Tax Evasion | “False Reporting of Raw Materials Incurs Additional Tax Even Without Knowledge”: Supreme Court Judgment Reaffirming the Substance-Over-Form Taxation Principle

The lower court upheld the tax authority's determination in full.

The court noted that the term “yeongyeong” ordinarily refers to the leaf vein, which is part of the tobacco leaf, and determined that the nicotine had in substance been manufactured using tobacco leaves as its raw material and therefore constituted tobacco under the Tobacco Business Act.

The court further determined that, with respect to the plaintiff's act of reporting the material as having been extracted from stems and thereby failing to pay the tax, no justifiable grounds were recognized, so the imposition of the tobacco consumption tax and the additional tax was lawful.

The Supreme Court held that in determining tax evasion, whether tax is imposed must be judged on the basis of the actual nature of the raw material rather than the form of the report.

In other words, the Court held that even if a contract or report describes the material as “stem nicotine,” where part of the tobacco leaf was in fact used, the material constitutes tobacco and is subject to taxation.

The Supreme Court held that a taxpayer has a duty to sufficiently verify the nature of the raw material.

The Court made clear that merely relying on the materials or explanations provided by the supplier is insufficient, and that, as to matters that directly affect whether tax is imposed, the taxpayer bears the responsibility to verify them on his or her own.

With respect to the imposition of an additional tax, the Supreme Court reaffirmed the position of its existing precedents.

That is, the Court determined that even where the taxpayer had no intent to evade taxes, an additional tax may be imposed if, viewed objectively, the taxpayer failed to report and pay the tax without justifiable grounds.

In particular, the Court held that a mistake in interpreting the statute or a mere misunderstanding does not amount to justifiable grounds.

For corporate practice, this judgment signifies the following changes.

The determination of tax evasion is made on the basis of the actual transaction structure and the substance of the raw material, not merely the method of reporting or the formal documents, and in particular, for importing and manufacturing companies, the responsibility to verify the supply chain as a whole has been strengthened.

Accordingly, simply relying on a counterparty's materials or reporting in accordance with existing practice can no longer serve as a safe response, and the matter has shifted into an area where legal and tax review at the preliminary stage is indispensable.

This judgment is significant in that it once again clarified the existing legal principle of shifting the standard for determining tax evasion from form to substance.

In particular, it made clear that where the nature of the raw material determines whether tax is imposed, the taxpayer's duty to verify is strictly recognized, and an additional tax may be imposed for a breach of that duty.

In the end, this judgment may be summarized as follows.

“In determining tax evasion, the circumstance that one ‘did not know’ cannot serve as a ground for exemption, and a breach of the duty to verify based on substance itself leads to legal liability.”

Our firm closely reviews, in related matters, what legal evaluation the transaction at issue may receive under the substance-over-form taxation principle, and analyzes step by step whether the matter is subject to taxation and whether the imposition of an additional tax is lawful.

We also comprehensively organize the materials, contract structure, and supply chain relationships involved in the import and manufacturing process, and establish strategies to rebut or supplement the grounds for the tax authority's determination.

In addition, we manage as a single continuous process the entire course extending through responses to tax audits, pre-assessment review (a Korea-specific procedure allowing a taxpayer to contest a tax assessment before it is formally issued), appeals to the Tax Tribunal, and administrative litigation, and we design directions for reducing the taxpayer's legal liability, focusing on the scope within which the duty to verify is recognized and on whether justifiable grounds exist.

Because tax evasion disputes are an area in which the outcome can vary greatly depending on the initial response, it is crucial to prepare a systematic response strategy from the taxation stage onward.

If you need assistance, we recommend arranging a 🔗tax attorney legal consultation, through which a one-stop response with legal professionals such as corporate attorneys and tax accountants is available.