A Case Study on Tax Planning Using Net Operating Loss and Non－Deducted Bad Debt Reserve on Merger
Asian Tax Journal Vol. 13 No. 3 (2012), pp. 113-140
Abstract
Many of Korean credit card companies were threatened with collapse due to their huge debts and deteriorating asset quality in 2003 when a credit bubble burst in Korea. In respond to liquidity problems of a credit card company, some of Korean banks were required to merge troubled credit card companies. As a result of it, Woori Banks merged Woori Credit Card and Korea Exchange Bank merged Korea Exchange Credit Card. In both cases, at the initial phase of merger, two banks were not supposed to enjoy tax benefits stemming from a transfer of net operating losses incurred by two credit card companies because both cases did not meet the conditions stated in the Corporate Income Tax Law for net operating loss transfer to a merging entity. In order to maximize tax benefit from the merger, Woori Bank and Woori Credit Card chose to increase capital of Woori Credit Card before the merger with a view to meeting a key condition for net operating loss transfer (Option1) and Korea Exchange Bank and Korea Exchange Credit Card selected to transfer of non－deducted bad debt reserve of Korea Exchange Credit Card (Option2). This study presents an analysis on two cases which two banks chose a different tax saving strategy in a similar situation and adopted a tax planning approach. In case of Woori Credit Card, Woori Financial Holding Company owned 100% share of Woori Bank and Woori Credit Card so that there is no substantial difference, from a contractual perspective as well as an implicit tax perspective of all taxes, between Option 1 entailed a change in the merger ratio and Option 2 brought no change in the merger ratio. From a explicit tax perspective, Option 1 is more favorable by 360 billion Korean Won, whereas Option 1 is slightly less favorable owing to an opportunity cost arising from the increase of capital from an all cost perspective. Consequently, this study concludes that Woori Credit Card was successful in choosing a more favorable tax planning strategy associated with the merger. In case of Korea Exchange Credit Card, Korea Exchange Bank owned 68.6% share of Korea Exchange Credit Card so that Option 1 subject to a change in merge ratio is less favorable from a contractual perspective and an implicit tax perspective of all taxes. On the other hand, Option 1 is favorable by 27.4 billion Korean Won from a explicit tax perspective. In Option 1, an opportunity cost resulting from an increase of capital exceeded a reduction in explicit tax amount if analyzed from an all cost perspective. Also there would have been an increase of the merge cost if Korea Exchange Bank had chosen Option 1. In this regard, Korea Exchange Credit Card is believed to choose more favorable tax strategy in connection with the merger. Additionally, this case study suggests that a tax authority should be considered as one of participants in transaction. As a matter of fact, the conditions provided in the Corporate Income Tax Law for a transfer of net operation loss of merged entity were created for the purpose of preventing tax evasion using a merger of entity with net operating loss. So, it is likely that tax revision to change its conditions for transfer of net operating loss was acceptable as mergers in both cases was not designed to enjoy tax benefits by a transfer of net operating loss. Their tax planning related to mergers would have been more effective if they had been able to utilize net operating losses from two merged credit card companies.
Keywords
- effective tax planning
- merger
- net operating loss
- bad debt reserve
- contractual perspective
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