There are key differences between South Korean and U.S tax practices, which all professionals involved in a Korean subsidiary’s tax audit should note.
Question: What’s the best way to manage your Korean subsidiary’s tax audit while avoiding frustration
After leading the tax controversy groups at two outstanding global law firms for more than twenty years, I left Washington, D.C., to join Kim & Chang’s tax department in Seoul, South Korea. My expectation was to spend a year or two with my esteemed co-counsel firm and then to return home with a deeper understanding of tax controversy practice in Korea and Asia. Now, more than five years on, I have come to realize that obtaining that “deeper understanding” is a complex and long-term undertaking I surely could not have achieved in a short stint. This brief article compares tax advocacy practices in Korea and the United States. My hope is that these observations can illuminate successful tax advocacy strategies that may be of use to TEI members confronting tax disputes in Korea and, more broadly, throughout Asia.
As a threshold matter, tax executives with experience in Korea and other Asian tax jurisdictions often use adjectives such as frustrating, aggressive, and obstinate to describe tax auditors here; indeed, it’s almost a cliché to do so. To be sure, many companies have experienced extreme exasperation with tax audits in this part of world. Let us now briefly compare the Korean tax dispute system with the parallel and differing procedures in the United States to aid in understanding some of the root causes of—and potential remedies for—this frustration.
Principal Characteristics of the National Tax Service
Much like the Internal Revenue Service, Korea’s National Tax Service (NTS) has a national headquarters and seven regional enforcement offices typically referred to by an acronym whose first letter is the city or region covered by that regional office. Thus, the Seoul Regional Tax Office or SRTO is the principal enforcement arm of the NTS in Seoul. Likewise, the tax law is administered and enforced in Busan (BRTO), Daegu (DRTO), and other major cities and regions in Korea by separate regional offices. Each regional office has an important internal hierarchy including one presiding commissioner, two or more assistant commissioners, and other senior, mid-level, and working-level personnel.
Admission to Korean government employment (within the NTS or any other agency) requires an applicant to pass a rigorous civil service examination. This examination is typically taken immediately following graduation from college or university or military service (Korea imposes two years of mandatory military service on all males). The year a government employee passes the civil service examination denotes his or her class, and this designation stays with the individual throughout his or her tenure with the NTS.
Performance at every level within the NTS is examined and graded scrupulously. In contrast with the IRS, at the NTS the great majority of employees stay with the agency for the long term. It is rare, for example, for a person to work for the NTS for a few years and then move to the private sector and then return to the NTS in the revolving-door manner that prevails in the United States. Employment with the Korean government is a highly prestigious and honorable career that is respected within Korean families and society.
Korea is a bona fide and thriving democracy and has been a member country of the Organisation for Economic Co-operation and Development since 1996. Moreover, Korea participates actively in OECD initiatives, and the NTS is modern and sophisticated in all respects. That said, the hierarchical form of civil service in Korea, with intensive examinations and performance grading, has some roots in the historically Confucian society that prevailed in Korea during the Joseon Dynasty (1392–1910). The country retains a devotion to hierarchy that forms the framework within which all decisions by the NTS are made.
Keeping these characteristics in mind can be of great practical assistance should your Korean subsidiary be subject to a tax audit. For one, on a philosophical level the NTS does not see the tax audit process as primarily confrontational or adversarial. Indeed, its stance is that the payment of the lawful amount of tax is a patriotic duty. NTS officers see themselves as justly ensuring that the proper and lawful tax is paid. While no one at the NTS is unaware that there are advocacy and controversy elements to tax examinations from both a company’s perspective and the government’s, the system here is not adversarial in the same sense or to the same degree that prevails in the United States. With these differences noted, we will look at a few distinct features of Korean tax advocacy.
Particulars of Korean Tax Audits
Korean tax audits are conducted at a pace and over a time frame that, from a U.S. perspective, are inconceivably fast. Tax audits in Korea are typically completed within ninety to 120 days. Even extensive Korean field audits rarely last more than six months, although periods of inactivity, known as suspensions, may prolong this period. As TEI members know well, IRS examinations often last from two to three years (or longer). Also, Korean tax audits generally embrace a five-year audit cycle. While recent amendments have enacted longer statutes of limitations for certain types of transactions, generally there is a five-year limitations period. Korean tax procedure does not permit that period to be extended or curtailed. From a compliance point of view, Korean tax return filings and Korean transfer pricing documentation and local file requirements are broadly similar to those in the United States.
