The Change of Specific Anti-Avoidance Regime in Korea and Japan

Abstract

Traditionally, Korea and Japan have observed specific anti-avoidance rules because they have observed strict rule of law emphasizing the taxpayer’s legal stability and predictability. To cope with tax abusive transactions effectively, they operate comprehensive anti-avoidance provisions under limited conditions, which are “the denial provisions for an unreasonable transaction or computation.” Notwithstanding the operation of denial provisions for an unreasonable transaction or computation, tax-abusive arrangements which the denial provisions cannot cover are still implemented successfully, which erodes revenue and is fiercely criticized by the public. However, Korea and Japan changed their existing positions in recent international tax avoidance cases. Korea started to apply the principle of taxation on substance prescribed in s14 of the Basic Act for National Taxes, which was not used by the courts due to its vagueness. Japan also developed “the denial of the legal effect of a transaction under the private law” theory to determine the substance of a transaction and to defeat tax-abusive transactions. This trend shows that they are moving from the observance of strict rule of law toward the acceptance of the comprehensive principle of substantial taxation as grounds for deciding tax-avoidance cases in court. It may further accelerate the enactment of a general anti-avoidance rule to prevent tax avoidance effectively within rule of law.