[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 was a reasonable ground to believe that the transaction partner is making a transaction by appropriately reflecting the objective exchange value, or there was a ground to view the transaction under such terms and conditions as normal from a reasonable economic person’s perspective, whether the transaction partner may be deemed to have justifiable grounds under Article 42(3) of the former Inheritance Tax and Gift Tax Act (affirmative) and whether gift tax may be imposed on the basis of Article 42(1) of the same Act (negative in principle)

[3] In a case where Gap corporation issued bonds with warrants and sold them to Byung corporation after acquiring all of them; on the same day, Eul corporation was the representative director of Eul corporation and Eul corporation, the largest shareholder of Eul corporation, the largest shareholder of Eul corporation, reported and paid gift tax on profits acquired from the exercise of preemptive rights; and upon reporting and paying gift tax as reported by the tax authority, the case holding that the judgment below erred by misapprehending the legal principles, although it is not possible to levy gift tax 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, even if non-absent profits gained from the exercise of preemptive rights, in light of the overall circumstances, even if non-absent profits gained from the exercise of preemptive rights

[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); / [2] Article 42(1) and (3) of the former Inheritance Tax and Gift Tax Act (Amended by Act No. 11609, Jan. 1, 2013); / [3] Article 2(4) of the former Inheritance Tax and Gift Tax Act (Amended by Act No. 11609, Jan. 1, 2013; see current Article 14(3)), Article 40(1)2 and 3, and Article 42(1)3 of the 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 LLC et al., Counsel for the plaintiff-appellant)

Seoul Regional Tax Office (former: Head of Yeongdeungpo District Tax Office) (Attorney Jin-si et al., Counsel for the defendant-appellant)

Seoul High Court Decision 2015Nu69340 decided October 18, 2016

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 Embiopic Co., Ltd. (the changed trade name is a company Green Cross; hereinafter referred to as “Empic”). In addition, the Plaintiff was the largest shareholder of Empic Holdings Co., Ltd. (hereinafter referred to as “BMH”) who owns approximately 7.4% of the shares of Empic around December 31, 2009.

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

3) On December 29, 2009, Enocella issued the instant bonds with warrants, and on the same day, Han Bank Co., Ltd. (hereinafter “ Han Bank”) that acquired the instant bonds with warrants (hereinafter “ Han Bank”) sold them to Hanyang Securities Co., Ltd. (hereinafter “ Hanyang Securities”) by separating the preemptive rights on the 30th of the same month following the date immediately following the date. On December 30, 2009, the Plaintiff purchased the preemptive rights of KRW 4 billion (hereinafter “instant preemptive rights”) from Hanyang Securities with the total face value of KRW 160 million.

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

5) The exercising price of the preemptive right to new stocks per share was adjusted to the lower price on several occasions on December 28, 2009, from September 1, 2010 to September 29, 2010, from September 29, 2010 to December 814, 2010, and from August 17, 2012, the total face value of the preemptive right to new stocks was increased to the lower price on several occasions, and accordingly, the total face value of the preemptive right to new stocks in this case was increased to the lower price on one share.

6) On May 24, 2012, the articles reported that Green Cross Co., Ltd. (hereinafter “Green Cross”) review the method of acquiring Enocella, and on June 26, 2012, Enocella’s share price sharply increased when the participation in Enocella’s capital increase was finally confirmed. Thereafter, Green Cross participated in Enocella’s capital increase, thereby becoming the largest shareholder of Enocella’s capital increase on August 17, 2012, and the de-listing committee held on September 28, 2012 decided to maintain the listing of Enocella’s stocks.

7) On October 9, 2012, the Plaintiff exercised the instant preemptive right at KRW 773 won per share on the two occasions on October 30, 2012. On January 18, 2013, the Plaintiff reported and paid gift tax of KRW 7,941,189,80 on the gift profits worth KRW 18,59,443 on October 18, 2013. 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 return (hereinafter “instant disposition”).

