Supreme Court Partially Overturns and Remands 89 Billion Won Tax Lawsuit of Cho Seok-rae, Honorary Chairman of Hyosung... "Unfair Non-Reporting Penalty Tax Must Be Reassessed"

Unreported Penalty Tax of Over 3.2 Billion Won Must Be Judged Based on Nominee Trustees

[Asia Economy Reporter Choi Seok-jin, Legal Affairs Specialist] The Supreme Court has ruled that the tax authorities must re-examine the portion of the unjust failure-to-report penalty tax imposed under Article 47, Paragraph 2 of the Framework Act on National Taxes, among the approximately 89 billion KRW in taxes levied from 2013 to 2015 related to stocks held under a borrowed name by Honorary Chairman Cho Seok-rae of Hyosung Group.

The unjust failure-to-report penalty tax is an additional tax imposed when a taxpayer conceals or disguises facts that form the basis for calculating the tax base or tax amount, thereby violating the obligation to report the national tax base or tax amount. Previously, the second trial court concluded that such 'fraudulent acts' occurred based on Honorary Chairman Cho, who lent his name, but the Supreme Court ruled that the determination of 'fraudulent acts' should be based on the nominal holders who are the taxpayers, not on Honorary Chairman Cho, the nominal trustee.

Earlier, the second trial court ruled to cancel the tax authorities' assessment on about 51.4 billion KRW out of the total approximately 89.7 billion KRW in taxes imposed on Honorary Chairman Cho, including gift tax, unjust failure-to-report penalty tax, comprehensive income tax, and capital gains tax, while upholding about 3.2 billion KRW of the unjust failure-to-report penalty tax as legitimate. In the retrial, if the amount of tax Honorary Chairman Cho must pay increases, the 3.2 billion KRW could be further reduced.

The Supreme Court's Third Division (Presiding Justice Noh Jeong-hee) on the 15th overturned the lower court's partial ruling in favor of the plaintiff in the appeal case where Honorary Chairman Cho sued the Gangnam Tax Office Chief and 48 other tax office chiefs to cancel the designation and notification of joint tax payment obligations for gift tax.

The court stated, "The taxpayer liable for gift tax under the deemed gift provision for nominal trust property is the nominal holder, and the nominal trustee only bears joint tax payment obligations with the nominal holder for the relevant gift tax. Therefore, the obligation to report the taxable amount and tax base of gift tax under the deemed gift provision for nominal trust property lies with the taxpayer, the nominal holder."

It added, "Since the unjust failure-to-report penalty tax is imposed when the 'taxpayer' fails to report the national tax base by the statutory deadline due to fraudulent acts, to impose the unjust failure-to-report penalty tax on the nominal holder regarding gift tax under the deemed gift provision for nominal trust property or to impose joint tax payment obligations on the nominal trustee, it must be evaluated that the nominal holder, the original taxpayer, committed fraudulent acts related to the failure to report."

Furthermore, the court explained, "It is illegal that the lower court judged the imposition of the unjust failure-to-report penalty tax as lawful solely based on the actions of the nominal trustee plaintiff without examining whether the nominal holder committed fraudulent acts related to the failure to report," which was the reason for remanding the case.

Previously, the Gangnam Tax Office and others notified Honorary Chairman Cho, who held Hyosung stocks under the names of current and former executives and employees, of his designation as a joint taxpayer for gift tax under the Inheritance and Gift Tax Act, which presumes that stocks held under borrowed names are deemed gifted to the nominal holder. They imposed taxes totaling approximately 89.7 billion KRW, including gift tax, unjust failure-to-report penalty tax, comprehensive income tax, and capital gains tax, for the years 2013 to 2015.

The trial focused on two main issues.

The first was whether the existing precedent limiting the overlapping application of the deemed gift provision for nominal trust property applies when a loan is taken out using stocks held under another's name as collateral to purchase new stocks, and before the new stocks are registered under the same nominal holder, the previously held nominal trust stocks are sold and the proceeds are used to repay the loan.

Article 45-2, Paragraph 1 of the Inheritance and Gift Tax Act (Deemed Gift of Nominal Trust Property) stipulates that when the actual owner and the nominal holder differ for assets requiring registration or other public notice methods for transfer or exercise of rights (excluding land and buildings), the value of such property is deemed gifted by the actual owner to the nominal holder on the date of registration (or the day after the end of the year following the year of acquisition in the case of registration).

The Supreme Court has held that "stocks acquired with the proceeds from the sale of nominal trust stocks that were initially subject to deemed gift taxation and registered again under the same person's name are not subject to the deemed gift provision again unless there are special circumstances recognizing them as separate new nominal trust stocks disconnected in time or nature from the original stocks."

