[1] The purport of Article 93 subparag. 11 (b) of the former Corporate Tax Act or Article 93 subparag. 10 (b) of the former Corporate Tax Act and Article 132 subparag. 10 (10) of the former Enforcement Decree of the Corporate Tax Act / Where the money paid by a foreign corporation as the cause of penalty or compensation in the Republic of Korea due to a breach or termination of a contract is within the scope of compensating for actual losses that may cause a decrease in net assets in relation to the contract, whether the said provision constitutes “money received in excess of compensation for payment itself which is the main

[2] The case holding that in case where the Export-Import Bank of Korea collects and imposes corporate tax, etc. on the Export-Import Bank of Korea for the pertinent business year on the ground that the advance interest falls under the domestic source income of a foreign corporation, on the ground that the Export-Import Bank of Korea did not withhold tax on other income under the former Corporate Tax Act, in light of all the relevant circumstances, in a case where Gap corporation, etc. and foreign corporation Eul, which is a domestic shipbuilding owner, entered into a shipbuilding contract, and the Export-Import Bank of Korea established a contract guaranteeing the obligation for refund of ship price, etc. which Gap corporation, etc. received in advance from Eul corporation, etc. according to the shipbuilding contract, and the Export-Import Bank of Korea cancelled shipbuilding contract, and the Export-Import Bank of Korea pays the advance interest and its interest to Eul corporation, etc., and the Export-Import

[1] Article 93 subparag. 11(b) of the former Corporate Tax Act (amended by Act No. 10423, Dec. 30, 2010) or Article 93 subparag. 10(b) of the former Corporate Tax Act (amended by Act No. 11128, Dec. 31, 201) provides that “income prescribed by the Presidential Decree as penalty or compensation paid in the Republic of Korea” as one of the domestic source income of a foreign corporation, and Article 132 subparag. 10(b) of the former Enforcement Decree of the Corporate Tax Act (amended by Presidential Decree No. 22577, Dec. 30, 2010) provides that “income prescribed by the Presidential Decree” under each of the said Articles refers to the value of money paid or other goods paid in excess of the original contents of the contract, regardless of the fact that the goods are paid in breach or termination of the contract on property rights,” and thus, refers to “income under each of the said Articles.”

The purport of the above provision is that a penalty or compensation paid by a foreign corporation in the Republic of Korea due to a breach or termination of a property right contract is compensation for the actual decrease in assets incurred due to a counterparty’s nonperformance of a contract, etc., and where there is no net asset increase, it shall not be deemed as other income if it constitutes “compensation for payment under the original contract”. However, if penalty or compensation has been paid in excess of this, it shall be deemed that it constitutes other income, which is a domestic source income of a foreign corporation, and thus, shall be subject to taxation.

In light of the contents and purport of the foregoing provision, even if a foreign corporation received money as a penalty or compensation in Korea due to a breach or termination of a contract, if it is within the scope of compensation for actual losses that may cause a decrease in net assets in connection with the contract, it does not constitute “money received in excess of compensation for payment under the original contract” as referred to in the foregoing provision.

[2] The case holding that in a case where the Export-Import Bank of Korea established a shipbuilding contract with Gap corporation, foreign corporation Eul, etc. which is a domestic shipbuilding owner, and the Export-Import Bank of Korea concluded a shipbuilding contract with Eul corporation, etc. to guarantee the obligation for refund of ship price, etc. which it received in advance from Eul corporation, etc. under the shipbuilding contract, and the Export-Import Bank of Korea cancelled shipbuilding contract, and the Export-Import Bank of Korea pays advance payment and its interest to Eul corporation, etc., the tax authority imposed damages on the advance payment interest under the former Corporate Tax Act (amended by Act No. 10423, Dec. 30, 201) or other income under the former Corporate Tax Act (amended by Act No. 11128, Dec. 31, 2011), on the ground that the Export-Import Bank of Korea did not withhold taxes on the domestic source income of foreign corporation, the court below's determination that the advance payment amount was legitimate in light of the overall circumstances, such as financial expenses and the scope of damages incurred in the shipbuilding contract.

