Third-Generation Business Heir Made 85.5 Billion Won from Stock Options as Company Was Sold: "Refund 13.1 Billion Won"... Loses Tax Refund Suit on Appeal [Invest&Law]

Entire Sale Price for Majority Shareholder's Stake Recognized as Market Value When Stock Options Were Exercised
All Gains Classified as Earned Income; KRW 13.1 Billion Refund Denied

A third-generation member of a domestic business-owning family sued to recover about 13.1 billion won in taxes paid after reporting profits from stock options exercised during a company sale as earned income, but lost in the second trial. The appellate court overturned the first-trial ruling, which had accepted the argument that the control premium included in the sale price should be excluded from earned income.

According to legal circles on October 14, the Seoul High Court’s Administrative Division 9-1, presided over by Judge Hong Ji-young, recently dismissed in full a lawsuit filed by Kim, a third-generation member of a domestic business-owning family, against the head of the tax office with jurisdiction over him. Kim had sought to overturn the denial of his claim for a reassessment of comprehensive income tax. A reassessment claim is a procedure through which taxpayers ask the tax authorities to refund taxes they have already paid, arguing that the amount exceeded what was due.

855 Billion Won in Gains from Two Stock Option Exercises

In 2014, a parent company led by Kim’s father sold a 60% stake in Company A to a consortium of outside investors. Company A’s controlling stake was subsequently resold to different private equity funds (PEFs) in 2017 and 2020. Kim served as co-CEO of Company A from 2014 to 2020, during which its largest shareholder changed several times.

Kim made a total of about 85.5 billion won by exercising stock options during the two sales of control of the company. The gain from buying shares below market value by exercising stock options is taxed as earned income. Any additional gain from a subsequent rise in the share price is treated as capital gains. Therefore, the amounts treated as earned income and capital gains depend on how the market value of the shares is determined at the time the options are exercised.

Kim initially reported the entire amount of about 85.5 billion won as earned income and paid comprehensive income tax on it. However, arguing that the sale price included not only the ordinary value of the shares but also a control premium, he sought a refund of about 13.1 billion won in 2021. He argued that the amount attributable to the control premium should be excluded from earned income and treated as capital gains. He filed a lawsuit after the tax authorities and the Tax Tribunal rejected his claim.

First Trial: "The Premium Must Be Separated Out"...Appeal: "The Right to Sell Is Also Part of the Share Value"

The first trial ruled in Kim’s favor. It found that the sale price set for transferring all the company’s shares along with control could not simply be treated as the market value of ordinary shares. The court’s reasoning was that the control premium included in the sale price should be distinguished from the earned income Kim received by exercising the stock options.

The appellate court reached a different conclusion. It found that the issue was not whether the sale price included a control premium, but what rights and transaction terms were attached to the shares Kim held.

The court noted, "The fact that the shares represent only a minority stake does not mean that their market value can be determined by taking the control premium out of the price paid for the largest shareholder’s stake." In other words, even if Kim was a minority shareholder, if he could sell his shares at the same price as the largest shareholder from the outset, that right must also be reflected in the value of his shares.

In fact, the first stock option Kim exercised in 2017 included a tag-along right allowing him to sell his shares on the same price and terms when the largest shareholder sold its stake. The second option, exercised in 2020, included a clause entitling him to receive the difference in cash, based on the largest shareholder’s sale price, if control of the company changed.

The court also considered that Kim had already entered into a share purchase agreement with the buyer, setting the sale price before he exercised the stock options. The appellate court found that, at the time he exercised the options, Kim already had the right to sell his shares at the same price as the largest shareholder and realize a gain.

Accordingly, the appellate court recognized the actual sale price as the market value of the shares at the time the stock options were exercised. Unlike the first trial, it found no reason to separate the control premium from the sale price. Since Kim sold the shares immediately at the same price on the day he exercised the options, the court also found that no additional gain arose after he acquired the shares. This means there was no amount to separately classify as capital gains.

Kim’s side appealed the ruling, and the case will now be decided by the Supreme Court.

This content was produced with the assistance of AI translation services.