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30 Jan 2018

Strengthening of Taxpayer’s Safeguards Regarding Temporary Custody of Documents During Tax Raids

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TAX LEGAL UPDATE + 2018.01.

Strengthening of Taxpayer’s Safeguards
Regarding Temporary Custody of Documents During Tax Raids

When Korean tax authorities conducted a tax raid (i.e., a tax audit conducted without provision of prior notice to taxpayer), the authorities have generally engaged in temporary custody of taxpayer’s documents, etc., with the taxpayer’s consent. Until now, because the legal basis for temporary custody did not provide for specific procedures for such custody nor safeguards for taxpayers, disputes between the tax authorities and taxpayer arose and there were also cases in which taxpayer’s rights were infringed upon.

In particular, while the authorities provided a list of documents, etc., subject to temporary custody, the list lacked details in most cases (e.g., for electronic materials, authorities referred to “PC” or “hard drive” rather than spelling out the individual material). Consequently, taxpayers found it considerably difficult to formulate defense strategies for the audit and litigation, as they had little clue on the documents that the authorities seized.

In order to address such problems and inadequacies and to protect taxpayer’s rights, the Korean government amended Korea’s National Tax Basic Act (the “NTBA”) (i.e., law) on December 19, 2017 (effective as of January 1, 2018). The implementing regulations (i.e., Presidential Decree of the NTBA) were drafted and open to public comments until January 29, 2018. After a cabinet meeting to consider the regulations, the executive branch of the Korean government is expected to promulgate the final regulations by the second week of February. Through these amendments, the Korean government has added requirements for performing temporary custody as well as procedures for temporary custody. In particular, we expect that it should become more difficult for the Korean tax authorities to maintain their currently unreasonable and aggressive practice with respect to temporary custody (e.g., it is anticipated that authorities may provide a more detailed list of documents, etc., subject to temporary custody).

We provide below a summary of the amendments, which have not been finalized as of the writing of this newsletter; however, we do not anticipate significant changes to the amendments described below. We also present our analysis of the anticipated impact on tax raids in the future.

I. SUMMARY OF AMENDMENTS

  Former Rules New Rules*
Requirements for performance of temporary seizure
Temporary seizure of documents, etc., to the minimum extent necessary for purposes of audit
Taxpayer’s consent
Temporary seizure of documents, etc., to the minimum extent necessary for purposes of audit
Taxpayer’s consent
[ADDED] Existence of one of the following causes (each referred to as a “Cause for Denial of Presumption of Good Faith Cooperation”):
- Taxpayer’s non-performance of obligation to cooperate (e.g., filing of returns, submission of confirmation of filing in good faith, preparation/submission of payment record)
- Where there is allegation of untruthful transactions, e.g., transactions without materials or sham transactions
- Where there is a tip-off (i.e., whistle-blowing) on specific tax evasion by a taxpayer
- Where there are clear materials indicating plausibility of allegation on omission or error in the taxpayer’s reported information
- Where taxpayer has provided money and valuables or aided and abetted provision thereof in connection with tax official’s duties
[ADDED] A person with legitimate right including taxpayer, custodian, etc., makes submission of the documents, etc., based on the person’s discretion
Method and procedure for temporary custody
Temporary custody of documents, etc., during the period of tax raid
Issuance of certificate of temporary custody to taxpayer
Temporary custody of documents, etc., during the period of tax raid
Issuance of certificate of temporary custody to taxpayer
[ADDED] Tax official must provide notice of the following to the taxpayer prior to temporary custody:
- Ground for temporary custody (i.e., statement of Cause for Denial of Presumption of Good Faith Cooperation)
- No temporary custody without taxpayer’s consent
- Temporary custody only permitted for documents, etc., submitted by the taxpayer based on his/her discretion
- Taxpayer may receive the documents, etc., in temporary custody upon request
[ADDED] Where the documents, etc., does not meet the requirements for temporary custody, taxpayer may refuse temporary custody
- Where the taxpayer refuses temporary custody on this basis, the tax official cannot retain temporary custody without “legitimate cause”
Procedure for return of documents, etc., in temporary custody
Where a taxpayer requests return of documents, etc., in temporary custody, such documents, etc., must be returned immediately so long as the return does not affect the audit
[AMENDED] Where a taxpayer requests return of documents, etc., in temporary custody, such documents, etc., must be returned in a maximum of 28 days from the date of request (more specifically, documents, etc., should be returned within 14 days but authorities may retain the documents, etc., for up to 14 additional days upon review and approval by the Taxpayer Advocacy Committee).
- [AMENDED] Regardless of the above, for documents, etc., that the tax official has determined to have no impact on the audit, such documents, etc., must be returned immediately upon taxpayer’s request
[ADDED] Tax official must return all documents, etc., in temporary custody by the time of conclusion of the tax audit

* The new rules based on the Presidential Decree of the NTBA will be effective as of the promulgation date (anticipated to be in the second week of February).

