SM Entertainment, which paid about 60 billion won over five years to former chief producer Lee Soo-man, won an administrative suit against the tax authorities. The court acknowledged that the producing fee paid to the former chief was excessively high and subject to adjustment under tax law. But it found it unlawful to reassess taxes based on a standard the tax authorities failed to prove, namely what an appropriate producing fee would be.
The Administrative Division 5 of the Seoul Administrative Court (presiding judge Director General Leejeong) on the 27th fully upheld the claims in SM's suit seeking to cancel the corporate tax assessment imposed by the Gangnam Tax Office chief.
The court canceled about 8.8 billion won of the roughly 16.1 billion won in corporate taxes imposed on SM. Of about 4.069 billion won in value-added taxes, it recognized only about 5 million won as a legitimate amount and canceled the remaining roughly 4.064 billion won. It accepted all parts SM sought to cancel in the suit.
The dispute arose from a master producing contract between SM and the company's founder and then-largest shareholder, the former chief. SM agreed to pay the former chief 6% of settlement-based sales, including records, digital content, overseas, management, and concerts. Accordingly, it paid about 60 billion won from 2015 to 2019 and treated the entire amount as a corporate tax expense.
◇ Tax authorities said services must be provided for each revenue item… court: "It is only a basis for calculating the fee"
The tax authorities judged that the fee was excessively high compared with the actual work provided by the former chief. They recognized about 20.2 billion won paid in line with record and music sales as an expense, but excluded about 23 billion won linked to appearance fees and royalties, saying those services were not provided.
They also found that roughly 14.6 billion won linked to vocal appearance fees and the like was excessively high compared with the average combined compensation of about 2 billion won for three chief producers in the same industry from 2015 to 2019. They did not recognize as an expense the amounts paid based on sales from records and music released before 2015, saying there was no contractual basis.
The court found the premise of this taxation method to be wrong. Under the contract, the services the former chief was to provide were "music and content producing and artist producing," and the settlement-based sales categories such as records or concerts were not a requirement to provide separate work for each item but merely a basis to calculate the overall fee.
Accordingly, it held that payments linked to that revenue could not be excluded from expenses solely because the former chief's individual services could not be identified in specific revenue items.
◇ "60 billion won is excessive"… still, no tax if the proper "market price" is not proven
However, the panel did not find the roughly 60 billion won paid to the former chief to be appropriate in itself. Considering the contract's purpose and performance method, the size of the fee, and the sharing of expenses, it found the payment excessive and subject to denial of unjust transaction calculation under tax law.
Denial of unjust transaction calculation is a system that allows tax authorities to make adjustments when a company transacts with a related party and unduly reduces its tax burden by paying more than a normal level of expense.
But to apply this system, the court held, the tax authorities must prove the "market price," the proper price that would have been paid in an arm's-length transaction. The panel found that merely showing the 60 billion won to the former chief was excessive was insufficient; the appropriate producing fee must be identified to calculate the amount to be excluded from expenses and the tax due. Because the tax authorities failed to prove this market price, the corporate tax assessments contested by SM were also canceled.
Most of the value-added taxes were also canceled on the same grounds. The tax authorities deemed the purchase tax invoices for the overpaid portion to be invoices inconsistent with the facts, but the panel found they could not be treated as false because SM and the former chief exchanged tax invoices using the actual agreed transaction amount as the supply price.
It was confirmed that the former chief paid income taxes on the roughly 60 billion won received from SM.