[1] Article 93 subparagraph 11 (b) of the former Corporate Tax Act (Amended by Act No. 10423, Dec. 30, 2010; see Article 93 subparagraph 10 (b) of the current Corporate Tax Act); Article 93 subparagraph 10 (b) of the former Corporate Tax Act (Amended by Act No. 11128, Dec. 31, 201); Article 132 (10) of the former Enforcement Decree of Corporate Tax Act (Amended by Presidential Decree No. 2257, Dec. 30, 2010); Article 132 (10) of the Enforcement Decree of the Corporate Tax Act / [2] Article 93 subparagraph 11 (b) of the former Corporate Tax Act (Amended by Act No. 10423, Dec. 30, 2010; see Article 93 subparagraph 10 (b) of the current Corporate Tax Act); Article 93 subparagraph 10 (b) of the former Enforcement Decree of the Corporate Tax Act (Amended by Act No. 131301, Dec. 13, 21317, 19, 2013

The Export-Import Bank of Korea (Law Firm LLC, Attorneys Kang Han-hun et al., Counsel for the plaintiff-appellant)

Yeongdeungpo-gu Tax Office (Law Firm ELKB Partners, Attorneys Shin-chul et al., Counsel for the plaintiff-appellant)

Seoul High Court Decision 2016Nu74721 decided May 23, 2017

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

A. During the period from May 11, 2007 to January 14, 201, Jinse Shipbuilding Co., Ltd. and two shipbuilding companies (hereinafter “domestic shipbuilding companies”) concluded a contract for shipbuilding with 12 vessels from the Prime Bulk Nvig (hereinafter “foreign vessel owners”) and from 11 other foreign corporations (hereinafter “foreign vessel owners”).

B. Under each shipbuilding contract of this case, foreign vessel owners shall first pay part of the vessel price to domestic shipbuilding officers prior to the completion of shipbuilding, and where each shipbuilding contract of this case terminates due to reasons such as termination or termination of shipbuilding, domestic shipbuilding officers shall refund to foreign vessel owners the vessel price already received (hereinafter “Advance payment”) and the interest calculated at the rate of 6-7% per annum from the date of receipt to the date of refund, but the refund of advance payment and interest shall be exempted from all obligations, duties and legal liability to both parties, and shall be governed by English law as the governing law.

C. Meanwhile, between July 6, 2007 and March 25, 2011, the Plaintiff concluded a contract with a foreign vessel owner to guarantee an advance payment and an obligation to refund interest on the foreign vessel owners under each shipbuilding contract of this case (hereinafter “each of the instant guarantee contracts”).

D. However, foreign vessel owners rescinded each of the instant shipbuilding contracts with domestic shipbuilding owners for reasons such as delay in delivery of the vessel, and filed a claim with the Plaintiff for the payment of the advance payment and interest that the domestic shipbuilding owners received based on each of the instant insurance contracts.

E. Accordingly, between June 24, 2009 and July 7, 2011, the Plaintiff paid each advance payment and its interest (hereinafter “interest at issue”) to the foreign vessel owners (hereinafter “interest at issue”).

F. The Defendant: (a) issued each of the instant dispositions to collect and impose corporate tax withheld for the business year from 2009 to 2011, and additional tax on the additional tax on the additional tax on the payment record and the additional tax on the additional tax on the payment record, on the ground that the Plaintiff did not withhold tax on other income under Article 93 Subparag. 11(b) of the former Corporate Tax Act (amended by Act No. 10423, Dec. 30, 201; hereinafter “former Corporate Tax Act”) or Article 93 Subparag. 10(b) of the former Corporate Tax Act (amended by Act No. 11128, Dec. 31, 201; hereinafter “Corporate Tax Act”); and (b) the Plaintiff did not withhold tax on the other income under Article 93 Subparag. 10(b) of the former Corporate Tax

2. Judgment on ground of appeal No. 1

The lower court, on the grounds indicated in its reasoning, determined that the interest at issue constituted damages paid due to the cancellation of a property right, not by returning unjust enrichment.

Examining the relevant legal principles and records, the lower court did not err by misapprehending the legal doctrine on the legal nature of the interest at issue, contrary to what is alleged in the grounds of appeal.

3. Judgment on ground of appeal No. 2

A. Key issue

The key issue in this part is whether the interest at issue constitutes a foreign corporation’s domestic source income as “the value of money or other goods received or delivered in excess of the damages on the payment itself under the original contract, regardless of its title, as compensation for breach or termination of a contract on property rights” under Article 93 subparag. 11(b) of the former Corporate Tax Act or Article 93 subparag. 10(b) of the Corporate Tax Act and Article 132(10) of the former Enforcement Decree of the Corporate Tax Act (amended by Presidential Decree No. 22577, Dec. 30, 2010; Presidential Decree No. 22577, Dec. 30, 2010).

B. The judgment of the court below

The lower court determined as follows: (a) in the case of the instant advance payment, the foreign vessel owners paid damages for active damages that were not returned to the domestic shipbuilding owners, among the damages incurred by the cancellation of each shipbuilding contract of this case; (b) while the interest on the instant advance payment was paid to compensate for the damages equivalent to the interest accrued due to the foreign vessel owners’ failure to use the key advance payment paid to the domestic shipbuilding owners in any other place; and (c) thereby, constitutes the money paid in excess of the compensation per se for the payment itself, which is the content of the original

C. Judgment of the Supreme Court

1) Article 93 subparag. 11(b) of the former Corporate Tax Act or Article 93 subparag. 10(b) of the Corporate Tax Act provides that “income prescribed by the Presidential Decree as penalty or indemnity paid domestically” shall be one of the domestic source income of a foreign corporation. The pertinent provision on delegation provides that “income prescribed by the Presidential Decree” under each of the said Articles means the amount of damages paid due to a breach or termination of a contract on property rights, which exceeds the damages to the payment itself under the original contract terms, regardless of the title thereof.”

