[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 in the form of private placement, Eul corporation acquired bonds with warrants from Eul corporation on the same day, sold them immediately to Byung who is the major shareholder of Eul corporation immediately, and Byung reported and paid gift tax on profits acquired by acquiring and exercising preemptive rights, and requested correction of gift tax for which Byung filed a claim for refund of gift tax paid, but the tax authority rejected such request, the case affirming the judgment below that in light of all the circumstances, Article 40 (1) 2 Item (b) of the former Inheritance Tax and Gift Tax Act shall not be deemed as the basis for taxation, and gift tax shall not be imposed by applying Article 2 (4) of the same Act, and furthermore, Article 42 (1) 3 of the same Act shall not be imposed

[1] Article 2(1) and (3) of the former Inheritance Tax and Gift Tax Act (Amended by Act No. 11609, Jan. 1, 2013; see current Article 4(1) and (4) (see current Article 2 subparag. 6); Article 14(3) of the Framework Act on National Taxes / [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(b); Article 42(1)3 and (3) of the former Framework Act on National Taxes; Article 14(1) of the former Financial Investment Services and Capital Markets Act (Amended by Act No. 11609, Dec. 18, 2013)

[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 (Bae, Kim & Lee LLC, Attorneys Yu-pon et al., Counsel for the plaintiff-appellant)

The Director of Gangnam District Office

Seoul High Court Decision 2016Nu76154 decided July 12, 2017

The appeal is dismissed. The costs of appeal are assessed against the defendant.

The grounds of appeal are examined.

1. As to the grounds of appeal Nos. 1 and 2

A. Article 40(1) of the former Inheritance Tax and Gift Tax Act (amended by Act No. 11609, Jan. 1, 2013; hereinafter “former Inheritance Tax Act”) provides, “In cases where a person who is the largest shareholder of a corporation that issued convertible bonds, etc. or his/her specially related person obtains any benefit falling under any of the following subparagraphs by converting into or exchanging stocks with convertible bonds, bonds with warrant (referring to warrant certificates where preemptive rights are separated) or other stocks, or by issuing bonds entitled to take over stocks (hereinafter “convertible bonds, etc.”), an amount equivalent to such benefit shall be deemed the value of property donated to the person who has obtained such benefit.” Article 40(1) of the former Inheritance Tax and Gift Tax Act provides, “In cases where a person who is the largest shareholder of the corporation that issued convertible bonds, etc. or his/her specially related person acquires and acquires stocks, etc. from an underwriter under Article 9(12) of the Financial Investment Services and Capital Markets Act, including cases where he/she acquires and acquires them from the corporation in proportion to the number of stocks.”

B. Based on the adopted evidence, the lower court determined that the instant company’s issuance of bonds with warrants in the form of private placement on July 14, 2010, and that the new mutual savings bank (hereinafter “new mutual savings bank”) acquired bonds with warrants from the instant company on the same day and immediately sold the instant preemptive right separated from the said bonds to the Plaintiff, on the same day, and on the following grounds, the new mutual savings bank 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”). Thus, the lower court determined that Article 40(1)2(b) of the former Inheritance Tax and Capital Markets Act cannot be deemed as the basis for imposing gift tax.

(1) There is no content that the new mutual savings bank bears risks arising from the issuance of bonds with warrants in the instant underwriting contract for bonds with warrants, and the new mutual savings bank has not received fees in return for the risk bearing.

(2) Since the instant company was faced with liquidity crisis at the time of the issuance of the instant bonds with warrants, it appears that the new mutual savings bank, as it owned the instant preemptive right and tried to secure profits through early sale rather than at risk of price drop.

(3) As such, in order to minimize the risks associated with investment in the instant bonds with warrants, the new mutual savings bank was immediately subject to investment in selling preemptive rights to the largest shareholder (non-party who is the spouse of the Plaintiff at the time) and the two shareholders (the plaintiff) on the date of issuance of the said bonds. The Plaintiff appears to have acquired the instant preemptive rights by accepting it.

(4) Ultimately, it is difficult to conclude that the new mutual savings bank acquired the instant bonds with warrants in the status of an investor seeking interest income and sales profit, and concluded that it was reasonable for the Plaintiff to acquire the instant bonds with warrants.

C. Examining the reasoning of the lower judgment in light of the relevant legal principles and records, the lower court’s conclusion that the Plaintiff cannot be taxed on the grounds of Article 40(1)2(b) of the former Inheritance and Gift Tax Act is justifiable. In so doing, contrary to what is alleged in the grounds of appeal, the lower court did not err by misapprehending the legal doctrine on Article 40(1)2(b) of the former Inheritance and Gift Tax Act and Article 9(12) of the former Capital Markets Act.

2. As to grounds of appeal Nos. 3 and 4

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 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 via a third party, or by performing two or more acts or transactions or by going through a continuous single act or transaction, it shall be deemed that a party has directly traded, or that a single act or transaction shall be subject to the application of paragraph (3) is a single act or transaction, regardless of the name, form, purpose, etc. of such act or transaction.”

