A manufacturer that operates through outsourced production without its own manufacturing facilities cannot be classified as a "manufacturing business" under the Korean Standard Industrial Classification, which is eligible for tax reductions, the Supreme Court has ruled.
According to the legal community Friday, the third division of the Supreme Court (presiding Justice Lee Sook-yeon) recently overturned a lower court's partial ruling in favor of the plaintiff in a lawsuit filed by outdoor clothing company K2 Korea against the head of Seoul's Gangnam district office. The case sought to cancel the rejection of an acquisition tax correction, and the court sent it back to the Seoul High Court.
K2 Korea built a knowledge industry center in Gangnam district, Seoul, in 2019, comprising nine floors above ground and one below. The company used part of the building as its headquarters and leased part of it to small and medium-sized enterprises. K2 Korea initially paid acquisition tax and other taxes, but later filed a correction claim, arguing the property qualified as a manufacturing knowledge industry center eligible for tax reductions under the Restriction of Special Local Taxation Act, and requested a refund of part of the acquisition tax. However, the tax authorities rejected the correction claim on the grounds that K2 Korea did not have manufacturing facilities, prompting K2 Korea to file an administrative lawsuit in protest.
The key issue was whether a manufacturer that operates through outsourced production without manufacturing equipment is still eligible for the knowledge industry center tax reduction under the Restriction of Special Local Taxation Act. The act provides local tax reductions for "those who establish a knowledge industry center in accordance with the Industrial Cluster Act." The Industrial Cluster Act defines facilities eligible to occupy a knowledge industry center as "facilities for operating manufacturing, knowledge-based industries, information and communications industries, and the like."
The first and second courts sided with K2 Korea. They reasoned that the Restriction of Special Local Taxation Act does not require, as a condition for the acquisition tax reduction, that "the manufacturing business be a factory within the knowledge industry center, that is, equipped with manufacturing facilities such as machinery and equipment." They also cited the point that under the Korean Standard Industrial Classification, manufacturing products through outsourcing is also classified as manufacturing.
The Supreme Court, however, reversed the lower court's judgment. It ruled that "facilities for operating a manufacturing business" under the relevant laws should be interpreted to mean a factory equipped with manufacturing facilities such as machinery and equipment. The court cited the fact that the Industrial Cluster Act defines a factory as "a business site equipped with manufacturing facilities such as machinery and equipment and their auxiliary facilities for conducting a manufacturing business."
The court also pointed out that granting tax benefits even to manufacturers without manufacturing facilities would excessively expand the scope of local tax reduction, causing difficulties in managing knowledge industry centers and running counter to the purpose of the system. "Tax law provisions should be interpreted as written, barring special circumstances, and should not be expansively or analogically interpreted without reasonable grounds," the Supreme Court said. "In particular, interpreting strictly those reduction requirements that can clearly be regarded as preferential provisions conforms to the principle of tax fairness."