B. Key issue of the instant case

1) The Defendant issued the instant disposition on the ground that the Plaintiff’s profit derived from the Plaintiff’s exercise of the instant preemptive right constitutes a gift tax subject 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 Act”), or constitutes a gift tax subject 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), 40(1)2 and 3, and 42(1)3 of the former Inheritance 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), 40(1)2 and 40(1)3 of the former Inheritance and Gift Tax Act apply to the instant case, and Article 42(1)3 of the former Inheritance 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 Enocell and the largest shareholder of BMH, was in the position to know the internal information of Enocell in detail, and appears to have participated in the process of issuing the instant bonds with warrant and the process of purchasing the instant preemptive right.

C. As the exercise price of the instant preemptive right was adjusted at a lower price while the Plaintiff was in office as a representative director, 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 42(1)3 and 42(1)3 of the former Inheritance and Gift Tax Act to the circumstances where Enocella was in need of financing at the time of the 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 to new stocks, etc.

F. Ultimately, the Plaintiff should be deemed to have avoided or reduced gift tax unfairly through a bypass transaction that is not similar to the acquisition of the instant preemptive right from a person with a special relationship.

3. Judgment of the Supreme Court

A. (1) Article 2(1) of the former Inheritance 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 and Gift Tax Act provides that “Where it is deemed that an inheritance tax or gift tax has been unjustly reduced by either an indirect method through a third party or by doing two or more acts or transactions, or by making a contribution, it shall be deemed that a party directly trades depending on the economic substance or by deeming that a single act or transaction is a continuous transaction or is subject to the application of paragraph (3) of the same Article, regardless of the name, form, purpose, etc. of such act or transaction.”

Meanwhile, Article 40(1) of the former Inheritance and Gift Tax Act provides, “In cases where a person who is not a shareholder of a corporation that issued convertible bonds, etc. has acquired benefits falling under any of the following subparagraphs by converting or exchanging convertible bonds, bonds with warrant (referring to warrant certificates if they are separated) or other stocks, or by transferring or exchanging stocks with the bonds entitled to take over the stocks (hereinafter “convertible bonds, etc.”), an amount equivalent to such benefits shall be deemed the value of the property donated to the person who has acquired such benefits.” Article 40(1)2(a) provides, “The profits that a person who is not a shareholder of the corporation that issued convertible bonds, etc. has acquired from a specially related person with the convertible bonds, etc. and a person who has a special interest in the largest shareholder who has issued the convertible bonds, etc. has taken over or exchanged the convertible bonds, etc. from the corporation and obtains profits directly or indirectly from the specially related person by converting or trading the convertible bonds, etc. with the method and profits similar to those prescribed in subparagraph 1 or 2.”

In addition, Article 42(1) of the former Inheritance and Gift Tax Act provides that "where profits other than donations pursuant to Article 40, which fall under any of the following subparagraphs and exceed the standard prescribed by Presidential Decree, are acquired, 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 from transactions which increase or decrease the capital of a corporation, such as conversion, acquisition, exchange, etc. of stocks through convertible bonds, etc. pursuant to the provisions of Article 40(1)." Meanwhile, Article 42(3) provides that "the profits acquired from transactions between a person who is not a specially related person

2) Article 2(4) of the former Inheritance and Gift Tax Act provides that gift tax shall be imposed by deeming the act or transaction which is subject to gift tax as a continuous single act or transaction by means of two or more acts or transactions. The said provision provides that gift tax shall be imposed by deeming the act or transaction to be subject to gift tax as a continuous single act or transaction according to the economic substance. In order to achieve the effect of gift through a variety of stages of transactions bypassing or transforminging the transaction, and to cope with an act of tax avoidance that unfairly reduces gift tax, the said various stages of transactions shall be denied and imposed by deeming the transaction as a single act or transaction that is subject to gift tax according to the substance. Accordingly, the said provision aims to promote tax equity by prescribing one of the following as a gift tax in terms of the form of application of the substance over form principle. However, a taxpayer may choose one of the various legal relations in order to achieve the same economic purpose when conducting economic activities, and the tax authority as a taxpayer shall respect the legal relationship chosen by the parties, barring any special circumstances, and the result of the transaction after multiple stages may intervene in compensation for losses, etc.

