Supreme Court Rules "Input Tax Deduction Required When VAT Paid Due to Mutual Mistake Is Refunded"

When a local government enters into a service contract without knowing that the service is exempt from value-added tax (VAT) and determines and pays the service fee including VAT, the Supreme Court has ruled that only the amount obtained by deducting the input tax from the paid VAT amount can be refunded.

This is because if it had been known from the beginning that the service was VAT-exempt, the companies participating in the bid would have included the input tax in their costs when determining the service fee.

Supreme Court, Seocho-dong, Seoul.

원본보기 아이콘

According to the legal community on the 4th, the Supreme Court's 3rd Division (Presiding Justice No Jeong-hee) overturned the lower court's ruling that favored the plaintiff in the appeal case filed by Yeongdeungpo-gu Office against waste disposal companies for the return of unjust enrichment and remanded the case to the Seoul Southern District Court.

From 2008 to 2012, Yeongdeungpo-gu Office signed service contracts with three waste disposal companies to handle waste that could not be brought into the Sudokwon Landfill Site within its jurisdiction and paid service fees totaling about 1.95 billion KRW. This included about 170 million KRW in VAT.

However, according to the Value-Added Tax Act, the waste disposal services provided by the companies were exempt from VAT. The district office later discovered this during an internal audit and in November 2013 requested the companies to return the mistakenly paid VAT.

The defendant companies filed a VAT correction claim with the tax authorities and returned the refunded VAT amount to Yeongdeungpo-gu Office, but only the amount obtained by deducting the input tax from the VAT sales tax on the originally paid service fees was returned.

Typically, when paying VAT to the government, the amount paid is the VAT on sales (output tax) received from providing goods or services to others minus the VAT on purchases (input tax) incurred for business maintenance expenses.

However, in cases like this involving VAT-exempt businesses, the Value-Added Tax Act does not allow deduction of input tax from output tax. Since the business operator bears the full input tax, costs increase, leading to higher prices.

Reflecting this, the Local Contract Act stipulates that when a local government contracts with a supplier of VAT-exempt goods or services, the supplier's input VAT on raw materials must be included in the estimated bid price.

The first and second trials had ruled in favor of Yeongdeungpo-gu Office.

The court recognized the return of unjust enrichment for one of the three defendant companies where the five-year statute of limitations under the Local Finance Act had expired, only for the remaining amount, but ordered the other two companies to return the full amount. The defendants' claims that there was no existing profit or that the damages from not deducting input tax due to Yeongdeungpo-gu Office's fault should be offset were rejected.

During the appeal process, the company exempted from the return obligation for the expired portion underwent compulsory mediation, while the two companies that lost entirely appealed to the Supreme Court.

The Supreme Court's judgment differed.

The lower courts had reasoned that if neither Yeongdeungpo-gu Office nor the defendant companies had been under the common misconception that the service was subject to VAT, the district office would not have entered into an agreement to bear VAT, and thus the entire amount paid as VAT should be considered unjust enrichment.

However, the Supreme Court found it reasonable to assume that if both parties had known at the time of contract that the service was VAT-exempt, the defendant companies would have factored in the input tax they had to bear when determining the cost (service fee).

The court stated, "If the plaintiff and defendants had known at the time of each service contract that the service was VAT-exempt, it is unlikely that the plaintiff would have agreed to pay the defendants the existing service fee including VAT."

As grounds for this judgment, the court pointed out, "Although the service was VAT-exempt, the plaintiff and defendants mistakenly believed it was subject to VAT and entered into the contracts under this misconception. Consequently, there was no specific agreement on how to reflect the input tax that the defendants could not deduct in the service fee."

Furthermore, the court explained, "In general taxable businesses, the operator receives VAT on sales from the service recipient and pays the government the difference after deducting input VAT, effectively not bearing the input VAT. However, in VAT-exempt businesses, the Value-Added Tax Act prohibits deduction of input VAT, so the operator bears the input VAT without receiving VAT on sales, increasing costs accordingly."

The court added, "Relevant laws stipulate that when contracting with a supplier of VAT-exempt goods or services, the input VAT on raw materials borne by the contract party must be included in the estimated price. The plaintiff announced the estimated service price and VAT separately on the premise that the service was subject to VAT. Accordingly, the defendants participated in the bids under the assumption that they could deduct input VAT related to the service and entered into the contracts with the plaintiff."

It concluded, "Nevertheless, the lower court ruled that the defendants must return the entire amount of VAT paid by the plaintiff. This ruling misapplied legal principles regarding the scope of unjust enrichment return, VAT payment under the Value-Added Tax Act, and supplementary interpretation of legal acts, affecting the judgment."

© The Asia Business Daily(www.asiae.co.kr). All rights reserved.