Seoul High Court-2016-Nu-54635 ( December 14, 2017)

Donation of title trust with respect to new stocks allocated by merger is illegal in violation of equity when there is a possibility of taxation on deemed donation of title trust with respect to the old state.

If a title trustee who received a title trust on the old state due to the merger received a title trust on the new shares re-title trust on the old state, if he/she had imposed or could have imposed a taxation on the constructive gift of title trust on the old state, the taxation on the constructive gift of title trust on the new shares

Article 45-2 of the former Inheritance Tax and Gift Tax Act

2016Du306444 revocation of revocation of disposition imposing gift tax

D et al. 8

○ Head of tax office

Seoul High Court Decision 2015Nu38872 Decided November 27, 2015

on October 31, 2019

The part of the lower judgment against the Plaintiff is reversed, and that part of the case is remanded to the Seoul High Court.

The defendant's appeal is dismissed.

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

1. As to the Plaintiff’s 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; hereinafter referred to as the "former Inheritance Tax and Gift Tax Act") provides that "in cases where the largest shareholder of a corporation that issued convertible bonds, etc. or a person specially related with it has acquired, acquired, or transferred convertible bonds, bonds with warrant (referring to warrant certificates, if they are separated) or other bonds entitled to take over the stocks (hereinafter referred to as "convertible bonds, etc.") by acquiring or exchanging them with other stocks, or where he/she has acquired, acquired, or exchanged the bonds, etc. with the rights to take over the stocks (hereinafter referred to as "convertible bonds, etc.") by acquiring, exchanging, or taking over the stocks with convertible bonds, etc., an amount equivalent to such profits shall be deemed the value of the property donated to the person who has acquired the profits therefrom, and where the largest shareholder or a person who has acquired them has acquired the stocks by acquiring or exchanging them with the stocks in excess of the market price (hereinafter referred to as "profit acquired by acquiring or exchanging them")

In addition, Article 9 (7) of the former Financial Investment Services and Capital Markets Act (amended by Act No. 11845, May 28, 2013; hereinafter "former Financial Investment Services and Capital Markets Act") provides that "public offering" is solicited by 50 or more investors to make an offer to acquire securities newly issued, and Paragraph (8) of the same Article does not constitute public offering, and Paragraph (9) of the same Article provides that "public offering" is made by offering 50 or more investors to make an offer to sell or purchase securities already issued, and Paragraph (11) of the same Article provides that "public offering" is made in any case of public offering, private placement, or public sale of securities falling under any of the following subparagraphs, and Paragraph (11) of the same Article provides that "the third party acquires all or part of such securities for the purpose of acquiring such securities" under subparagraph 1 and Paragraph (12) of the same Article provides that "public offering or private placement is made."

In light of the contents of the aforementioned relevant laws and regulations, “takeover” under Article 40(1) of the former Inheritance Tax and Gift Tax Act refers to a person who acquires convertible bonds, etc. for the purpose of acquiring them by soliciting a third party to acquire them for the purpose of issuing convertible bonds, etc., and a person who acquires them for the purpose of simple investment without such purpose shall not be deemed an underwriter, barring any special circumstance (see Supreme Court Decision 2017Du49560, May 30, 2019).

B. Review of the judgment of the first instance court as cited by the lower court and the record reveals the following facts.

1) On December 3, 2010, AAA (formerly: BB; hereinafter referred to as “AAA”) entered into a contract with the EE ECE Private Equity Fund (hereinafter referred to as “instant private equity fund”) to raise funds for the purchase and sale of shares of the CCC Co., Ltd. (formerly, DDD Co., Ltd.; hereinafter referred to as “CCC”), and issued the instant bonds with warrants (hereinafter referred to as “instant bonds with warrants”) with 10 billion won face value (hereinafter referred to as “instant bonds with warrants”). On December 7, 2010, the instant bonds with warrants were issued to the instant private equity fund.

2) On December 3, 2010, the instant private equity fund concluded a sales contract with the Plaintiff on December 3, 2010, to transfer KRW 5 billion (hereinafter “instant warrant certificates”) of the face value of the warrant certificates separated from the instant warrant certificates to KRW 200 million.

