiable reason to believe that there is no justifiable reason to believe that there is no justifiable reason to believe that there exists a transactional relationship between unrelated parties based on the transaction between unrelated parties, it should be deemed that there is no justifiable reason to view that there exists any justifiable reason for the transactional duty of Article 2(3).

[3] In a case where Company A issued bonds with warrants in the form of private placement, and Company B, etc. immediately sold the preemptive right separated from the bonds with warrants from Company A on the same day to Company B, who is the representative director and the largest shareholder of Company B, and C, upon reporting and paying gift tax on profits acquired from the acquisition and exercise of preemptive right, requested for the refund of gift tax paid, but the tax authority rejected such request, the case affirming the judgment below that Company B, etc. cannot be deemed to have acquired bonds with warrants in the position of investors for the purpose of gaining interest profits and sale profits, and thus, it cannot be deemed to have obtained bonds with warrants without justifiable grounds under Article 9(12) of the former Financial Investment Services and Capital Markets Act (amended by Act No. 11845, May 28, 2013); Article 40(1)1 of the former Inheritance Tax and Gift Tax Act (amended by Act No. 11609, Jan. 1, 2013; hereinafter “former Inheritance Tax Act”) or Article 40(1)2) of the former Tax Act.

[1] Article 2(1) and (3) (see current Article 4(1) and (4) (see current Article 2 subparag. 6) of the former Inheritance Tax and Gift Tax Act (Amended by Act No. 11609, Jan. 1, 2013); Article 14(3) of the Framework Act on National Taxes / [2] Articles 35(2), 42(1) and (3) of the former Inheritance Tax and Gift Tax Act (Amended by Act No. 11609, Jan. 1, 2013); Article 9(12) and (3) of the former Financial Investment Services and Capital Markets Act (Amended by Act No. 11845, May 28, 2013); Article 2(4) and (3) of the former Inheritance Tax and Gift Tax Act (Amended by Act No. 11609, Jan. 1, 2013; see current Article 14(3) and (4)1); Article 4(3) and (3)(1) and (2)(3)(a) of the former Framework Act on National Taxes

[1] Supreme Court Decision 2015Du3270 Decided January 25, 2017 (Gong2017Sang, 475) / [2] Supreme Court Decision 2013Du5081 Decided August 23, 2013 (Gong2013Ha, 1731) Supreme Court Decision 2012Du20915 Decided June 12, 2014 (Gong2013Du24495 Decided February 12, 2015) (Gong2017Du61089 Decided March 15, 2018)

Plaintiff (Law Firm Woo, Attorney Lee Jae-soo, Counsel for plaintiff-appellant)

Director of the tax office

Seoul High Court Decision 2016Nu40933 decided July 14, 2017

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. Whether Article 40(1)1(b) and Article 40(1)2(b) of the former Inheritance Tax and Gift Tax Act apply (ground of appeal No. 1)

A. Article 40(1) of the former Inheritance Tax and Gift Tax Act (amended by Act No. 11609, Jan. 1, 2013; Article 40 of the same Act was amended by Act No. 1357, Dec. 15, 2015; hereinafter “former Inheritance Tax Act”) provides that “where a person acquires or acquires convertible bonds, bonds with warrant (referring to warrant certificates if they are separated) or bonds entitled to take over stocks by converting into or exchanging with other stocks, or by which a right to take over stocks is granted (hereinafter “convertible bonds, etc.”) by acquiring or exchanging stocks with stocks, or by acquiring or exchanging stocks with convertible bonds, etc., he/she shall be deemed the value of property donated to the person who has acquired such profits.” Subparagraph 1(b) and subparagraph 2(b) of Article 40(1) of the same Act provides that “In cases where a person who has obtained profits from the largest shareholder of the corporation who has issued convertible bonds, etc. or his/her specially related person, acquires or exchanges stocks from the corporation in proportion to their market price.”

B. Comprehensively taking account of the evidence adopted, the lower court acknowledged the fact that the instant company issued bonds with warrants in the form of private placement on June 28, 201, and the Ga Capital Co., Ltd. (hereinafter “Ga Capital”) and the Ga Capital Co., Ltd. (hereinafter “Ga Capital”) acquired bonds with warrants from the instant company on the same day and immediately sold the instant preemptive right separated from the bonds with warrants to the Plaintiff. Based on such fact, the lower court determined that the Ga Capital Capital and Do Capital cannot be deemed an underwriter under Article 9(12) of the former Financial Investment Services and Capital Markets Act (amended by Act No. 11845, May 28, 2013; hereinafter “former Capital Markets Act”). Accordingly, the lower court did not impose gift tax on the grounds that Article 40(1)1(b) or 2(b) of the former Capital Markets Act cannot be deemed as the following grounds.