These factors combined mean that NTS auditors insist on replies to their information requests within very short time frames, typically overnight or within a few days. To be sure, these same demands are made of Korean companies and, thus, to that extent, there is a level playing field on which foreign and domestic companies are treated equally. Yet, because most multinational corporations have recordkeeping, decision-making, and compliance duties distributed among headquarters, a regional office, and local subsidiaries, it is often the case that the Korean subsidiary of a foreign MNC simply cannot comply in a period that NTS auditors regard as timely. The tension that delayed responses bring to a Korean tax audit is palpable. Audit team members must report delays to their team leader, the team leader must report to the director, and the director must report to the assistant commissioner and then to the commissioner on up through the hierarchy. Soon enough the company is found to be “uncooperative.” Such a finding has unhappy consequences, ranging from more exacting and aggressive requests by the auditors to the use of treaty requests for foreign documentation, an unwillingness to consider amicable resolution, and in serious cases the imposition of administrative fines for lack of cooperation or the use of the drastic Korean “dawn raid” procedure.
Several practical measures can minimize these risks. Simply making your tax organization aware of the pace and intensity of Korean tax audits helps immeasurably. If your organization and your in-house tax colleagues know that the NTS audit will be completed over the course of weeks (not years) and that responses to information request are expected very promptly (within days, not weeks) then marshalling timely responses becomes less of a struggle.
Also, establishing a rapid response team within your Korean subsidiary is most helpful. The types of information NTS auditors typically request are quite foreseeable. If all stakeholders know whom to call and what to expect in advance, then responses may be more timely and effective.
Setting up a communications team either internally or with outside advisors that parallel the rank and duties of the NTS audit team is also highly useful. Titles and rank are very important in Korea. Thus, a designated person of approximately similar rank should be assigned to liaise with the NTS audit team staff, a different and more senior person with the audit team leader, still a different person with the director above the team leader and, if needed, other senior officials in regional office leadership. Doing so will invite a more open, candid, and flexible dialogue between the company under audit and every level of the NTS audit team. Such an approach helps to minimize the risk of miscommunication and misunderstanding that cause audit controversies to escalate.
Also, when formulating a response to NTS’ information requests, it may be tempting to resort to two responses that are sometimes used by U.S. tax practitioners when dealing with certain IRS audit requests. One is that the information cannot be produced because it is confidential or proprietary. The other is to interpret unilaterally any ambiguous or vague request in the narrowest possible way. In most cases, neither tactic is helpful with Korean auditors. Indeed, to the greatest extent possible, in Korea (and more broadly throughout Asia) flatly declining to respond to a request or declining evasively should be avoided wherever possible. Right or wrong, government officers consider such responses defiant and disrespectful. Simply put, in Korea, a reply in the form of “yes, however” with a sincere explanation is always preferable to “no, because.”
Korean tax audits are concluded by either an assessment notice (preliminary or final) or a notice that the return is not subject to adjustment. Korean tax procedure does not provide for sophisticated settlement procedures similar to those in the United States (e.g., no Office of Appeals, no closing agreements, no fast track, and no post-Appeals mediation). Yet, notwithstanding the absence of conventional alternative dispute-resolution procedures, tax audits are frequently resolved in Korea amicably. Achieving an agreed resolution places a great premium on acknowledging the decision-making hierarchy within the NTS. To obtain an agreed and amicable resolution requires proactive engagement—in a smart and respectful fashion—at each level of the NTS hierarchy. In the United States tax advocacy often focuses on proving that the IRS’ position is wrong or mistaken. In Korea, that strategy is sometimes the only option. However, whenever possible, it is most effective for the company to frame its position as seeking a win-win outcome. In other words, rather than demonstrating that the auditor’s position is “wrong” or “unlawful,” the better approach, if feasible, is to show how the company’s position is fair, just, and reasonable to all parties.
