Deals & Cases

Corporate 2019-10-04
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DR & AJU Clarifies the Limit for Applying the Principle of Substantial Taxation in Cases When a Parent Company Increases Paid-in Capital for Its Subsidiary Company to Dissolve the Debt of the Subsidiary Company, for Which the Parent Company Has Guaran

​When a parent company sells an overseas subsidiary due to the financial difficulties related to running it, a case can develop where the parent company repays its overseas subsidiary’s liabilities before selling it at the request of a buyer. With regard to the above liabilities, there are many cases where the parent company has already guaranteed a payment for its overseas subsidiary. 

There are two methods by which the parent company can repay its subsidiary’s liabilities in the above case: one is that the parent company directly pays by subrogation, and the other is that the subsidiary repays the liabilities by itself using capital raised after a paid-in capital increase for the subsidiary. However, the parent company’s effects on the company’s domestic taxes will vary greatly depending on which method is chosen. 

In the case of the former, even if the parent company acquires a claim for indemnity against its subsidiary through the direct payment by subrogation, the parent company cannot appropriate the claim as a “bad debt,” as it is a non-trade receivable. Accordingly, it is not acknowledged as a loss under the Corporate Tax Act. Meanwhile, in the case of the latter, the paid-in capital increase paid by the parent company can be acknowledged as a loss under the Corporate Tax Act, because it is deemed to be a loss due to the sale of securities after selling the subsidiary.

Recently, the tax authorities have negated the total amount of paid-in capital increases as a loss by applying the principle of substantial taxation, as they regard the parent company to have directly paid by subrogation its subsidiary’s liabilities, even though the parent company has adopted the latter method in the above case. DR & AJU made a rectification claim (tax refund) on behalf of one of the leading domestic construction companies, of which the paid-in capital increase equivalent to KRW 80 billion for its foreign subsidiary failed to be acknowledged as a loss, in accordance with the tax authorities’ position. As a result, DR & AJU drew the decision on acceptance (the tax refund of KRW 30 billion), through which the National Tax Service’s Taxation Fact Judgment Advisory Committee reversed the existing position.  

DR & AJU provided an aggressive explanation of the client’s inevitable circumstances, in which the client had no choice but to sell its overseas subsidiary and decided to increase the paid-in capital in the process thereof through a close fact investigation. DR & AJU also argued that the effect of a legal act chosen by a taxpayer should not be thoughtlessly negated by applying the principle of substantial taxation just because the economic effect is the same through the in-depth legal review.

In the above case, the taxpayer-selected legal act type, or the paid-in capital increase transaction, could be acknowledged according to the detailed relevant facts, or an enormous amount of taxes could be imposed by negating it according to the principle of substantial taxation. Accordingly, companies placed in the same situation will need to minimize their risks through prior consultation with an expert.