South Korea - Tax impact on warranty clauses | KPMG | GLOBAL

South Korea - Tax impact of warranty clauses

South Korea - Tax impact of warranty clauses

Tax impacts of warranty clauses in South Korea.

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Does the seller grant warranties or indemnities to the purchaser when acquiring a company?

Yes, in general the seller grants warranties or indemnities to the purchaser when acquiring a company.

Does the tax treatment of the warranty depend on its legal classification (e.g. indemnity vs. reduction in the purchase price vs. others)?

For tax purposes, the tax treatment of consideration in relation to warranty provisions (i.e. indemnity or warranty provisions) should be determined based on its substance, and such determination would generally depend on various factors and circumstances, such as the nature of the payment, specific terms and conditions of the SPA, reason for the payment, etc.
For example, even though the SPA classifies the payment as a price adjustment, if the nature of the payment is consideration for the indemnity in substance, then it is likely to be treated as income to the party receiving such indemnity payment for tax purposes.

Is classification of the contractual warranties as a price reduction clause or an indemnity clause relevant in your jurisdiction?

Both types of contractual provisions (i.e. warranties and indemnities) are relevant in Korea. However, as aforementioned, the classification of tax treatment would depend on various factors and the substance.

Are mixed clauses included in the SPA (for instance, a warranty drafted partially as a price-reduction clause for the portion corresponding to the purchase price and as an indemnity clause for the amount exceeding the purchase price)?

Mixed clauses are often utilized.

Is the classification usually mentioned in the SPA?

The classification can be mentioned in the SPA, but it is not very usual.

Are there criteria to distinguish between a price reduction clause and an indemnity clause? Could you briefly describe these criteria?

No specific criteria exist. Also, in Korea, no payments are generally made directly to the target company. Rather, the payments would take place between the buyer and seller of the relevant transactions.

What is the most common type of warranty in your jurisdiction?

No warranty clause is more common than others, it depends on the facts and circumstances of each transaction.

Is a tax warranty usually provided by way of a separate warranty agreement (different from the SPA)?

No. Tax warranty provisions are usually included as a part of the SPA.

Is it usual / a market practice to negotiate after-tax settlements, i.e. to reduce the price adjustment to a net payment (i.e. indemnity minus the tax effect of the deduction for the acquirer or target) or to guarantee full indemnification (i.e. gross-up payment to guarantee a net indemnity)?

Such negotiation would vary on a case-by-case basis.

Acquirer

  Corporate Income Tax Personal Income Tax
Price reduction clause The price adjustment has no direct impact on the taxable income of the purchaser. It is treated as a decrease in the investment value of the shares. Consequently, future capital gains will be increased The price adjustment has no direct impact on the taxable income of the purchaser. It is treated as a decrease in the investment value of the shares. Consequently, future capital gains will be increased
Indemnification clause The indemnity payment is generally treated as taxable income of the recipient. The indemnity payment is generally treated as taxable income of the recipient.

Vendor

  Corporate Income Tax Personal Income Tax
Price reduction clause The price reduction may reduce the capital gains of the vendor. Lower taxable gains leading to a refund of capital gains tax already paid. The price reduction may reduce the capital gains of the vendor. Lower taxable gains leading to a refund of capital gains tax already paid.
Indemnification clause The indemnity may be tax deductible if such payment is made in accordance with the relevant terms and conditions of SPA. The indemnity does not affect the capital gains.

Target

Price reduction clause N/A*

*Non-available

Contact

Ihn Byung-Choon – KPMG in South Korea

Partner, Tax Services

Tel : (+)82 2 2112 0951

bihn@kr.kpmg.com
 

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