Seoul High Court 2015Nu69340 ( October 18, 2016)

Where a preemptive right is acquired through a third financial institution, gift tax under Article 40 of the Inheritance Tax and Gift Tax Act may not be levied.

Where a preemptive right is acquired through a third financial institution, gift tax under Article 40 of the Inheritance Tax and Gift Tax Act may not be levied.

Article 40 (Donation of Benefits from Conversion, etc. of Convertible Bonds, etc. into Stocks)

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 and key issue

A. Case summary

1) From March 28, 2005 to August 16, 2012, the Plaintiff served as the representative director of ○○○, a corporation established for the purpose of research and development of ○○, etc. (the changed trade name is a corporation ○○○, a corporation, hereinafter referred to as “○○○”). In addition, the Plaintiff was the largest shareholder of ○○○○, a corporation, the largest shareholder of which owns approximately 7.4% of the shares of ○○○○, around December 31, 2009.

2) On December 28, 2009, the board of directors decided to issue bonds with warrants (hereinafter referred to as “instant bonds with warrants”) with the total face value of eight billion won, and on the column for the matters concerning the preemptive rights publicly announced to the Korea Exchange at the time, the period for exercising the rights was stated as the date of commencement, December 29, 2010, November 29, 2012, and the other party to the sale as the “Plaintiff (4 billion won).”

3) On December 29, 2009, ○○○ issued the instant bonds with warrants, and on the same day, ○○ Bank Co., Ltd. (hereinafter “○○ Bank”) that entirely acquired the instant bonds with warrants sold ○○ Securities Co., Ltd. (hereinafter “○○ Securities”). On December 30, 2009, the Plaintiff purchased the preemptive rights of KRW 4 billion in total face value from ○ Securities with KRW 160 million (hereinafter “instant preemptive rights”).

4) On March 23, 2012, ○○○ was designated as a management issue on the ground that “business losses for the latest four consecutive business years” occurred, and there was a trend that the share price falls alternatively due to a growing possibility of delisting.

5) The per share price of ○○○ preemptive right was adjusted to 1,116 won on December 28, 2009, the date of issuance on the ground of the stock price decline, 1,067 won on September 29, 2010, 2010, 814 won on December 29, 2010, and 773 won on August 17, 2012. Accordingly, the total face value of the instant preemptive right was increased to 1,116 won on the basis of the stock price per share price.

6) On May 24, 2012, an article was published that ○○○ (hereinafter “○○○”) reviews the method of acquiring ○○○○○ on the same day. On June 26, 2016, ○○○○○○○○○’s participation in the capital increase with a final and conclusive judgment on ○○○○○○○○’s participation in the capital increase with a final and conclusive judgment on ○○○○○○○’s participation. Thereafter, ○○○ became the largest shareholder of ○○○○○○○ on August 17, 2012, and the de facto de-listing review committee held on September 28, 2012 decided to maintain the listing of ○○○○’s shares.

7) On October 9, 2012, the Plaintiff exercised the instant preemptive right at KRW 773 per share of KRW 30,000,000 per share, and on January 10, 2013, the Plaintiff reported and paid the gift tax at KRW 0,00,00 on the gift income equivalent to KRW 0,00. On November 29, 2013, the Defendant notified the Plaintiff that there was no tax to separately notify the Plaintiff of the details of the gift tax, as the details of the return on the gift tax are appropriate (hereinafter “instant disposition”).

B. Key issue of the instant case

1) The Defendant issued the instant disposition on the ground that the Plaintiff’s profits derived from the Plaintiff’s exercise of the instant preemptive right constitute the subject of gift tax under Articles 2(4) and 40(1)2 and 3 of the former Inheritance Tax and Gift Tax Act (amended by Act No. 11609, Jan. 1, 2013; hereinafter “former Inheritance Tax and Gift Tax Act”), or constitutes the subject of gift tax under Article 42(1)3 of the former Inheritance Tax and Gift Tax Act.

2) The key issue of the instant case is whether Article 2(4), Article 40(1)2 and 3, and Article 42(1)3 of the former Inheritance Tax and Gift Tax Act can be applied to the instant case.

2. The judgment of the court below

For the following reasons, the lower court determined that Articles 2(4) and 40(1)2 and 40(1)3 of the former Inheritance Tax and Gift Tax Act apply to the instant case, and Article 42(1)3 of the former Inheritance Tax and Gift Tax Act applies even if it is not so.

A. The transaction of the instant preemptive right was conducted in a short period, and the instant bonds with warrants seems to have been scheduled and issued by the Plaintiff to purchase the instant preemptive right.

B. The Plaintiff, as the representative director of ○○○○ and the largest shareholder of ○○○○○○○, was in a position to know in detail the internal information of ○○○○○, and appears to have participated in the process of issuing the instant bonds with warrants and the process of purchasing the instant warrant

C. As the exercise price of the instant preemptive right was adjusted at a lower price while the Plaintiff was in office as the representative director of ○○○○, the number of exercising shares increased.

