1. Issues relating to deduction of purchase value-added tax (“VAT”) amount

Since the tax office may refuse to deduct to deduct purchase VAT amount in case of the non-issuance of a tax invoice (Article 17(2)(ii) of the Value Added Tax Act; the “VAT Act”), if a business did not receive a tax invoice when making a purchase of goods or services, in principle, the relevant purchase VAT amount may not be deducted from the sales VAT amount.  However, a tax invoice issued after such purchase but within the tax assessment period in which such purchase occurred (January 1 ~ June 30 and July 1 ~ December 31, respectively) may be eligible for deduction (see Supreme Court decision on case no. 2007Du15049 rendered on January 18, 2008).

Therefore, if the seller of such purchase improperly refuses to cooperate with the issuance of a tax invoice, the buyer may apply for deduction with buyer’s tax invoice[1] issued by its own during the tax assessment period (Article 126(4) of the Special Tax Treatment Control Act).  If the buyer fails to obtain a deduction as a result of not being issued a tax invoice without any fault attributable to the buyer itself, then the buyer would be entitled to compensation of damages against its counterparty for breach of contract or tort (Supreme Court en banc decision on case no. 2002Du5771 rendered on November 18, 2004).

2. Interpretation of whether VAT is included in payment amount when there is no mention of VAT in a court judgment, mediation order, etc. in a suit for monetary payment

The supplier may seek payment of VAT from the buyer upon an agreement between the parties on who assume responsibility for VAT (Supreme Court decision on case no. 99Da33984 rendered on November 12, 1999), and if payment of the VAT amount together with the supply price amount is sought through litigation, the VAT amount must be explicitly included in the “purport of claims” and the “grounds for claims” sections of the complaint, and if it is not included, under the principle of Korean Civil Procedure laws, the court does not have grounds to order the payment of such VAT amount.  In such case, the supplier has to either expand the scope of claims or commence separate litigation in order to obtain payment of VAT.

In the case of a court judgment, it is possible to determine whether VAT was included in the amount set forth in the “order” section by reviewing the grounds for the judgment, etc., but in the case of mediation, the process of calculation of such amount cannot be known, which may result in issues of interpretation.  Therefore, it would be necessary to determine whether VAT is included through the litigation records (i.e., whether the plaintiff included VAT in the amount of claims, whether a tax invoice was previously issued, and what the issues are between the plaintiff and the defendant, etc.).  If it is determined upon review that VAT is not included, additional review would be necessary given that mediation decisions, in contrast with court judgments, usually include the phrase “the remaining claims are waived,” and if it is clear that the claim itself did not include VAT, the plaintiff would have intended to waive the remaining amounts other than the mediation amount of the plaintiff’s claims, and it would be difficult to view that the plaintiff also intended to waive the VAT amount as well.  As a result, absent special circumstances, the payment of VAT may be obtained through a separate lawsuit.  Therefore, when participating in mediation, it may be advisable for the party responsible for monetary payment to consider foreclosing the possibility of assuming additional liability for VAT by adding language to the effect that “all disputes relating to this case shall be concluded, and no further claims of any kind shall be raised” in addition to “the remaining claims are waived.”

3. Tax issues relating to gains obtained in consideration for withdrawal of lawsuit

  1. If there is a waiver of property right which corresponds to consideration received for withdrawal of lawsuit

Since no taxable income is generated, such consideration is not taxable.  For example, if KRW1.4 billion is received by the plaintiff in a lawsuit seeking payment for the purchase of goods in the amount of KRW1.5 billion in consideration for withdrawing such lawsuit, then no taxable income is generated since the plaintiff has been paid KRW1.4 billion in consideration for waiving its claim for payment in the amount of KRW1.5 billion.

  1. If there is no waiver of property right which corresponds to consideration received for withdrawal of lawsuit

If the defendant in a lawsuit pays settlement money to the plaintiff for prompt resolution of the dispute even though the plaintiff’s claims are clearly groundless, the plaintiff receives the settlement money without waiver of any property right, which constitutes “remuneration” prescribed by Article 21(1)(xvii) of the Income Tax Act, a type of miscellaneous income that may be subject to taxation [see Tax Tribunal decision on case no. 2009Joong3587 rendered on December 17, 2009 (in a case where a partner of a partnership for a reconstruction project, which is subject to the approval of the relevant authority, commenced administrative litigation, arguing that a resolution for reconstruction was invalid, and was paid in consideration for withdrawing such administrative litigation in addition to compensation for his damage, the Tax Tribunal held that it is reasonable to view the payment as “remuneration” without consideration, in order to facilitate the reconstruction project, as constituting miscellaneous income), and Tax Tribunal decision on case no. Income 46011-240 rendered on February 17, 2000 (money paid to an existing tenant without obligation to do so, in order to facilitate the prompt evacuatino of a building acquired through an auction, constitutes miscellaneous income from which withholding tax must be withheld)].

However, in situations where it is not clear whether a party is legally entitled to a payment, money paid as settlement money for a dispute does not fall under the types of income enumerated under the Income Tax and does not constitute taxable income [see Supreme Court decision on case no. 90Da11813 rendered on June 14, 1991 (during the pendency of a lawsuit seeking confirmation of the invalidity of an employee’s dismissal, if there is a settlement whereby the employer pays a certain amount to the employee, but the employee waives the remaining claims, then such settlement money is money paid for settlement of the dispute, and it does not fall under any of wage income, retirement income, or miscellaneous income, which is subject to taxation under the Income Tax Act).