Claim Litigation | Supreme Court Judgment Recognizing the Bad Debt Tax Deduction of VAT on Irrecoverable Claims upon a Debtor's Bankruptcy

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.

The lower court dismissed the plaintiff's claim. Its reasoning was as follows.

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.

The Supreme Court reversed the lower judgment and remanded the case for further hearing, clarifying the following legal principles.

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.