II. ANTICIPATED IMPACT ON TAX RAIDS IN THE FUTURE

A. Temporary custody

Until now, during a tax raid, where a tax auditor requested temporary custody of a broad range of documents, etc., held by the taxpayer, it was practically difficult for the taxpayer to refuse such request due to lack of attorney-client privilege and out of consideration of maintenance of an amicable working relationship with the auditor (as well as the potential risk that tax authorities could obtain a warrant for such temporary custody).

However, with the amendment’s requiring tax auditors to give notice of various matters including the cause for temporary custody and permitting the taxpayer to refuse temporary custody for documents unrelated to the purpose or scope of the tax raid, we expect that the Korean tax authorities will seek to comply with the procedures for temporary custody prescribed under the laws and regulations and be more open to protecting taxpayer’s rights.

B. Taxpayer’s request for return of documents, etc.

Until now, even if a taxpayer requested return of documents, etc., in temporary custody, the Korean tax authorities could have denied return thereof based on the ground that such return would affect the audit. Moreover, taxpayers in many cases could not even know what documents they should request to be returned, because the tax authorities provided only a vague list of documents subject to temporary custody (e.g., referring to “PC” or “hard drive” for electronic materials rather than listing the individual material). As a result, taxpayers found it considerably difficult to prepare defense strategies and arguments for the audit and litigation, as they had little information on the documents held by the authorities.

Under the amended NTBA and Presidential Decree thereof, where a taxpayer requests return of documents, etc., in temporary custody and the tax authorities determine that such return has no effect on the audit, the requested documents must be returned immediately. Even if this is not the case, the requested documents must be returned within a maximum of 28 days. Lastly, if taxpayer makes no request for return, the tax auditors must return all of the documents held in temporary custody by the end of the tax audit. In sum, all documents in temporary custody must eventually be returned to the taxpayer.

As a result of the amendments, we expect the tax authorities to prepare a more detailed list of documents, etc., subject to temporary custody. In connection with return of documents, etc., in order for a taxpayer to confirm return of all of the documents, etc., in temporary custody, it will become important for the taxpayer to verify the accuracy of the list of documents stated in the certificate of temporary custody (which is issued by the tax authorities at the time of temporary custody). Moreover, where a taxpayer requests return of electronic materials, the tax authorities should return all of the electronic materials and only retain copies that are necessary.

C. Validity of assessments based on illegal temporary custody

If the tax authorities do not comply with the procedure or requirements on temporary custody in order to retain temporary custody of documents, etc., and make an assessment based on such documents, this may be viewed as a violation of principle of due process prescribed under Korea’s Constitution. Thus, a tax assessment based on materials obtained via violation of the required procedure may be cancelled (in a manner similar to a criminal sentence based on illegally obtained evidence).

Since the courts also hold the position that a tax assessment based on materials collected from an illegal tax audit is illegal (e.g., Supreme Court Decision 2012Du911 dated June 26, 2014), we believe that violation of the new procedures and requirements relating to temporary custody may serve as grounds for the conclusion that the assessment at issue is illegal and thus should be cancelled.

III. CONCLUSION

The amendments to procedures and requirements for temporary custody certainly constitute a positive development for taxpayers that promote transparency for taxpayers and improvement of unreasonable tax audit practice of the authorities. However, there still remain some issues with the amendments that may indicate the authorities’ continuation of their aggressive practice with respect to temporary custody.

First, in order for the auditors to retain temporary custody of taxpayer’s documents, etc., there must be a Cause for Denial of Presumption of Good Faith Cooperation. We expect that authorities will most frequently cite existence of “clear materials indicating plausibility of allegation on omission or error in the taxpayer’s reported information”. It is currently unclear under practice and precedents what constitutes the above “clear materials”; as a result, tax authorities may justify their aggressive temporary custody of documents based on a pro-revenue interpretation of this cause. Thus, clarification may be necessary in this area. Next, “documents, etc.” subject to temporary custody are defined as books, documents, or other things for purposes of determination or correction of tax base and tax amount for national tax. Again, the tax authorities may broadly interpret the range of “documents, etc.” subject to temporary custody in order to maintain their current aggressive practice.

Thus, developments in practice and precedents with respect to temporary custody should continue to be monitored in order for taxpayers to be well prepared for tax raids.

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CONTACT

Kim, Dong Soo Kim, Kyu Dong
+82-2-528-5219 +82-2-528-5542
dskim@yulchon.com kdkim@yulchon.com
Lim, Jeong Hun Koo, Jeong Mo
+82-2-528-5332 +82-2-528-5948
jhlim@yulchon.com jmkoo@yulchon.com
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