Is the childbirth incentive received in a child's account considered a gift? ... The ambiguous 'Substance Taxation Principle' [Song Seungseop's Financial Light]

Booyoung Group 'Gifted' Childbirth Incentives
Taxes Drastically Different from Earned Income
'Principle of Tax Law' and 'Substance Taxation Principle'
Will the Monthly 200,000 Won Tax-Free Limit Increase?

The photo is unrelated to the article content.

Your company has decided to pay performance bonuses. However, it was decided to transfer the money to your child's account instead of your own. Since you earned money, you have to pay taxes, but a problem has arisen. Since you received it as compensation for work, should you pay 'earned income tax'? Or since your assets have been transferred to your child, should you pay 'gift tax'? It seems like you should just follow the law, but in fact, the law does not provide a clear answer. Following the law is not necessarily the correct answer either. This may sound confusing, but there is a deep tax law principle hidden here.

Booyoung's 'Gift' of Childbirth Incentives... Taxes Differ Greatly from Earned Income Cases

The previous case is a real story from Booyoung Group. Recently, Booyoung Group paid childbirth incentives of 100 million won to employees who had children after 2021. But strictly speaking, Booyoung Group did not give childbirth incentives to the employees themselves. They paid the childbirth incentives to the employees' children. Since it was paid to the same family anyway, one might wonder what difference it makes, but under current law, there is a huge difference. The amount of money that employees and companies have to pay differs.

Lee Joong-geun, chairman of Booyoung Group, is taking a commemorative photo after presenting childbirth incentives to a family with multiple children at the New Year's ceremony held on the morning of the 5th at the Booyoung Building in Jung-gu, Seoul.
[Photo by Yonhap News]

Booyoung Group considered the money given to employees' children as a gift. Therefore, employees have to pay gift tax. The gift tax rate is 10% for amounts up to 100 million won. Since employees received 100 million won, they pay 10 million won in taxes. Booyoung Group also incurs additional taxes. Corporate tax is levied on profits after deducting expenses from revenue. However, gifts are not recognized as expenses because they are considered unrelated to business operations. Therefore, Booyoung Group's profits on the books increase, resulting in additional corporate tax of up to 26.4 million won per employee.

What if Booyoung Group had interpreted it as 'earned income' instead of a gift? Then employees would have to pay earned income tax instead of gift tax. They would face a tax rate of over 35% at the highest, meaning taxes could reach up to 41.8 million won. On the other hand, the company would have no tax burden because salaries paid to employees are recognized as expenses. In other words, Booyoung Group chose the gift method of paying directly to the children to reduce employees' tax burden. Although the company's burden increases, employees save up to 31.8 million won in taxes.

Isn't Following the Law Enough?... 'Principle of Legality in Taxation' and 'Substance over Form Principle'

[Image source=Yonhap News]

However, the fact that taxes increase remains unchanged. Whether it is a company voluntarily stepping up to overcome the low birthrate problem or an employee receiving incentives after having a child, someone has to pay more taxes. Then President Yoon Suk-yeol instructed, “Immediately devise various support measures, including tax benefits, to activate voluntary childbirth support by companies.” Kim Soo-kyung, spokesperson for the presidential office, also said that upon receiving a report that corporate efforts are spreading, President Yoon called it “quite encouraging.” The intention is to reduce the tax burden as much as companies do good deeds.

However, taxes must be collected according to the law. This is called the 'principle of legality in taxation.' It is to protect citizens' property. South Korea explicitly states the principle of legality in taxation in Article 59 of the Constitution. Therefore, our laws specify not only tax items and rates but also who must pay taxes, the subjects, standards, and procedures. Taxes not based on law are not allowed. Then shouldn't taxes be collected by examining tax laws even in Booyoung Group's case? How is it possible for the government or companies to arbitrarily impose taxes despite the law?

The answer lies in the 'substance over form principle.' This principle means that taxes must be collected based on the substance of the transaction. Focusing only on the law can sometimes cause a gap with reality. Sometimes people comply only with the formalities prescribed by law to evade taxes. To prevent such side effects, taxes must be collected by appropriately balancing law and reality. For example, if you put a bed in an office building and live there, how should taxes be levied? Although it is registered as an office building on paper, since it is actually used as a residence, it would be reasonable to impose taxes related to residential housing.

Government Ponders Tax Law Interpretation... Will Tax-Exempt Limits Increase?

Jeong Jeong-hoon, Director of the Taxation Office, Ministry of Strategy and Finance [Image source=Yonhap News]

The same applies to Booyoung Group's childbirth incentives. Jeong Jeong-hoon, head of the tax system office at the Ministry of Economy and Finance, explained this case as follows.

“If a company gives something to an employee, whether money, a car, fitness expenses, or childbirth incentives, it is basically earned income. But sometimes, instead of giving it directly to the employee, it might be given to the parents' bank account, right? Whether this is a gift to the parents or not is ambiguous, and the childbirth incentives from Booyoung Group are the same. (Omitted) Whether to consider it earned income or a gift should be interpreted according to the substance over form principle. We are considering how to interpret this and how to supplement the law.”

The Ministry of Economy and Finance plans to reform the system in a way that reduces tax burdens, following the president's directive. For a corporation to recognize childbirth support payments as expenses, they must be paid according to common standards to all employees, and Booyoung Group's childbirth support payments are judged to meet this criterion. Also, expanding the current tax-exempt limit of 200,000 won per month is reportedly under consideration.

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