D. The Plaintiff immediately sold stocks acquired by exercising the instant preemptive right, and obtained marginal profits from the sale thereof.

E. The application of Articles 2(4), 40(1)2 and 40(1)3 and 42(1)3 of the former Inheritance Tax and Gift Tax Act to the circumstances where ○○○○ was in need of raising funds at the time of issuance of the instant bonds with warrants, or the Plaintiff was at risk of share price fluctuations for three years after the Plaintiff acquired the instant preemptive right, etc.

F. Ultimately, the Plaintiff should be deemed to have avoided or reduced gift tax by means of a bypassing transaction that is irrelevant to the direct acquisition of the instant preemptive right by ○○○○○○ having a special relationship.

3. Judgment of the Supreme Court

A. 1) Article 2(1) of the former Inheritance Tax and Gift Tax Act provides that gift tax shall be imposed on donated property from another person’s donation. Article 2(3) of the former Inheritance Tax and Gift Tax Act provides that “Where it is deemed that the inheritance tax or gift tax has been unjustly reduced by either an indirect method via a third party, or a method of performing two or more acts or transactions or by going through a continuous single act or transaction, such as the name, form, purpose, etc. of the relevant act or transaction, without consideration (including where the relevant act or transaction is transferred at a significantly low price) or by an indirect method, it shall be deemed that the relevant party has directly traded, or that paragraph (3) shall apply to such case by deeming that the relevant act or transaction is a single act or transaction in succession.”

Meanwhile, Article 40 (1) of the former Inheritance Tax and Gift Tax Act provides that "where any of the following profits is acquired by converting into or exchanging with convertible bonds, bonds with warrant (referring to warrant certificates if the warrant certificates are separated) or other stocks, or by converting into, exchanging with, or taking over stocks with the bonds entitled to take over the stocks (hereinafter "convertible bonds, etc."), an amount equivalent to such profits shall be deemed the value of the property donated to the person who has acquired such profits." subparagraph 2 (a) of the same Article provides that "where convertible bonds, etc. are acquired from a specially related person and the value of the stocks issued or to be issued by the convertible bonds, etc. exceeds the conversion price, exchange, or taking over the convertible bonds, etc. (hereinafter "convertible bonds, etc.")", and subparagraph 2 (c) provides that "for profits acquired by a specially related person of the corporation who is not a shareholder of the corporation who has issued convertible bonds, etc. and who has acquired the stocks, etc. issued or to be issued by the convertible bonds, etc. from the corporation, it refers to "for profits acquired directly or indirectly from the specially related person by converting them through convertible bonds, etc."

In addition, Article 42(1) of the former Inheritance Tax and Gift Tax Act provides that "where profits falling under any of the following subparagraphs, other than donations under Article 40, are acquired, and above the standard prescribed by Presidential Decree, such profits shall be deemed the value of donated property of the person who has acquired such profits." Article 42(1)3 provides that "the profits acquired by a transaction which increases or decreases the capital of the corporation by means of a conversion, acquisition, exchange, etc. of stocks through convertible bonds, etc. under Article 40(1)" while Article 42(3) provides that "the same shall not apply where

2) Article 2(4) of the former Inheritance Tax and Gift Tax Act provides that gift tax shall be imposed by deeming the act or transaction subject to gift tax as a continuous single act or transaction according to its economic substance in cases where it is deemed that the said act or transaction has been unjustly reduced by two or more acts or transaction. In order to achieve the effect of gift bypassing or changing the transaction, and to cope with the act of tax evasion that unfairly reduces gift tax, it is intended to deny such various transaction forms and to impose tax depending on the substance as one act or transaction subject to gift tax. Furthermore, one of the forms of application of the substance over form principle is set at the level of gift tax in order to achieve the same economic purpose. On the other hand, the taxpayer may choose one of the various legal relations selected by the parties in order to achieve the same economic purpose, and the tax authority may respect the legal relationship chosen by the parties, barring any special circumstance, and the outcome of the transaction may intervene in compensating for the risk, such as losses, etc. and external factors or activities after making a variety of stages of transactions.

In addition, the legislative purport of Article 42(1) of the former Inheritance Tax and Gift Tax Act, which requires a transaction partner to levy gift tax on the profits earned by the transaction partner when the transaction partner transfers the profits gained from the acquisition and exercise of preemptive rights to the transaction partner without compensation through abnormal means, is to cope with and promote fairness in taxation. However, in the case of transactions between unrelated parties, it is inevitable to allow the transaction partner to gain gift by giving up opportunities to make profits easily and easily obtained by himself/herself, and thus, Article 42(3) of the former Inheritance Tax and Gift Tax Act provides that Article 42(1) of the former Inheritance Tax and Gift Tax Act does not apply in cases where the “justifiable reason for the transaction practice” exists. Therefore, even if the transaction partner gains profits from the acquisition and exercise of preemptive rights through the transactions between unrelated parties, if there are reasonable grounds to believe that the transaction partner will make a transaction by reflecting an objective exchange value appropriately, or if such transaction with such conditions can have been seen as having been made from a reasonable economic point of view, it is reasonable to impose gift tax based on Article 425(2).2(3).