3) On January 11, 2012, the Plaintiff purchased the instant warrant certificates from the instant private equity fund, and subsequently acquired AA’s new shares 2,942,90 shares by exercising the instant warrant certificates at KRW 1,699 per share price on November 30, 2012.

4) The instant private equity fund did not receive underwriting fees for the transfer of the instant bonds with warrants from AA, and there was no content that the instant contract bears the risk of the instant private equity fund to issue the instant bonds with warrants.

5) Rather, the instant private equity fund acquired the instant bonds with the purpose of obtaining investment returns by participating in the AA’s CCC management acquisition. In the instant contract, the private equity fund determined that one person designated by the instant private equity fund will be appointed as a director of the AA, as well as only for the purpose of paying the amount of payment of the purchase price of the CCC’s stocks.

6) In addition, the instant private equity fund created a pledge right to the CCC shares to secure the redemption of the instant bonds with warrants, and requested the Plaintiff and AA to purchase the instant warrant certificates in order to minimize the risks associated with the investment in the instant bonds with warrants, and there is no evidence to deem that the instant warrant certificates were publicly offered, privately offered, and sold in accordance with Article 9 of the former Capital Markets Act.

C. Examining these factual relations in light of the aforementioned legal principles and records, it is reasonable to view that the instant private equity fund acquired the instant bonds with warrants as an investor, not an underwriter under the former Capital Markets Act, on the ground that the private equity fund constitutes an underwriter under the former Capital Markets Act. Nevertheless, the lower court determined otherwise on the ground that the private equity fund of this case constitutes an underwriter under the former Capital Markets Act, the part within the reasonable tax scope among the instant disposition under the premise that Article 40(1)2(b) of the former Inheritance Tax and Gift Tax Act is lawful. In so determining, the lower court erred by misapprehending the legal doctrine on the underwriter under Article 40(1) of the former Inheritance Tax and Gift Tax Act, thereby adversely affecting

2. As to the Plaintiff’s grounds of appeal Nos. 2 and 3 and Defendant’s grounds of appeal

A. 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 same Act provides that “Where it is deemed that the inheritance tax or gift tax has been unjustly reduced by either indirect or indirect means through a third party, or by performing two or more acts or transactions, or by performing one or more consecutive acts or transactions, such as the name, form, purpose, etc. of the relevant act or transaction, without consideration (including where such act or transaction is transferred at a significantly low price) or by indirectly or indirectly means, it shall be deemed that the relevant party has directly traded or that paragraph (3) shall apply to such case.”

Article 2(4) of the former Inheritance Tax and Gift Tax Act provides that gift tax shall be imposed by deeming it as a continuous act or transaction according to the economic substance in cases where it is deemed that an act or transaction subject to gift tax has been unjustly reduced by two or more acts or transactions. The said provision provides that gift tax shall be imposed by denying such various stages of transactions in order to achieve the effect of gift while coping with the act of tax avoidance bypassing or changing the transaction through a variety of stages of transactions subject to gift tax, and that it shall be imposed by deeming the same as a single act or transaction subject to gift tax depending on the substance. In addition, the said provision aims to ensure fair taxation by prescribing one of the following as a gift tax in terms of the form of application of the substance over form. However, the taxpayer may choose one of the various legal relations in order to achieve the same economic purpose, and the tax authority may respect the legal relationship chosen by the parties, and the outcome after a variety of transactions may intervene in compensating for risks, such as losses, etc. and external factors or activities after such transactions, and then the gift tax shall not be readily concluded as a gift act (see, 2015).

B. Article 42(1) of the former Inheritance Tax and Gift Tax Act provides that "if profits falling under any of the following subparagraphs, other than donations under Article 40, are profits above the standard prescribed by Presidential Decree, such profits shall be deemed the value of property donated to the person who has acquired such profits, and subparagraph 3 of Article 40 provides that "the profits acquired by a transaction which increases or decreases the capital of the corporation, such as the conversion, acquisition, exchange, etc. of stocks by convertible bonds, etc. under Article 40(1)" while Paragraph (3) provides that "no such profits shall apply where a transaction between a person who is not a specially related person

