[Tax Story] The Coordinates of Public Interest Corporation Tax System and Tax Policy

Voices calling for increased transparency of public interest corporations are growing amid accounting fraud controversies involving public interest organizations. In the National Assembly, a legislative amendment is being promoted to lower the threshold for businesses required to verify settlement reports of government subsidies from 300 million won to 100 million won annually, and to reduce the asset threshold for public interest corporations obligated to submit audit reports from 1 billion won to 500 million won. Tax regulations on public interest corporations are also being strengthened. Previously, public interest corporations only needed to obtain confirmation from local tax offices every five years regarding excess stock holdings, but a mandatory annual reporting system has been introduced and implemented starting this year. Since March, the National Tax Service has established dedicated teams for public interest corporations in each local tax office to verify compliance with key obligations such as the use of donated assets, stock holdings in specific corporations, hiring status of directors and executives, and adherence to internal transaction prohibitions. This marks a phase of comprehensive pressure on public interest corporations.

Under the Public Interest Corporation Act, a public interest corporation refers to a foundation or an incorporated association established for the purpose of contributing to the general welfare of society through activities such as scholarships, research funding, academic pursuits, or charitable projects. Public interest corporations receive tax benefits as nonprofit entities, and additional benefits are granted if certain conditions are met. For ‘donation-eligible public interest corporations’ such as social welfare corporations, medical corporations, and religious organizations, donations made to these entities are recognized as deductible expenses for corporations or tax credits for individuals. ‘Public interest corporations under the Inheritance and Gift Tax Act’ receive benefits such as exemption from inheritance and gift taxes on contributions. ‘Diligent public interest corporations under the Inheritance and Gift Tax Act’ are allowed to hold additional stocks. The reason for granting various benefits to public interest corporations is that they can efficiently achieve public welfare objectives in areas overlooked by social safety nets. In practice, the main issue is whether an entity qualifies as a public interest corporation under the Inheritance and Gift Tax Act rather than under the Public Interest Corporation Act. According to the 2020 National Tax Statistics Yearbook, as of 2019, there were a total of 39,897 public interest corporations registered as designated donation organizations under the Corporate Tax Act, a significant increase of about 15% from 34,843 the previous year. By purpose of public interest activities, the breakdown was: religion 20,876, academic and scholarship 4,875, social welfare 4,165, educational projects 1,820, arts and culture 1,613, and medical 1,043.

Public interest corporations are subject to strict regulations both before and after receiving tax benefits. Under the Inheritance and Gift Tax Act, public interest corporations bear various obligations regarding donated assets and the use of donations. They must use donated assets, proceeds from sales, and operating income directly for public interest purposes, and must not receive or acquire stocks exceeding 5% (10% or 20% for diligent public interest corporations) of domestic corporations. Donors or their special related parties must not constitute more than one-fifth of the total number of directors, and unfair internal transactions with specific companies or related parties are prohibited. Furthermore, they are subject to broad tax cooperation obligations such as submitting financial statements and reports, maintaining books, undergoing external audits, and opening and using dedicated accounts. Failure to comply with these obligations results in the imposition of gift taxes or additional taxes. As seen in the case of the Guwon Scholarship Foundation, which donated stocks worth about 18 billion won but faced a tax bill of 14 billion won, high rates of gift and additional taxes can jeopardize the financial stability of public interest corporations and place donors in serious difficulties.

While tax support for public interest corporations that substitute for government public services is important, and corresponding regulations on these corporations are necessary, excessive regulation can instead create negative externalities that shrink public interest activities. Uniform regulations imposed on public interest corporations every time incidents occur result in excessive administrative burdens on small and medium-sized public interest corporations. Instead of imposing heavy taxes for non-compliance with tax cooperation obligations, it is necessary to consider a shift in framework, such as providing incentives like the diligent public interest corporation system.

Under the current legal framework, the scope of public interest corporations differs among the Public Interest Corporation Act, Corporate Tax Act, and Inheritance and Gift Tax Act, causing regulatory arbitrage. To address this, it is reasonable to stipulate only the basic matters concerning public interest corporations in the Public Interest Corporation Act and have related provisions applied by reference in other laws. The unclear requirements for diligent public interest corporations and sanctions for violations cause excessive unexpected penalties, so it is necessary to clarify application requirements and reduce the severity of sanctions. There is also value in considering replacing heavy gift tax assessments with income tax or converting donations to income deductions to encourage large donations. It is time to introduce differentiated support and regulatory measures that reflect the realities of individual public interest corporations rather than uniform regulations for about 40,000 public interest corporations.

Futurist Peter Drucker predicted that in future society, the roles of the government and public sector (first sector) and the corporate and market sector (second sector) would diminish, while the importance of nonprofit organizations and public interest groups (third sector) would rapidly increase, calling this the ‘new growth sector leading modern society.’ Excessive regulation focusing only on the tax benefits enjoyed by public interest corporations not only contradicts the ideals of constitutional liberal democracy but also risks the folly of “killing the ox to save the horn” by causing greater harm while trying to solve minor problems. It is time to seek wisdom for moderation and balance in the tax system for public interest corporations.

Baek Jeheum, Lawyer at Kim & Chang