Title Trusts of Convertible Bonds and Tax Treaty Abuse: Standards of Economic Substance in Three Judgments

Question

Whether the effect of a deemed gift under a nominee trust, once established merely by the transfer registration of the name of convertible bonds, extends to the shares acquired upon conversion is the first issue. If bonds and shares are separate property, there is considerable room to view a new nominee trust relationship as having arisen at the time of conversion. However, if the same economic value has already been taxed or could have been taxed under the initial deemed gift, the result would be double taxation of the same economic value.

Where an intermediate company that created the appearance of satisfying the requirements for the reduced rate under the tax treaty is identified, the extent to which the benefit is to be withdrawn is also at issue. A standard is needed as to whether the reduced rate is to be denied to the name-holding company that created the appearance while the application as against the beneficial owner is left in place, or whether the entire structure is to be excluded.

It must also be examined whether the disallowance of improper accounting may be applied merely because the price of a transaction between related parties differs from the market price. Where there are special circumstances, such as pressure upon the transfer of management control or the need for corporate restructuring, a transfer at a low price can hardly be asserted on the basis of the price written in the contract alone.

Material to check

The bond register and the name transfer registration records, the conversion request, and the details of issuance upon conversion must be obtained. If the time at which the name transfer registration functioned as the opposability requirement (assertability against third parties) and the time at which the shares were issued upon conversion are separated from each other, the standard for the time of taxation may also change.

Arrange the course of the movement of funds and the details of dividend transmission in chronological order. Whether the intermediate company raised funds on its own, and whether it passed the dividends it received on to the beneficial owner as they were, become the key facts for the determination of abuse.

Record each company's business purposes, the businesses conducted, the assets held, the placement of officers and employees, and the actual state of control and management. If there is no business activity other than shareholding, the grounds for viewing it as having created the appearance of satisfying the requirements for the reduced rate are increased.

Gather together transaction prices between non-related parties, the market conditions at the time, financial statements and audit materials, and the details of debt waiver and financial support. Filing materials as to whether the property was taxed or could have been taxed under the initial deemed gift must also not be omitted.

Possible readings

One interpretation reads the deemed gift provision and the anti-abuse provision strictly and separately. Because convertible bonds and converted shares are separate property, a new nominee trust relationship arises at each conversion; if treaty abuse is confirmed, the benefit is removed from the structure as a whole; and if the price of a related-party transaction differs from the ordinary price, the disallowance of improper accounting may be applied.

The other interpretation places weight on the continuity of value and tax equity. It holds that the effect left by the initial deemed gift must be respected so that the corresponding shares are not taxed again; that where economic reasons also exist, this is not the main purpose of the abuse and the benefit should be retained; and that transactions in which special circumstances exist cannot be denied on the basis of the contract price alone.

The two interpretations differ in the order of determination and the weight of the requirements. The former divides the unit of property and asks whether the requirements are satisfied at each point in time, while the latter views the flow of economic value as one and examines double taxation and equity together. In practice, depending on which is given emphasis first, the arrangement of materials and the direction of proof differ.

What the decisions held

Supreme Court Decision 2016Du1165, on the basis of the main text of paragraph (1) of Article 45-2 of the former Inheritance Tax and Gift Tax Act, held that registered convertible bonds fall within the property subject to the deemed gift, because the name transfer registration in the bond register is the opposability requirement (assertability against third parties). It drew the line, however, that although the shares received upon conversion are separate property and a new nominee trust relationship arises, the re-taxation of shares corresponding to convertible bonds that were taxed or could have been taxed at the outset must in principle be prevented. The scope necessary for preventing tax avoidance, the contradiction with the effect of the initial deemed gift, the continuity of value without additional contribution, and the equity of double taxation were mentioned together as grounds.

Supreme Court Decision 2016Du841 held that the principle of taxation according to substance in Article 14, paragraph (1) of the Framework Act on National Taxes applies as it is to the interpretation and application of tax treaties as well, unless there is a special provision excluding it. Article 27, paragraph (2) of the Korea-Germany Tax Agreement is a provision that denies benefits to abuse whose main purpose is to create rights without proper economic reasons so as to create the appearance of satisfying the requirements for the reduced rate, and it is determined comprehensively in light of the circumstances under which the rights were created, the business purposes and details of activities, the roles, and whether there is control and management. Because GmbH 1 and GmbH 2 had no business activity other than shareholding, received all funds from TMW, and passed the dividends on to TMW as they were, the 5 percent under item (a) of paragraph (2) of Article 10 was not allowed to the name-holding companies, while the 15 percent under item (b) as to the beneficial owner could not be excluded, since its application could hardly be regarded as having been the main purpose.

Supreme Court Decision 2017Du47519 held that the disallowance of improper accounting applies only where, in a transaction with a related party, a tax burden is unduly avoided or reduced without resorting to the rational method of a person in a normal economic position. Economic rationality is determined by examining together the various circumstances of the transaction, the prices with non-related parties, and the special circumstances at the time, and it noted that the preceding agreement and the subsequent agreement under the supplementary agreement in the course of the transfer of management control between the plaintiff and Megaarc cannot be regarded as collusion. It stated that where accumulated deficits and a valuation of 0 won, financial support, and debt waiver are considered together, a transfer at a low price or an abnormal transaction cannot be asserted.

Practical checklist

First, check whether the boundary between the property that became subject to the initial deemed gift and the property newly created thereafter was divided and recorded. The date of name transfer registration and the date of issuance upon conversion, the time of taxation and the details of filing, should be capable of being placed side by side in the same table for comparison.