In addition, the legislative purport of Article 42(1) of the former Inheritance and Gift Tax Act, which requires the transaction partner to levy gift tax on the profits earned by the transaction partner when the transaction partner actually transfers profits from the acquisition and exercise of preemptive rights to the transaction partner by abnormal means, is to cope with and promote fairness in taxation. However, in the case of transactions between unrelated parties, the conflict of interests between the transaction partner and the parties without a special relationship is a general and easy way to give up opportunities to make profits and make the transaction partner gain gift profits by giving up the opportunity to make profits easily. Thus, Article 42(3) of the former Inheritance and Gift Tax Act adds taxation requirements not to apply to cases where “justifiable reasons exist in light of transaction practices” under Article 42(1) of the former Inheritance and Gift Tax Act. Therefore, even if the transaction partner gains profits from the acquisition and exercise of preemptive rights through transactions between unrelated parties, it is reasonable to levy gift tax on the grounds that there are reasonable grounds to believe that the transaction partner should appropriately exchange the objective value, or that it is reasonable to impose gift tax from a reasonable economic perspective.

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

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

2) Although, prior to the issuance of the instant bonds with warrants, the Plaintiff, the representative director of Enocell, was scheduled to acquire the instant preemptive right, it seems that it would meet the demand of one bank at the time of the issuance. In other words, Enocell is anticipated that the demand for the preemptive right to new stocks is limited since Enocell has already been in difficult management situations at the time. As such, one bank was required to make the Plaintiff purchase a certain portion of the preemptive right to new stocks.

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

3) Ultimately, the Plaintiff’s acquisition of the instant preemptive right is merely a result of voluntary transaction between one bank and Hanyang Securities according to its respective business objectives, and cannot be deemed to exist with the intent to transfer the Plaintiff without compensation 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 Enocella and one bank, all of which were uniformly conducted every three months.

On the other hand, Enocell’s share price was KRW 1,030 as at the time of issuance of the instant bonds with warrants, and around May 18, 2012, the rise or decline has been repeated, such as declineing to KRW 561,561, which is lower than the exercise price of the instant preemptive right, but around June 24, 2012, green Cross began to make a sudden increase with the confirmation of a plan to participate in the subscription to new shares with respect to Enocell. On the other hand, around October 9, 2012, the Plaintiff became KRW 7,000 and KRW 5,020, respectively, around October 30, 2012 when the Plaintiff exercised the instant preemptive right.

5) The Plaintiff’s acquisition of the instant preemptive right and gains from the exercise thereof can be deemed as a result of the Plaintiff’s assumption of the potential of price decline due to credit risk, etc. caused by Enocell’s poor business activities. Furthermore, the rise in Enocell’s price around June 24, 2012 led to Enocell cell therapy development outcome, leading to the participation of Enocell cell therapy in capital increase.

Furthermore, at the time of issuance of the instant bonds with warrants, Enocell was in need of financing, and the Plaintiff acquired preemptive rights to exercise only one year after the date of issuance, and it is difficult to readily conclude that the Enocellian share price was sufficiently anticipated at the time of such exercise.

In light of this, it is difficult to view that the Plaintiff intended to obtain profits from acquiring Enocell new stocks from the beginning through a series of acts, such as the issuance of the instant bonds with warrant, the acquisition and exercise of the instant preemptive right, and the acquisition and exercise of Enocell’s new stocks. Ultimately, such a series of acts as mentioned above is not a round-over transaction used as the means, with the intention to anticipate Enocell’s stock price increase from the beginning and to allocate excessive profits to the Plaintiff, who is the representative director of Enocell.

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 during 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 the market price and acquisition price by allowing the Plaintiff, a representative director of Enohcell, to acquire the 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 and Gift Tax Act. Rather, it is normal when viewed from a reasonable economic standpoint, and thus, there is justifiable cause as stipulated in Article 42(3) of the former Inheritance and Gift Tax Act.

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

Justices Lee Ki-taik (Presiding Justice)