In other words, when A holds stocks under B's name, the Inheritance and Gift Tax Act presumes that A gifted the stock value at the time of registration to B and imposes gift tax accordingly. If A sells the nominal trust stocks and uses the proceeds to acquire new stocks registered under B's name, applying the deemed gift provision again to tax this as a gift would constitute double taxation.

The issue in this case was whether this Supreme Court precedent applies when a loan is taken out using stocks held under B's name as collateral to acquire new stocks.

The second issue was whether the unjust failure-to-report penalty tax can be imposed on the nominal trustee or joint tax payment obligations imposed on the nominal trustee solely because the nominal trustee committed fraudulent acts, even if the nominal holder cannot be evaluated as having committed fraudulent acts. The Supreme Court overturned the second trial court's ruling because of differing judgments on this point.

In the first trial, the court recognized approximately 85.8 billion KRW of the taxes imposed on Honorary Chairman Cho, including gift tax and unjust failure-to-report penalty tax of about 64.2 billion KRW, comprehensive income tax of about 2.5 billion KRW, and capital gains tax of about 19.1 billion KRW, as legitimate tax assessments. However, it canceled tax assessments amounting to about 4 billion KRW, noting that the exact tax amount could vary depending on how the tax base is calculated, and thus canceled all tax amounts.

The amount of canceled tax assessments increased significantly in the second trial.

The reason was related to the first issue: just as the deemed gift provision cannot be applied to prevent double taxation when new stocks are purchased with proceeds from the sale of existing nominal trust stocks and registered under the same name, the court held that if a loan was taken out using existing nominal trust stocks as collateral to purchase new stocks, and the loan was repaid by selling the existing nominal trust stocks before registration of the new stocks, the deemed gift provision cannot be applied.

The second trial court stated, "If the nominal trustee used a loan secured by existing nominal trust stocks to acquire new stocks and registered them under the same name, and if the loan was repaid by selling the existing nominal trust stocks before the registration of the new stocks, this is not substantively different from acquiring new stocks with proceeds from the sale of existing nominal trust stocks and registering them under the same name. Therefore, the legal principle excluding the deemed gift provision applies in such cases as well."

Ultimately, the second trial court concluded that only about 16.7 billion KRW of the approximately 64.2 billion KRW in gift tax and unjust failure-to-report penalty tax upheld by the first trial court was legitimate, reducing the tax amount Honorary Chairman Cho must pay by about 47.5 billion KRW compared to the first trial. The court maintained the first trial's conclusions on comprehensive income tax and capital gains tax.

The Supreme Court also agreed with the second trial court's judgment on this point.

Regarding this, the court stated, "If the nominal trustee repaid the loan secured by old stocks by disposing of those stocks before the registration of new stocks under the nominal holder's name (a third party), it cannot be considered that separate nominal trust relationships were established between the old and new stocks. Therefore, as with acquiring new stocks with proceeds from the sale of old stocks, the deemed gift provision under Article 45-2, Paragraph 1 of the Inheritance and Gift Tax Act cannot be applied again to tax the new stocks."

On the other hand, the Supreme Court did not uphold the second trial court's judgment regarding the unjust failure-to-report penalty tax.

The court said, "To impose the unjust failure-to-report penalty tax on the nominal holder for gift tax under the deemed gift provision or to impose joint tax payment obligations on the nominal trustee, it must be evaluated that the nominal holder, the original taxpayer, committed fraudulent acts related to the failure to report. The lower court's ruling that the imposition of the unjust failure-to-report penalty tax was lawful solely based on the nominal trustee's actions without examining whether the nominal holder committed fraudulent acts is illegal."

Although the Supreme Court instructed the second trial court to re-examine the unjust failure-to-report penalty tax portion of about 3.2 billion KRW deemed legitimate by the second trial court, it does not necessarily mean that the entire tax assessment will be canceled. In the retrial, following the Supreme Court's remand, it is expected that the tax authorities will investigate whether the employees who lent their names to Honorary Chairman Cho committed 'fraudulent acts' such as concealing or disguising all or part of the facts forming the basis for calculating the tax base or tax amount, and based on the results, either cancel the entire or part of the 3.2 billion KRW tax assessment or uphold it as legitimate.

This Supreme Court ruling is the first to explicitly state that in cases where new stocks are purchased with loans secured by existing nominal trust stocks, if the loan is repaid by disposing of the existing stocks before the registration of the new stocks, the deemed gift provision cannot be applied as when acquiring new stocks with proceeds from the sale of existing stocks.

It is also the first case to explicitly declare that for imposing unjust failure-to-report penalty tax or joint tax payment obligations related to gift tax under the nominal trust deemed gift provision, the determination of fraudulent acts should be based on the nominal holder, not the nominal trustee.

This content was produced with the assistance of AI translation services.