Article 2(4) of the former Inheritance 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 act or transaction subject to gift tax has been unjustly reduced by two or more acts or transactions. In order to achieve the effect of gift through a variety of stages of transactions 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 a variety of stages of transactions and to impose tax on the substance by deeming the transaction as a single act or transaction subject to gift tax as a gift tax in the form of gift tax. However, one of the forms of application of the substance over form principle is intended to promote fair taxation by prescribing one of the various legal relations in order to achieve the same economic purpose, 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 of transactions may intervene in the external factor or transaction, and thus, it shall not be readily concluded that the transaction subject to gift tax is 2015.

B. Article 42(1) of the former Inheritance and Gift Tax Act provides that “In cases 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 earned, such profits shall be deemed the value of donated property to the person who has acquired such profits.” Article 42(1)3 provides that “The profits earned by a transaction which increases or decreases the capital of a corporation, such as conversion, acquisition, and exchange of stocks through convertible bonds, etc. pursuant to Article 40(1).” Meanwhile, Article 42(3) provides that “The profits earned by a transaction between persons who are not specially related persons prescribed by Presidential Decree, which

The legislative purport of Article 42(1) of the former Inheritance and Gift Tax Act, which requires a trading partner to levy gift tax on the profits earned by the trading partner when the trading partner actually transfers profits generated from the acquisition and exercise of preemptive rights to the trading partner by 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 trading partner to gain gift by waiver of opportunities to make profits easily and easily obtained by himself/herself. As such, Article 42(3) of the former Inheritance and Gift Tax Act provides that Article 42(1) of the former Inheritance and Gift Tax Act does not apply to cases where “justifiable cause for trading practice” exists. Therefore, even if the trading partner gains profits from the acquisition and exercise of preemptive rights through the trading between unrelated parties, there is no reasonable ground to believe that the trading partner should appropriately exchange the stocks, or from a reasonable economic perspective, it is reasonable to deem that there is no justifiable reason to impose gift tax under Article 25(2)14 of the former Inheritance and Gift Tax Act.

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

(1) On June 2010, the instant company borrowed the instant bonds with warrants on a large scale from multiple financial institutions prior to the issuance of the instant bonds with warrants. On June 1, 2010, the current debt was faced with liquidity crisis exceeding the current assets. The instant company issued the instant bonds with warrants in order to convert the short-term loans into long-term loans as part of the efforts to avoid such crisis situation, and issued the instant bonds with warrants in order to convert the short-term loans into long-term loans. The interest rate on the said bonds was 4% per annum, and 6.5% per annum on maturity guarantee return, which was favorable to the interest on the loans received by the instant company from other financial institutions. Accordingly, the issuance of

(2) The Plaintiff purchased the instant preemptive right immediately after the issuance of the instant bonds with warrants is expected to be difficult to sell the instant preemptive right separated from the financial situation of the instant company to a third party, based on the request of the new mutual savings bank. The new mutual savings bank was able to recover early profits by having the Plaintiff, a major shareholder of the instant company, purchase the instant preemptive right, and the Plaintiff, through such a method, could minimize business restrictions associated with the issuance of the instant bonds with warrants while raising operating funds for the instant company. In light of this, it cannot be deemed that there was no business purpose other than the purpose of tax avoidance in the issuance of the instant bonds with warrants or the purchase of the instant preemptive right with warrants.

(3) The exercising price of the instant preemptive right was objectively determined with the new mutual savings bank without special relationship so as to be calculated based on the weighted average share price for a certain period of time, such as one month or one week. Furthermore, on the ground that the purchase price of the instant preemptive right was lower than the theoretical price publicly notified at the time of issuance, it is difficult to deem that the Plaintiff either issued the instant bonds with warrants or purchased the instant preemptive right with the aim of evading gift tax without business purposes

(4) The Plaintiff gained profits from the acquisition and exercise of the instant preemptive right is a result of the Plaintiff’s heavy potential for stock price decline due to credit risk, etc. caused by the failure to perform the instant company’s business activities. The Plaintiff acquired the preemptive right to exercise at least one year after the date of its issuance, and there is insufficient ground to readily conclude that at the time of its exercise, the stock price increase of the instant company was sufficiently anticipated.

(5) Ultimately, it is difficult to view that the Plaintiff intended to obtain profits from the series of acts, such as the issuance of the instant bonds with warrants and the acquisition and exercise of the instant warrant rights, from the beginning. It is difficult to readily conclude that such a series of acts were used from the beginning as a means to plan the stock price increase of the instant company and to distribute the Plaintiff an excessive profit arising from the stock price increase.

D. Examining the reasoning of the lower judgment in light of the aforementioned legal principles and records, such determination by the lower court is justifiable, and contrary to what is alleged in the grounds of appeal, the lower court did not err by misapprehending the legal doctrine on Articles 2(4), 40(1)2(b), and 42(1)3 and (3) of the former Inheritance and Gift Tax Act.

3. Conclusion

Therefore, the appeal is dismissed, 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 Park Sang-ok (Presiding Justice)