Korean Tax Litigation
Both Korea and the United States are rule-of-law jurisdictions with a sophisticated, highly capable, and independent judiciary. However, there are meaningful differences between the two systems.
Once a notice of assessment is issued, a company may appeal to the Korean Tax Tribunal. This administrative review body convenes a four-member panel to review the evidence and arguments offered by the taxpayer and the NTS. Hearings before the Tax Tribunal are very short, typically less than a day. Submission of evidence and testimony is usually made by affidavit or brief. Live witness testimony is infrequent and, if needed, greatly limited compared to proceedings in the United States. Importantly, the NTS may not appeal an adverse decision by the Tribunal. Most observers believe that this rule causes the Tax Tribunal to be conservative in ruling against the NTS.
Appeals from the Tax Tribunal are to the District Court and, thereafter, to the High Court. Again, live witness and expert testimony is used exceedingly sparingly in Korea, but it is permitted. Discovery is (mercifully) limited and allowed only at the discretion of the court. Trials are conducted in one-day sessions separated by weeks or longer distributed over a lengthy period. Both the District Court (the first judicial court available to review tax cases) and the High Court permit the admission of new evidence. A final appeal is to the Supreme Court (the only level at which new evidence is not permitted). Quite unlike in the United States, the Korean Supreme Court’s review is mandatory if sought by either party.
The process of litigation from Tax Tribunal through to a decision in Supreme Court takes between four and five years. Unlike in the United States, the NTS rarely entertains the settlement of tax cases in litigation, with the agency taking the view that a dispute consigned to the judiciary should be resolved by the courts.
Most significant, Korea does not have a system of decided cases having a precedential and binding effect beyond the parties in the particular case. Indeed, most Korean court decisions are not officially published or released. Thus, the development of tax law jurisprudence in Korea is much more informal and more a creature of subjective evaluation than in the United States. The certainty and clarity that come from a highly developed body of tax jurisprudence, as in the United States, is not yet found here.
While it is quite difficult to generalize about the combined effect of these characteristics on Korean tax litigation, some observations and distinctions can reasonably be made. First, Korean courts strive to apply the law uniformly and in a fair and unbiased manner. This said, tax law and tax jurisprudence in Korea are not as explicit or as elaborately articulated as they are in the United States. Consequently, in many areas of tax law, Korean courts have issued diverse opinions that are challenging to reconcile. Noteworthy among them are decisions on beneficial ownership and the substance versus form rules. Also, because Korean courts do not rely heavily on oral witness testimony, it is critical to develop a powerful and well-documented factual case by use of affidavits, demonstrative evidence, analogies, examples, and practices in other countries to eliminate any doubt the courts may have over factual issues presented by a case. Whereas courts in the United States might find such an approach to be repetitive or overkill, in the Korean courts, particularly on factual issues, there is little risk in supplying too much proof.
Korea is a wonderful place to do business, with a highly educated, industrious, and foreigner-friendly population. Moreover, the country is a safe and enjoyable place to live and work and has world-class infrastructure. Although Korea is unquestionably a rule-of-law jurisdiction and has been an OECD member for nearly twenty-five years, tax enforcement here can be highly challenging. Several measures can be taken to minimize frustration in a Korean tax controversy. Understanding and acknowledging up front that the enforcement prerogatives and characteristics of the NTS are quite different from those of the IRS is a very helpful start. Planning for the rapid pace of Korean tax audits and recognizing the importance of avoiding being labeled “uncooperative” are also crucial. Heightened sensitivity to the importance of building a relationship of trust with your tax auditors and seeking to find a win-win solution are essential. Finally, if litigation is unavoidable, realizing that advocacy before the Korean courts turns on effective and unassailable evidentiary proof of your essential factual case will help the Korean courts apply the rule of law in a fair and just fashion.
Michael Quigley is a senior partner at Kim & Chang in Seoul, Korea.
Acknowledgment: I wish to acknowledge with profound gratitude the patience and understanding my colleagues at Kim & Chang have shown me while teaching me about the practice of tax law and controversy in Korea. Without their guidance, support, and friendship I would be lost. My colleagues have also kindly reviewed this article, but any shortcomings in it are entirely attributable to me.