"The money paid to Lee Soo-man was excessive"... Why SM Entertainment's 12.86 billion won tax bill was canceled

[Financial News] The court ruled that the tax authorities' imposition of about 12.86 billion won in corporate and value-added taxes on SM Entertainment (SM) was illegal and ordered it to be canceled.
Although the court acknowledged that the production fees SM paid to its founder and then-largest shareholder, Lee Soo-man, were excessive, it said the tax authorities failed to prove the appropriate market price.
On the 27th, Administrative Division 5 of the Seoul Administrative Court, presided over by Judge Lee Jeong-won, ruled in favor of SM in its lawsuit seeking to overturn the corporate tax assessment and related penalties filed against the head of the Gangnam District Tax Office.
As a result, about 8.8 billion won of the roughly 16.1 billion won in corporate tax imposed on SM by the Gangnam District Tax Office in 2021, and about 4.064 billion won of the roughly 4.069 billion won in value-added tax, will be canceled.
The case stemmed from an agreement under which SM promised to pay Lee 6% of settlement sales as compensation for his role as chief producer. Settlement sales included revenue from albums, digital content, overseas business, management, ancillary businesses, and concerts.
Under the agreement, SM paid Lee about 60 billion won from 2015 to 2019 and received input tax invoices for value-added tax on the quarterly payments. It also treated the amount as deductible expenses in its corporate tax filings for fiscal years 2015 through 2019. Deductible expenses refer to costs recognized under tax law and subtracted from the corporate tax base.
The Gangnam District Tax Office viewed the contract as a production services agreement and examined whether Lee had actually provided services for each category of settlement sales, refusing to recognize some of the payments as deductible expenses.
Specifically, it recognized 20.2 billion won in payments related to album and music sales as deductible expenses, saying services had been provided. By contrast, it excluded 23 billion won tied to revenue such as appearance fees and usage fees, saying Lee had not provided related services.
For 14.6 billion won in payments related to singing appearance fees and similar revenue, the office applied the abuse-of-rights rule, saying the amount was far too high compared with the average total compensation of about 2 billion won earned by chief producers in the same industry, including Park Jin-young PD, Yang Hyun-suk, and Bang Si-hyuk, from 2015 to 2019.
It also refused to recognize payments related to albums and music released before 2015 as deductible expenses, saying there was no contractual basis for them. It then reassessed and notified SM of about 16.1 billion won in corporate tax and about 4 billion won in value-added tax.
The court accepted all of SM's claims.
First, the bench said, "Lee cannot be regarded as having a duty to provide services for the settlement sales items." It explained that the services Lee agreed to provide under the contract were "music and content producing and artist producing," and that the settlement sales items were merely a basis for calculating compensation for those services.
Accordingly, the court said the tax authorities were wrong to assume that the related payments could be recognized as expenses only if Lee provided services corresponding to each individual sales item.
However, the court did not find that the roughly 60 billion won SM paid Lee was appropriate. It said, "Considering the purpose of the contract, the method of performance, the size of the compensation, and the sharing of costs, the payment to Lee was excessive and falls under the abuse-of-rights rule."
Still, it pointed out that to apply the abuse-of-rights rule, the tax authorities had to prove the market price of the production compensation Lee provided, and because they failed to do so, the corporate tax assessment was illegal.
The value-added tax assessment was also canceled. The court said that because SM and Lee issued and received input tax invoices based on the actual agreed transaction amount, they could not be regarded as "tax invoices different from the facts."
 
[email protected] Choi Eun-sol Reporter