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 benefit accrued from the acquisition and exercise of warrant certificates in an abnormal manner, is to cope with an altered donation act and promote fair taxation. However, in a transaction between unrelated parties, it is a common and easy way to allow a transaction partner to gain gift by giving up an opportunity to gain benefit in a general and easy manner. As such, Article 42(3) of the former Inheritance Tax and Gift Tax Act provides for a requirement for taxation not to apply to cases where “justifiable cause exists in light of the transaction practice” under Article 42(1) of the former Inheritance Tax and Gift Tax Act. Therefore, even if a transaction partner gains profit from the acquisition and exercise of warrant certificates through a transaction between unrelated parties, if there are reasonable grounds to believe that the transaction partner would have made a transaction by reflecting an objective exchange value appropriately, or if such transaction under such conditions was based on a reasonable economic perspective, it is reasonable to deem that there exists a justifiable reason under Article 42(2)4(2)1 of the former Inheritance Tax and Gift Tax Act.

C. According to the judgment of the first instance court as cited by the lower court and the record, the following facts are revealed.

1) By December 9, 2010, AA was necessary to raise the CCC’s funds to sell and purchase shares. However, since the instant private equity fund proposed investment method by issuing bonds with warrants and subsequently, the instant bonds with warrants were issued to the instant private equity fund, the issuance of the instant bonds with warrants itself is a transaction for business purposes.

2) Upon the request of the instant private equity fund, the Plaintiff purchased the instant warrant certificates in KRW 200 million, which is 4% of the face value (5 billion won). The private equity fund of this case, as a shareholder and representative director of AA, had the Plaintiff guarantee the redemption of the instant warrant certificates, and could have the Plaintiff gain investment profits from the sale of the warrant certificates, and as a result, AA and the Plaintiff could minimize management restrictions while securing the trade fund of CCC shares.

3) The Plaintiff acquired the new shares of AA by exercising the warrant certificates of this case in KRW 1,699 per share, adjusted to KRW 3,774 per share, the exercising price of the warrant certificates of this case, and the exercising price of the above exercise price is objectively determined in accordance with the provisions on the issuance and public disclosure of the securities.

4) The share price per share of AA began to decline continuously after the issuance of the instant bonds with warrant and began to increase since the end of 2012. The Plaintiff’s exercising benefit of the instant warrant right seems to have resulted from the Plaintiff’s increase in share price by making efforts to raise funds and improve management due to the issuance of the instant bonds with warrant, and there is no ground to deem that the Plaintiff had sufficiently predicted the share price increase at the time when approximately two years elapsed after the issuance of the instant bonds with warrant.

5) The Plaintiff’s acquisition price of the warrant certificates of this case 200 million won (the face value of KRW 5 billion) corresponds to 4-5% of the face value of the preemptive right that was traded in the securities at the time.

D. Examining these facts in light of the aforementioned legal principles and the record, the series of acts from the issuance of the instant bonds with warrants to the exercise of warrant certificates and the acquisition of new stocks cannot be deemed to have been performed normally in order to unjustly avoid or reduce the gift tax without any particular business purpose. Thus, by applying Article 2(4) of the former Inheritance Tax and Gift Tax Act, gift tax cannot be imposed pursuant to Article 40(1)2 of the former Inheritance Tax and Gift Tax Act. Furthermore, from a reasonable economic standpoint, inasmuch as the transactional practice under Article 42(3) of the former Inheritance Tax and Gift Tax Act is justifiable, it cannot be imposed pursuant to Article 42(1)3 of the former Inheritance

Nevertheless, the lower court determined otherwise, that even if the private equity fund of this case does not constitute an underwriter under the former Capital Markets Act, the Plaintiff traded the instant warrant certificates bypassing that it was directly acquired from AA, and that the Plaintiff’s acquisition of the instant warrant certificates from the private equity fund of this case cannot be deemed a justifiable cause in light of transactional practice, since it was not a reasonable transaction by an economic person. In so determining, the lower court erred by misapprehending the legal doctrine on Articles 2(4) and 42(1)3 and (3) of the former Inheritance Tax and Gift Tax Act, thereby adversely affecting the conclusion of the judgment. The Plaintiff’s ground of appeal pointing this out is with merit, and the Defendant’s ground of appeal on the premise of objection cannot

3. Conclusion

Therefore, the part of the lower judgment against the Plaintiff is reversed, and that part of the case is remanded to the lower court for further proceedings consistent with this Opinion. Defendant’s appeal is dismissed. It is so decided as per Disposition by the assent of all participating Justices on the bench