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Court Allows Tax Deduction on Loss Incurred by Taxpayer upon Redemption of Exchangeable Bonds Issued by Offshore SPV


A Korean company (the “taxpayer”) established a special purpose vehicle (the “SPV”) in the Cayman Islands to issue JPY-denominated exchangeable bonds (the “EBs”) to raise funds from foreign investors.  When the SPV was required to redeem the EBs, it did not have sufficient cash as a result of the increase in the JPY/KRW exchange rate, and the taxpayer was therefore mandated under the contract to remit approximately an additional KRW 300 billion in cash to the SPV.  The taxpayer claimed the KRW 300 billion as a loss and tax deductible expense. 

The Korean tax authority denied a tax deduction on the basis that the payment was made due to a subrogation of a debt obligation between related parties (from the SPV to the taxpayer), which cannot be claimed as a tax deductible expense by the taxpayer under Korean tax law.  However, based on a thorough review and analysis of the “orphan structure” under which the EBs were issued, Kim & Chang successfully argued that (i) the taxpayer (not the SPV) was in substance the issuer of the EBs and (ii) any losses incurred from the payment was essentially borne by the taxpayer since the taxpayer did not have any right to indemnity against the SPV for the loss it has incurred.  In the end, the Daegu Administrative Court and Daegu High Court agreed with our position and ruled in favor of the taxpayer.

This case is important because in the context of using an overseas SPV to borrow funds through issuance of EBs, it sets a precedent where the taxpayer that has actually used the borrowed funds and bore the relevant costs may be deemed as the issuer of EBs.

We leveraged our experience from a prior successful Supreme Court case (2006Du7904) that involved a similar issue to effectively explain the complex transaction structure to the court in collaboration with our finance team and highlight the similarities between the two cases, leading the courts to decide in favor of the taxpayer.

Despite the complexity of the transaction structure, e.g., use of an orphan SPV in the Cayman Islands, this is a meaningful case where the court allowed the taxpayer to claim tax deduction for the loss incurred in the process of repaying the EBs, by treating the taxpayer (as opposed to the SPV) as the agent that issued the EBs and borrowed the funds from foreign investors.