The Korean Supreme Court recently rendered an important decision on the application of provisions concerning the Extended Statute of Limitations (the “ESOL”) for disposition of tax collection (“jingsucheobun” in Korean) as set forth in Article 26-2 (2) (a) of the former National Tax Basic Law (the “NTBL”) (Supreme Court Decision 2017Du36908, November 12, 2020, the “Decision”).  The Decision also addressed the point in time when the statute of limitations for tax collection (the “SOLTC”) commences and whether the SOLTC has tolled due to lawsuit defended by the tax authority.

Overview of the Decision

Bank A (the “Plaintiff”), a foreign corporation (bank), purchased shares of a Korean bank in April 2005 from Company B established in Labuan, Malaysia for KRW 1.6 trillion, and did not withhold any corporate income tax on the proceeds pursuant to the Korea-Malaysia Tax Treaty (Bank A was the withholding tax agent under the Korean tax law).  However, the tax authority denied application of the Korea-Malaysia Tax Treaty by treating Company B as a mere conduit/look-through entity, and imposed a personal income (withholding) tax of KRW 43 billion on the basis that investors of Limited Partnership C, which was established in the Cayman Islands (“Cayman Partnership C”), were the beneficial owners (hereinafter referred to as beneficial owners or the “BO”) of the subject capital gains.  More specifically, the tax authority did not consider Cayman Partnership C as the BO but rather made a tax assessment based on the tax treaties of each investor’s respective tax residency.  In subsequent appeals, the Plaintiff asserted that Company B, the transferor of shares at issue, is the BO of the subject capital gains.  However, both the Seoul Administrative Court and Seoul High Court ruled in favor of the tax authority and consequently dismissed the Plaintiff’s claim.

However, the Supreme Court reversed the lower courts’ decisions and remanded the case back to the Seoul High Court on grounds that the High Court should have tried whether Cayman Partnership C could be deemed as a foreign corporation under the former Corporate Income Tax Law based on the assumption that Cayman Partnership C is the BO of the capital gains at issue (Supreme Court Decision 2010Du20966, July 11, 2013).  In the wake of the Supreme Court’s decision, the Jongno District Tax Office (the “Defendant”) changed their tax assessment basis from personal income (withholding) tax to corporate income (withholding) tax, deeming Cayman Partnership C to be the BO.  Nonetheless, the Supreme Court ruled that such change by the tax authority cannot be allowed and ultimately rendered a decision in favor of the Plaintiff (Supreme Court Decision 2014Du3068, September 4, 2014).

Within a year from the aforementioned Supreme Court decision, on April 17, 2015, the Defendant made a subsequent tax assessment denying application of all tax treaties on grounds that Cayman Partnership C is the BO of the subject capital gains, and issued a tax payment notice of KRW 180 billion for corporate income (withholding) tax, which was more than four times the previous tax assessment.  The Plaintiff appealed shortly thereafter and the Seoul Administrative Court and Seoul High Court rendered decisions in favor of the Plaintiff, which were recently affirmed by the Supreme Court (Supreme Court 2017Du36908, November 12, 2020). 

Summary of the Supreme Court’s Decision

The Supreme Court’s decision involved not only traditional tax issues such as analogical application and mutatis mutandis application of the ESOL, but also legal issues such as general provisions of the Civil Code pertaining to the point in time when the SOLTC commences, causes for tolling of the SOLTC and abuse of the SOLTC.

First, as to whether the ESOL on the rights of tax assessment under the NTBL can be applied mutatis mutandis or by analogy to the statute of limitations on the rights for tax collection, the Supreme Court clarified that “the obligation to pay corporate income withholding taxes is automatically established pursuant to the relevant legal provisions, and is not dependent upon the tax authority’s exercise of its rights of tax assessment.  Therefore, there is no room for application of the ESOL.”  As such, the Supreme Court held that there was no unlawful aspect to the lower court’s decision(s) that the ESOL set forth under Article 26-2 (2) (a) of the NTBL could not be applied to the disposition of tax collection.

Concerning the starting point of the statutory period for which the government has the right to collect corporate income (withholding) tax, i.e., whether it is one day after the tax payment due date (May 11, 2005) or the date of the Supreme Court’s final decision (September 4, 2014), the Supreme Court viewed the former (May 11, 2005) as the starting point of the statutory period since the tax authorities could have exercised its tax collection right from that date.  This is true irrespective of the fact that it may have been difficult for the tax authorities to determine the BO before the previous decision of the Supreme Court was rendered.

Significance of the Decision

The Supreme Court’s decision represents a significant development in that it was the first time a Korean court upheld the legal principles that (i) application of the ESOL on the tax authority’s tax assessment right is limited only to the same type of tax; and (ii) statute of limitations on the tax authority’s tax assessment right shall not be applied mutatis mutandis or in an expansive manner to the rights of tax collection.  With this Supreme Court decision having clarified that provisions concerning the statute of limitations apply to disposition of tax collection, a ten-year SOLTC under the current NTBL, will apply to withholding taxes over KRW 500 million (Article 27 (1) (a) of the NTBL).

In this case, the tax authority argued that unlike in traditional tax assessment, type of tax is not a fundamental element in a withholding situation, and that there was no clear or specific precedent on the extent of re-disposition of tax collection because existing precedents on re-disposition pertained only to tax assessments (and not tax collection).

Kim & Chang demonstrated that since the tax authority’s rights of tax collection, unlike those of tax assessment, already implements a “tolling of SOLTC” system, there would be no need to apply the ESOL to tax assessment in an expansive manner.  We also argued that since the taxpayer, taxable period and type of tax are fundamental elements that comprise the unit of tax liability, there is no room to apply the ESOL where two cases involve different types of tax.

We successfully represented the Plaintiff in the first appeal to induce a decision of cancellation for the personal income (withholding) tax assessment in the amount of approximately KRW 43 billion, and also obtained in the second appeal the decision of cancellation of the Defendant’s assessment of KRW 180 billion in its entirety.  Both rulings by the Supreme Court are significant and may impact subsequent cases as they clarified that (i) the ESOL on tax assessment does not apply to a disposition of withholding tax collection and (ii) in legal relationship pertaining to withholding, type of tax serves as the fundamental element that comprises the unit of tax liability.