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Supreme Court Rules on Whether Share Purchase Price may be Taxed as Deemed Dividends Based on Substance-Over-Form Principle


This article provides an overview of a Supreme Court decision (2022Du38014, June 16, 2022; affirmed without further review) regarding whether share purchase price may be taxed as deemed dividends by re-characterizing a share transfer between shareholders of an acquirer and target companies as a capital transaction based on the substance-over-form principle.

A Korean company (“KoreaCo”) was established for the development and sale of software.  The plaintiff, which is an affiliate of KoreaCo, acquired all of the shares in KoreaCo from its existing shareholders with the intent to merge KoreaCo with another Korean affiliate company.  While the transaction was in the form of a share transfer, the Korean tax authorities asserted that the substance of the transaction was in fact a capital transaction (i.e., a merger), and accordingly assessed withholding tax on the plaintiff for the deemed dividend portion.

The Supreme Court took into account several factors such as the circumstances leading up to the share transaction between the plaintiff and shareholders of KoreaCo, the intent of both parties, the method of determining the share sales price, and determined that the share transaction was reasonably executed to minimize the tax burden arising from the merger.  As such, the Court ruled that under the substance-over-form principle, the purchase price cannot be re-characterized as the “merger consideration” being paid to the merged company’s shareholders as part of the merger, and thus is not taxable as deemed dividend income.

The issue of this case was whether the sales price for the share transfer less the acquisition cost could be re-characterized as a deemed dividend income under the substance-over-form principle by treating the share transfer as a capital transaction.

Recently, there have been cases where the Korean tax authorities re-characterized two-step transactions (i.e., a share transfer followed by a merger) as pure capital transactions (i.e., merger only) in order to levy taxes on deemed dividend incomes arising from mergers.  This owed to the difference in tax rates applicable to capital gains from a share transfer (i.e., 20%) and progressive individual income tax rates for deemed dividends (i.e., 38% in this case).  This Supreme Court decision is meaningful as it acknowledged the business purpose and reasonableness of the two-step transaction explained above based on the facts and circumstances of the transaction.