ATJ Asian Tax Journal

Asian Tax Journal

Print ISSN 1738-3323 Online ISSN 2733-9270

A Case Study on Dividend Tax Avoidance by Selling Inherited Shares to a Controlled Company

  • Oh Jong Moon Dongguk University

Asian Tax Journal Vol. 18 No. 3 (2017), pp. 91-119

Abstract

This paper examined a case, in which individual taxpayers sold their inherited shares to a corporation controlled by those individuals, and the corporation issued a debt instrument to them with respect to the proceeds from the sale of the shares. In the above mentioned transaction, individual taxpayers could avoid the personal income tax by receiving the dividends on the transferred shares in the form of annual repayments of the debt. Under the US tax law system, at least three tax provisions are relevant to this transaction, and the implications of these in Korean tax law are as follows： Firstly, in cases where the indebtedness is held pro rata by shareholders and the debt－equity ratio of the corporation is unreasonable, a substantial body of US common law considers the alleged indebtedness as a contribution of capital for tax purposes rather than as a bona fide debt. As a result, the debt repayments in such a case should be deemed to be a distribution to the shareholders. It is recommended for Korea to consider introducing provisions with similar effects. Secondly, the US tax law recasts stock sale through related corporation as stock redemption in order to prevent a bailout which could be achieved by a shareholder selling the stock to another controlled corporation. However, since the tax treatment of stock redemption in Korea differs from that of the United States, it would be very cumbersome to make anti－bailout rule by referring to this provision. Finally, the US tax law imposes the personal holding company tax on the undistributed income of those corporations that serve as vehicles to shelter passive income. It is designed to prevent shareholders of closely held corporations avoiding higher individual taxes by accumulating earnings at the corporate level. Since it would compel the corporation to distribute its accumulated earnings, it would provide sufficient reference to Korean tax laws. It is expected that legal loopholes be properly amended to efficiently block any forms of bailout or tax－free withdrawals of earnings from a corporation.

Keywords

  • tax avoidance
  • bailout
  • stock redemption
  • personal holding company tax

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