(1) In order to constitute an underwriter under Article 9(12) of the former Capital Markets Act, securities must be acquired for the purpose of acquiring them to a third party. It is insufficient to deem that the said purpose was established at the time, and there is no other evidence to acknowledge otherwise.

(2) Rather, the first sentence of the underwriting contract for the instant bonds with warrants states that, by stating that “the term “the acquisition under this contract means the acquisition of the right to the bonds issued under this contract, and it does not mean the acquisition under Article 9(11) of the former Capital Markets Act,” it is not an underwriter pursuant to Article 9(12) of the former Capital Markets Act. In addition, the said underwriting contract does not include the content that Capital Capital and New Capital shall not bear risks arising from the issuance, etc. of the bonds with warrants, nor does it receive fees equivalent to the price for the acquisition of the bonds.

(3) In order to minimize investment risks in bonds with warrants and to realize investment profits early, Capital Capital and Capital took the terms of investment in separating preemptive rights on the day on which the bonds are issued and selling them to the Plaintiff, etc., who is the largest shareholder, as a condition for investment. The Plaintiff merely acquired the preemptive rights of this case on the day when the bonds are issued.

(4) Ultimately, it is reasonable to view that the Capital Markets and the Capital Markets do not constitute an underwriter under Article 9(12) of the former Capital Markets Act, but merely acquired bonds with warrants in the position of an investor to obtain interest income and sales profit.

C. Examining the reasoning of the lower judgment in light of the relevant legal doctrine and the evidence duly admitted, the lower court did not err in its judgment by misapprehending the legal doctrine on the interpretation and application of Article 40(1)1 Item (b) and Article 40(1)2 Item (b) of the former Inheritance and Gift Tax Act, contrary to what is alleged in the grounds of appeal.

2. Whether Articles 2(4), 40(1)1(a), 40(1)2(a), 40(1)3, 35(2), and 42(1)3 of the former Inheritance and Gift Tax Act apply (ground of appeal Nos. 2, 3, and 42(1)3)

A. Article 2(1) of the former Inheritance and Gift Tax Act provides that gift tax shall be subject to taxation of donated property from another person’s gift. Article 2(3) of the same Act provides that “Where it is deemed that an inheritance tax or gift tax has been unjustly reduced by either an indirect method via a third party, or by doing two or more acts or transactions, or by doing so, through a continuous single act or transaction, the economic substance thereof shall be deemed to have been directly traded by the party concerned or by deeming that a single act or transaction is subject to the application of paragraph (3).”

Meanwhile, Article 40(1) of the former Inheritance and Gift Tax Act provides for the donation of profits from the acquisition and acquisition of convertible bonds, etc., and conversion of stocks, etc. as above. Article 40(1) of the former Inheritance and Gift Tax Act provides for “the profits accrued from the acquisition of convertible bonds, etc. from a related party prescribed by Presidential Decree by acquiring the convertible bonds, etc. at a price lower than the market price, and from the acquisition of the convertible bonds, etc. at a price lower than the market price, the profits accrued from the acquisition of the convertible bonds, etc. as a result of the conversion or exchange of stocks or the acquisition of stocks by the convertible bonds, etc., and subparagraph 3 of the same Article provides for “the profits acquired directly or indirectly from the related party by the conversion of the convertible bonds, etc. into the stocks, etc.

In addition, Article 35(2) of the former Inheritance and Gift Tax Act provides that where a person who is not a specially related person acquires an asset at a price significantly lower than the market price due to transactional practices, without justifiable grounds, the amount equivalent to the difference between the price and the market price shall be presumed to have been donated and the amount equivalent to the profits prescribed by Presidential Decree shall be deemed to be the value of donated property to the person who has acquired such profits. In addition, Article 42(1) of the former Inheritance and Gift Tax Act provides that "where any of the following profits, other than donations pursuant to Article 40, has been acquired, such profits shall be deemed to be the value of donated property to the person who has acquired such profits." Article 42(1)3 provides that "The profits acquired from the conversion, acquisition, exchange, etc. of stocks by convertible bonds, etc. pursuant to Article 40(1) shall not apply to transactions between the persons who are not a specially related person as prescribed by Presidential Decree, which are deemed to have justifiable grounds in view of transactional practices."