The purport of the instant provision is to: (a) a penalty or compensation paid in Korea by a foreign corporation due to a breach or termination of a property right contract is compensation for the actual decrease in assets incurred due to a counterparty’s default, etc.; and (b) a net asset increase is not deemed as other income in the event there is no net asset increase; (c) however, if penalty or compensation has been paid in excess of the aforementioned compensation, it constitutes other income, which is a domestic source income of a foreign corporation, due to the occurrence of a new income or income beyond the compensatory damages, and thus, is subject to taxation.

In light of the contents and purport of the foregoing provision, even if a foreign corporation received money as a penalty or compensation in the Republic of Korea due to a breach or termination of a contract, if it is within the scope of compensation for actual losses that may cause a decrease in net assets in connection with the contract, it does not constitute “money received in excess of compensation for payment under the original contract” as referred to in the instant provision.

2) Review of the reasoning of the lower judgment and the record reveals the following circumstances.

A) Generally, shipbuilding requires enormous amount of funds, and thus, vessel owners’ raising funds for shipbuilding at the time of shipbuilding contracts is ordinarily conducted in such a way as receiving loans from ordinary financial institutions, etc. (the form of vessel financing, such as a large number of cases in which a number of financial institutions participate, is diverse). In such a case, a vessel owner would raise capital by attaching a certain additional interest rate to the interest rate on shipbuilding.

B) Ship financing is generally conducted in the form of borrowing shipbuilding funds by a special purpose company (SPC) established in a convenience country for the purpose of owning vessels. One special purpose company normally owns one vessel for the purpose of strengthening the security interest of a financial institution. In this regard, many interested parties, such as real vessel owners, nominal vessel owners, special purpose companies established by a special purpose company, such as financial institutions, lender groups of financial institutions, shipbuilding companies, shipping companies, and guarantors, can participate in the contract.

C) With regard to each shipbuilding contract of this case, foreign vessel owners appear to be a special purpose company established by Turkey corporations, etc. for ship financing, etc., which is a convenience-free country. The contract amount is from USD 25,300,00 to USD 74,50,000, to USD 45,405,404,00, to KRW 66,585,119,999, while each of the above contracts is deemed to have participated in the aforementioned Turkey corporations, foreign vessel owners, domestic shipping officers, and many interested parties, including the Plaintiff.

D) In light of the aforementioned extenuating circumstances, such as motive or necessity to take measures different from the ordinary vessel financial practice or structure at the time of each shipbuilding contract, it is reasonable to view that the foreign vessel owners, even in each shipbuilding contract of this case, have raised a huge amount of funds by means of financing in general vessel financing rather than equity capital.

E) It seems that the annual rate of 6-7% for the instant advance payment, which was the basis for calculating the interest rate, does not deviate from the scope of ordinary vessel financing costs of foreign vessel owners and other costs for concluding shipbuilding contracts.

F) Therefore, the interest at issue may be deemed to have been expected to be paid as compensation for financial expenses ordinarily incurred by foreign vessel owners in the course of procuring each advance payment of this case paid to domestic vessel owners, and other expenses incurred in the course of concluding each shipbuilding contract of this case. The scope thereof also is within the reasonable scope of damages actually incurred by foreign vessel owners in light of the developments leading up to the conclusion and cancellation of each shipbuilding contract of this case, and the details of property damage that foreign vessel owners may incur.

3) Examining the aforementioned circumstances in light of the legal principles as seen earlier, it is reasonable to deem that the interest at issue is not damages for the amount exceeding the damages actually incurred by the foreign vessel owners, but damages for recovering the net asset decrease actually incurred. There is no other evidence to deem otherwise.

4) Nevertheless, solely on the grounds indicated in its reasoning on different premise, the lower court determined that each of the instant dispositions was lawful by deeming that the interest at issue was a passive loss and constituted money paid in excess of the damages to the payment itself, which constitutes the original content of the instant contract under the instant provision. In so determining, the lower court erred by misapprehending the legal doctrine on penalty or indemnity under Article 93 Subparag. 11(b) of the former Corporate Tax Act or Article 93 Subparag. 10(b) of the Corporate Tax Act, thereby adversely affecting the conclusion of the judgment. The allegation contained in the grounds of appeal

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)