B. Examining the facts acknowledged by the court below in light of the legal principles as seen earlier, in the instant case, the gift tax cannot be levied on the following grounds by applying Articles 2(4), 40(1)2 and 3, and 42(1)3 of the former Inheritance Tax and Gift Tax Act.

1) ○○○ issued the instant bonds with warrants to raise funds necessary for the operation of the Company, which is itself a business purpose.

2) Although, prior to the issuance of the instant bonds with warrants, the Plaintiff, the representative director of the ○○○○○○, was scheduled to acquire the instant bonds with warrants, this seems to have been in accordance with the demand of the ○○ Bank at the time. In other words, ○○○ was expected to have limited demand for the instant bonds with warrants due to the difficult management situation at the time. As such, ○○ was anticipated to have limited demand for the preemptive rights, it was necessary for the Plaintiff to make a mandatory purchase of

In addition, the ○ Bank immediately sold the preemptive right to new stocks separate from the bonds, thereby realizing profits at an early stage, the ○ Securities also participated in the transaction and obtained revenue equivalent to the brokerage commission, and even ○○○○, there were advantages to minimize management restrictions on the issuance of bonds with warrants by separating the operating fund from the bonds and preemptive right.

3) Ultimately, the Plaintiff’s acquisition of the instant preemptive right is merely a result of voluntary transaction between ○○○ Bank and ○○ Securities according to the respective business objectives, and cannot be deemed to exist with the intent to gratuitously transfer the Plaintiff or evade taxes.

4) The initial exercising price of the instant preemptive right was determined on the basis of the weighted average of the prices of the instant preemptive right during a certain period, including one month or one week, and the adjustment of the exercise price was determined objectively between ○○ and ○○ Bank without any special relationship, and all of them were uniformly conducted every three months.

Meanwhile, ○○○○’s share price was KRW 1,030 at the time of issuance of the instant bonds with warrants, and around May 18, 2012, the rise and decline occurred as a result of the decline in KRW 561,561 below the exercise price of the instant preemptive right, etc. However, around June 24, 2012, ○○○○ became a final and conclusive plan to participate in the capital increase with ○○○○○○’s capital increase, and the Plaintiff became KRW 7,000 and KRW 5,020, respectively, around October 9, 2012 and around the 30th day of the same month as the date when the Plaintiff exercised the instant preemptive right.

5) The Plaintiff’s acquisition of the instant preemptive right and the acquisition of marginal profits from the exercise thereof can be deemed as the result of undermining the potential of price decline due to credit risk, etc. arising from the depression of ○○○’s business activities for a considerable period of time. Furthermore, the rise in ○○○’s share price around June 24, 2012 led to the ○○○○○’s participation in capital increase with capital increase.

Furthermore, at the time of issuance of the instant bonds with warrants, ○○○ was in need of raising funds, and the Plaintiff acquired preemptive rights that can be exercised only one year after the date of issuance, and it is difficult to readily conclude that ○○○○○’s share price was sufficiently anticipated at the time of such exercise.

In light of this, it is difficult to view that the Plaintiff planned from the beginning to obtain gains from acquiring ○○○’s new shares through a series of acts, such as the issuance of the instant bonds with warrant and the acquisition and exercise of the instant preemptive right, and ultimately, the said series of acts is a round-over transaction used as such for the purpose of allocating excessive profits to the Plaintiff, who is the representative director of ○○○○○, for the purpose of promising the stock price increase from the beginning and allocating excessive profits from the stock price increase.

6) In full view of the above circumstances, a series of acts conducted from the issuance of the instant bonds with warrants to the acquisition and exercise of the Plaintiff’s preemptive right to new stocks to about 2 years and 10 months in order to unjustly avoid or reduce gift tax without any particular business purpose, and its substance is difficult to be deemed as a series of continuous act or transaction with the same difference between market price and acquisition value as a donation by allowing the Plaintiff, who is the representative director of ○○○○, to acquire new stocks at low price. Moreover, it is difficult to view that such series of acts or transactions are similar to those stipulated in Article 40(1)2 of the former Inheritance Tax and Gift Tax Act. Rather, the above series of acts or transactions are normal when seen from a reasonable economic standpoint, and thus, there is justifiable reason for the transaction practice stipulated in Article 42(3) of the former Inheritance Tax and Gift Tax Act.

Therefore, even if the Plaintiff obtained a substantial benefit from the exercise of the preemptive right, gift tax cannot be levied by applying each of Articles 2(4), 40(1)2 and 3, and 42(1)3 of the former Inheritance Tax and Gift Tax Act to the Plaintiff.

C. Nevertheless, the lower court determined that the instant disposition was lawful solely based on its stated reasoning. In so determining, the lower court erred by misapprehending the legal doctrine on the subject of gift tax, thereby failing to exhaust all necessary deliberations, thereby adversely affecting the conclusion

4. Conclusion

Therefore, without further proceeding to decide on the remaining grounds of appeal, 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.