B. As above, Article 2(4) of the former Inheritance and Gift Tax Act provides that where it is deemed that gift tax has been unjustly reduced by means of two or more acts or transactions, it shall be imposed by deeming such acts or transactions as a series of acts or transactions according to the economic substance thereof. This means that, in order to achieve the effect of gift bypassing or transforminging the acts or transactions subject to gift tax through various stages of transactions, and to cope with the tax avoidance act unreasonably reducing gift tax while it is possible to impose tax by deeming such various stages of transactions as one act or transaction subject to gift tax as one act or transaction subject to gift tax, one of the forms to which the principle of substantial taxation applies is applied. However, taxpayers may choose one of the various legal relations in order to achieve the same economic purpose, and the tax authority shall respect the legal relationship chosen by the parties, barring any special circumstance. Moreover, the outcome of transactions after multiple stages of transactions may intervene not only in compensation for losses, etc., but also in external factors or acts, etc., and such result shall not be readily concluded as a gift act subject to gift tax (see, 2015).

The legislative purport of Articles 35(2) and 42(1) of the former Inheritance and Gift Tax Act is to cope with and promote fairness in taxation by imposing gift tax on the profits earned by the transaction partner when a transaction partner gains profit from an abnormal method. However, in the trades between unrelated parties, it is a general and easy way for the transaction partner to gain gift benefits while giving up opportunities for the transaction partner to gain profit easily. As such, Articles 35(2) and 42(3) of the former Inheritance and Gift Tax Act add taxation requirements for transactions between unrelated parties, different from the trades between unrelated parties, “where there is no justifiable reason in light of transaction practice,” as to transactions between unrelated parties. Therefore, even if the transaction partner gains profit from an abnormal transaction between unrelated parties, there is no reasonable reason to believe that the transaction partner should properly reflect the objective exchange value, or that such transaction terms are deemed as reasonable from a reasonable economic point of view, there is no justifiable reason to see Article 35(2) and 25(3)4 of the former Inheritance and Gift Tax Act.

C. Based on the following circumstances, the lower court determined that since a series of acts from the issuance of the instant bonds with warrants to the exercise of the instant warrant certificates and the acquisition of new stocks were conducted in an abnormal manner in order to unjustly avoid or reduce gift tax without any particular business purpose, gift tax may not be imposed by applying Articles 2(4), 40(1)1(a), 40(1)2(a), or 40(1)3 of the former Inheritance and Gift Tax Act, and furthermore, from a rational economic perspective, it cannot be deemed that there is no justifiable reason in light of trade practice, and thus, it cannot be imposed even on the grounds of Articles 35(2) and 42(1)3 of the former Inheritance and Gift Tax Act.

(1) At the time of issuance of the instant bonds with warrants, the instant company was planning to invest in the new business, and thus, required to raise operating funds. In particular, the interest rate of the said bonds was more favorable than that of the loans that the instant company received from other financial institutions at the time. Therefore, the issuance of the instant bonds with warrants by the instant company constitutes a transaction for business purposes.

(2) The Plaintiff purchased the instant preemptive right on the date of the issuance of the bonds because it was demanded the Plaintiff to obtain profits by disposing of the preemptive right separated from the bonds early, and at the same time, avoiding the risk of stock price fluctuation. In light of this, it cannot be deemed that there was no business purpose for the sale of the instant preemptive right.

(3) The Plaintiff’s acquisition price of the instant preemptive right (4.5% of the face value) meets the standards for the premium of preemptive rights (4-5% of the face value) that was traded in securities at the time. Moreover, the original exercise price of the instant preemptive right was objectively determined in accordance with the “Regulations on Issuance and Public Notice of Securities,” and the adjustment of exercise price was uniformly determined between the said capital company and the instant company without a special relationship at a certain time.

(4) Even if the Plaintiff obtained profits from the acquisition and exercise of the instant preemptive right, this is the result of the Plaintiff’s considerable risk of a decline for a considerable period of time, and other multiple complex factors, such as the instant company’s financing and entry into new businesses. There is no evidence suggesting that the stock price increase of the instant company was anticipated at the time of the Plaintiff’s acquisition of the instant preemptive right.

(5) Ultimately, it is difficult to deem that the Plaintiff intended to obtain marginal profits from a series of acts, such as the issuance of bonds with warrants and the acquisition and exercise of the instant preemptive right. Therefore, it cannot be readily concluded that such a series of acts were used as a means of action, with the intention of planning the stock price increase from the beginning and allocating excessive profits arising from the stock price increase to the Plaintiff.

D. Examining the reasoning of the lower judgment in light of the aforementioned legal doctrine and the evidence duly admitted, the lower court did not err by misapprehending the legal doctrine on the interpretation and application of Articles 2(4), 40(1)1(a), 40(1)2(a), 40(1)3, 35(2), and 42(1)3 of the former Inheritance and Gift Tax Act, contrary to what is alleged in the grounds of appeal.

3. Conclusion

The Defendant’s appeal is dismissed as it is without merit, 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.

Justices Lee Dong-won (Presiding Justice)