CONTENTS
- 1. Overview of the Claim Litigation Case
- 2. First-Instance Determination in the Claim Litigation
- - Second-Instance Determination in the Claim Litigation
- 3. The Supreme Court's Determination in the Claim Litigation
- - Implications of This Judgment
- 4. Daeryun's Strategy in the Claim Litigation
1. Overview of the Claim Litigation Case
The plaintiff construction company, which brought the claim litigation, held construction payment claims totaling 103 billion won against the developer, Company A.
However, when Company A fell into financial difficulty, the plaintiff lent 49 billion won to Company A in order to keep the project going, and they agreed that, upon any future repayment, the loan claim would be repaid in priority to the construction payment.
Company A subsequently paid a total of 48.4 billion won, and the plaintiff applied this to repayment of the loan in accordance with the agreement.
Soon afterward, however, Company A was declared bankrupt due to its financial collapse, and the plaintiff's construction payment claim was confirmed to be irrecoverable.
The plaintiff therefore treated the relevant amount as a bad debt deductible in calculating income under the Corporate Tax Act and, at the same time, filed a request for correction seeking a bad debt tax deduction of 7.7 billion won under the Value-Added Tax Act.
The tax authority, however, argued that the 48.4 billion won already received should be regarded as having been applied to partial repayment of the construction payment, and it recognized only the 4.35 billion won in VAT corresponding to the remaining construction payment claim while declining to recognize the remaining 3.37 billion won.
The plaintiff accordingly brought a lawsuit seeking revocation of the disposition.
2. First-Instance Determination in the Claim Litigation
The lower court dismissed the plaintiff's claim. Its reasoning was as follows.
The court premised its reasoning on the proposition that the fact that a bad debt may be deductible in calculating income under the Corporate Tax Act does not by itself mean that a bad debt tax deduction is recognized under the VAT Act.
· The issue of abandonment of collection
The court found that the plaintiff's applying the 48.4 billion won first to the loan amounted, in substance, to a voluntary abandonment of collection of the construction payment.
· Absence of confirmed irrecoverability
The court determined that, although the debtor had gone bankrupt, it was difficult to conclude that the construction payment claim had been objectively confirmed to be irrecoverable, because of the plaintiff's method of applying the repayment.
In the end, the first-instance court accepted the tax authority's reasoning as it stood and did not recognize the plaintiff's request for correction.
Second-Instance Determination in the Claim Litigation
The second-instance court likewise upheld the lower court's determination as it stood.
It emphasized that, in order to recognize a bad debt tax deduction, not only must the debtor be bankrupt, but the construction payment claim itself must be in an objectively irrecoverable state.
It also found that, because the plaintiff had voluntarily applied the payment first to the loan, this could be interpreted as conduct by which the plaintiff itself blocked the possibility of collection.
Accordingly, it held that no deduction could be allowed for the remaining 3.37 billion won.
In other words, both the first- and second-instance courts interpreted the requirement of "confirmed irrecoverability of the claim" very narrowly and ruled in favor of the tax authority.
3. The Supreme Court's Determination in the Claim Litigation
The Supreme Court reversed the lower judgment and remanded the case for further hearing, clarifying the following legal principles.
The Supreme Court held that a "claim that cannot be collected due to the debtor's bankruptcy" under the Value-Added Tax Act means a claim whose complete irrecoverability has been objectively confirmed as a result of the bankruptcy.
· A deduction cannot be denied merely because collection had been possible
The Supreme Court held that a bad debt tax deduction cannot be denied merely on the ground that collection of the claim had been possible before the bankruptcy or that the creditor had applied the payment first to the loan.
It further took the view that, absent special circumstances showing that the taxpayer clearly and voluntarily abandoned the claim, the deduction should be recognized.
· Consistency between the Corporate Tax Act and the VAT Act
The court held that because the grounds for a bad debt tax deduction directly incorporate the grounds for deducting a bad debt in calculating income under the Corporate Tax Act, interpreting the two differently is contrary to the principle of no taxation without law.
· Respect for the agreement on application of repayment
The Supreme Court took the view that it is not permissible for the tax authority to arbitrarily reinterpret the order of application of repayment agreed upon by the parties, that the application of repayment must be respected in accordance with the principle of freedom of contract, and that it cannot be concluded to be an abandonment of collection.
Implications of This Judgment
This judgment leaves the following implications regarding claim litigation.
1. Reaffirmation of the principle of no taxation without law
It put a check on the practice of interpreting the VAT Act and the Corporate Tax Act differently and applying them to the taxpayer's disadvantage.
2. Presentation of an objective standard of confirmation
It made clear that, when the objective ground of bankruptcy arises, irrecoverability should be regarded as confirmed, and that past possibility of collection or the choice of application does not affect the substance.
3. A precedent favorable to corporate claim management
It opened the way for a creditor who, due to liquidity problems, chose to apply repayment first to a loan to receive a VAT deduction if collection of the construction payment later became impossible because of bankruptcy.
4. Strengthened protection of small businesses
It is regarded as a judgment that gives effect to the original legislative purpose of "easing the funding burden on small self-employed businesses and small and medium-sized enterprises."
4. Daeryun's Strategy in the Claim Litigation
Based on this precedent, Daeryun Law Firm LLP has prepared the following strategy for claim litigation and tax appeal cases.
① Precise analysis of the facts
We distinguish the causes of the construction payment and the loan and document the reasonableness of the agreement on application of repayment.
From the tax investigation stage onward, we secure claim management materials (contracts, approval documents, meeting minutes, and the like) and use them as a basis for the appeal.
② Securing evidence of confirmed bad debt
We collect all relevant documents, such as the bankruptcy decision, the distribution schedule, the liquidation-value assessment, and the court's decision confirming the claim, in order to prove "objectively confirmed irrecoverability."
③ Simultaneous response on corporate tax and VAT
We consistently assert the deduction of the bad debt in calculating income under the Corporate Tax Act and the bad debt tax deduction under the VAT Act, thereby blocking any dual interpretation by the tax authority.
④ Strengthening the defense argument
Where the tax authority asserts "abandonment of collection," we emphasize that this is merely an agreement on application of repayment and is distinct from an abandonment of collection.
We prove that priority repayment of the loan was unavoidable under industry practice, such as in project financing.
⑤ Support for corporate practice
We verify, for each claim, whether the tax invoice issuance records and the accounting treatment are consistent.
We standardize the application-of-repayment process, claim classification, and tax filing process into a manual to prevent recurrence of the same risk.
This precedent made clear that where objective irrecoverability has been confirmed due to the debtor's bankruptcy, the VAT bad debt tax deduction is recognized regardless of the method of application of repayment.
This is a judgment that serves as an important standard for companies in managing claims and responding to tax risks in bankruptcy cases.
If you need legal assistance with matters such as claim litigation, you are welcome to make a 🔗legal consultation reservation with Daeryun Law Firm LLP, whose attorneys have experience in tax-related litigation, including requests for correction of value-added tax.