Second, check whether the intermediate company's purpose of establishment, financing, business activities, and the flow of dividends were evidenced in chronological order. Whether there are traces of an independent business, and whether funds enter and leave all in one direction, must be shown through objective materials.

Third, check whether materials for comparing transaction prices between non-related parties and the special circumstances at the time are in place. Only when the market conditions, financial condition, circumstances of negotiation, and prices of alternative transactions are placed together can the logic of asserting on the basis of the contract price alone be prevented.

Fourth, check whether internal approval materials and negotiation records capable of rebutting the causal relationship between economic rationality and the reduction of the tax burden are retained. If the need for restructuring or the decision to relinquish management control is not left in documents, special circumstances tend to remain as mere assertions.

Glossary

A nominee trust means a state in which the actual owner and the name holder are different. The deemed gift is a system under which, even without donative intent, the value of the property is deemed to have been received as a gift on the day the registration, etc. is made in the name of the name holder, and it applies notwithstanding the provisions of Article 14 of the Framework Act on National Taxes.

The anti-abuse provision of a tax treaty is a provision that excludes benefits in transactions whose main purpose is to create the appearance of satisfying the requirements for the reduced rate. The principle of taxation according to substance is the principle of Article 14, paragraph (1) of the Framework Act on National Taxes that taxation follows the substance of a transaction, and unless there is a special provision excluding it, it extends as it is to the interpretation and application of tax treaties.

The disallowance of improper accounting is a system under which the tax authority denies the accounting for a related-party transaction and deems objective and reasonable income to exist by methods prescribed in statutes. Economic rationality is a criterion for determining whether the method accords with that which a person in a normal economic position would choose, and it is examined together with whether there is abuse in the guise of the form of the transaction.

Sources and limitations

This white paper was prepared on the basis of only Supreme Court Decision 2016Du1165, Supreme Court Decision 2016Du841, and Supreme Court Decision 2017Du47519 and the relevant provisions cited in those judgments. No Case other than these three Cases has been cited, and the point in time of the case-law information was checked as of 2026-10-15.

This material is a white paper for general research purposes and is not legal advice. Because the conclusion in an individual matter may vary with the facts, evidence, and applicable statutes, it must without fail undergo the review of the responsible expert before being used in actual response.

Points left open

The standard as to whether, when the scope of convertible bonds that were taxed or could have been taxed under the initial deemed gift is set broadly, the scope of the corresponding shares is broadened accordingly as well, or whether it must be calculated anew for each conversion, remains open. The method of determining the corresponding ratio has not been fixed by the judgments alone either.

Remaining issues also include to what extent the benefit should be retained where economic reasons exist in part in treaty abuse, and how the weight of special circumstances should be weighed in the disallowance of improper accounting. In both issues, the results of the comprehensive determination are greatly driven by the facts.

When to reconsider

If the statutes of the period covered by these Cases are amended, or if new judgments are rendered concerning the scope of the initial deemed gift, the determination of beneficial ownership, and the method of calculating the ordinary price, the arrangement and conclusions of this white paper are reviewed again. Where the wording of the tax treaty changes as well, the section on the interpretation of the anti-abuse provision needs to be revised.

If evidence of the flow of funds is newly revealed, or if it is confirmed that the facts concerning the business activities of the intermediate company have changed, the facts section is updated immediately. Even where, in the same facts, the time of taxation or the unit of property subject to taxation is raised as an issue in a different manner, the order of determination is rechecked from the beginning.

Statutes referred to

• 구 상속세 및 증여세법(2007. 12. 31. 법률 제8828호로 개정되기 전의 것) 제45조의2 제1항 본문
• 상법 제479조
• 국세기본법 제14조, 제14조 제1항
• 대한민국과 독일연방공화국 간의 소득과 자본에 대한 조세의 이중과세회피와 탈세방지를 위한 협정 제10조 제2항 가목, 제10조 제2항 나목, 제11조 제2항, 제12조 제2항, 제21조, 제27조 제1항 가목, 제27조 제2항
• 구 법인세법(2008. 12. 26. 법률 제9267호로 개정되기 전의 것) 제93조 제2호, 제98조 제1항 제3호
• 구 법인세법(2010. 12. 30. 법률 제10423호로 개정되기 전의 것) 제52조
• 구 법인세법 시행령(2010. 2. 18. 대통령령 제22035호로 개정되기 전의 것) 제88조 제1항
• 구 상속세 및 증여세법(2010. 1. 1. 법률 제9916호로 개정되기 전의 것) 제63조

Decisions referred to

• 대법원 2019. 9. 10. 선고 2016두1165 판결 · Decision ledger
• 대법원 2019. 6. 27. 선고 2016두841 판결 · Decision ledger
• 대법원 2018. 12. 28. 선고 2017두47519 판결 · Decision ledger

Verification status

The judgments in Supreme Court Decisions 2016Du1165, 2016Du841 and 2017Du47519 and the original texts of Article 479 of the Commercial Act and Article 14 of the Framework Act on National Taxes cited in those judgments were checked on the National Law Information Center as at 15 October 2026. Provisions of former statutes, such as Article 45-2 of the former Inheritance Tax and Gift Tax Act, and the provisions of the tax treaty with Germany could not be checked because their original texts could not be accessed. This brief cites only the three judgments listed among the judgments examined.