A Comparison between EU and South Korean VAT from a Legal Transplants Perspective¹

The field of application for VAT is taxable transactions. Taxable transactions in VAT form crucial components of any comprehensive understanding of VAT systems. This section delves into the transactions subject to VAT, shedding light on the key principles, criteria, and considerations governing VAT’s imposition on various goods and services.

According to Article 2 of the Second VAT Directive, the supply of goods and the provision of services within the territory of a country by a taxable person against payment and the importation of goods shall be subject to VAT. At the time the Second Directive came into effect, the EC had not yet realized its Single Market, which is now known as the Internal Market. It had thus not introduced intra-Community acquisitions as the third feature subject to VAT today. The Internal Market was established in 1993. Consequently, the supply of goods and provision of services within the territory of a country and the importation of goods were the only taxable transactions.

The supply of goods and the provision of services were subject to VAT if they were within the country, carried out by a taxable person and against payment, insofar as they were not VAT-exempt under Article 10 of the Second VAT Directive. The Second VAT Directive defines the supply of goods as “the transfer of the right to dispose of tangible property as owner.”⁶⁵ The provision of a service is defined as “any transaction which does not constitute a supply of goods.”⁶⁶ The word “provision” regarding services was replaced with “supply” in the Sixth VAT Directive.⁶⁷

Article 5 (2) of the Second VAT Directive further elaborates on what shall be considered as a supply of goods. This applies to the transfer of goods pursuant to a contract under which a commission is payable on a purchase or sale. In the Second VAT Directive, there is no corresponding provision regarding services. However, Article 6 (4) of the Sixth VAT Directive states that when a taxable person acting in his/her own name but on behalf of another takes part in a supply of services, he or she shall be considered to have received and supplied those services him/herself.

Transactions without payment could also be subject to VAT under the Second VAT Directive. These constituted the appropriation by a taxable person, from his undertaking, of goods which he or she applies to his/her own private use or transfers free of charge, as well as the use for the needs of his/her undertaking, by a taxable person, of goods produced or extracted by him/her or by another person on his/her behalf.⁶⁸ In the Second VAT Directive, there were no corresponding provisions regarding the supply of services free of charge. Such rules occurred for the first time in the Sixth VAT Directive. According to Article 6 (2) of the Sixth VAT Directive, the use of goods forming part of the assets of a business for the private use of the taxable person or of his/her staff or more generally for purposes other than those of the business should be treated as supplies of services for consideration. This only applies where the input VAT on such goods is wholly or partly deductible. Equally, supplies of services carried out free of charge by the taxable person for his/her own private use or that of his/her staff or more generally for purposes other than those of his business, should be treated as supplies of services for consideration. Additionally, the Member States were allowed, but not obliged, to treat as a supply of services for consideration the supply by a taxable person of a service for the purposes of his/her undertaking where the VAT was levied on such a service, had it been supplied by another taxable person, would not be wholly deductible.⁶⁹

Annex A of the Second VAT Directive deals with the situation when a whole or part of a company’s assets is given as a contribution to another company. In that case, the Member States were allowed but not obliged to regard the benefiting company as the successor in the title of the contributor. Under Article 5 (8) of the Sixth VAT Directive, the transfer, whether for consideration or not or as a contribution to a company, of a totality of assets or part thereof, can be considered by the Member States as not to constitute a supply of goods. In that event, the recipient shall be treated as the successor to the transferor. The Member States may take the necessary measures to prevent distortion of competition in cases where the recipient is not wholly liable to tax. Article 5 (8) applies similarly to the supply of services.⁷⁰ The Member States were not obliged to exclude the transfer of business from the scope of the supply of goods or services, since this was an optional rule for the Member States to implement. From the wording of Article 5 (8), it is not obvious that it is specifically aimed at the transfer of a business. That this was the fact became clear in 2003 in the CJEU case Zita Modes Sàrl, where Article 5 (8) of the Sixth VAT Directive was confirmed to apply to “any transfer of a business or an independent part of an undertaking, including tangible elements and, as the case may be, intangible elements which, together, constitute an undertaking or a part of an undertaking capable of carrying on an independent economic activity.”⁷¹

Importation is defined in Article 7 of the Second VAT Directive. Importation of goods means the entry of goods into the territory of the country. The wording is identical to the Sixth VAT Directive.⁷²

The Korean VAT Act of 1977 lists taxable transactions in Article 1.⁷³ According to this article, VAT shall be levied on the following transactions:

the supply of goods or services; and

Under Article 1 Paragraph 2 of the Korean VAT Act of 1977, goods refers to all tangible and intangible objects with property value. Services refers to other activities with property value other than goods.⁷⁴ The Korean VAT Act’s original version deals with composite goods and services supplies in Article 1, Paragraph 4. According to this provision, a supply of goods or services essential to the supply of goods should be considered included in the main supply.

The supply of goods is defined in Article 6 of the Korean VAT Act of 1977 as “the delivery or transfer of goods due to any contractual or legal cause.” “Delivery” is generally applied to movable property among goods, and “transfer” is generally applied to immovable real estate or intangible objects among goods.

Article 6 of the Korean VAT Act of 1977 also covers a deemed supply of goods to maintain taxation equity and tax neutrality. The deemed supply of goods occurs when an entrepreneur directly uses and consumes the goods produced or acquired in connection with his own business, where the entrepreneur uses and consumes the goods produced or acquired in connection with his/her own business for his/her employee’s personal purposes or for any other purposes, as well as where he/she donates the goods to customers or to many and unspecified persons.⁷⁵ Also, goods remaining by the entrepreneur when he closes down his/her business is a taxable supply of goods.⁷⁶ Furthermore, in the case of consignment trading or trading by an agent, the consignor or the principal shall be deemed to have directly supplied or received the goods.⁷⁷ However, this is not the case if the consignor or the person in question is unknown.⁷⁸

The provision of goods as collateral and the transfer of business shall not be regarded as the supply of goods.⁷⁹ The reason why VAT is not levied on the transfer of business is as follows. Since the transaction amount is large, the VAT amount is also significant in the case of the transfer of business. The transferee can normally be expected to deduct the input tax amount on the transfer of business. However, for such a transaction, having the transferor collect the output tax amount⁸⁰ would impose an unnecessary financial burden on the transferee of the business. The rationale for this provision is thus to avoid an unnecessary financial burden. In addition, the transfer of business, which sets the overall price of a business entity and pays for it, does not conform to the essential nature of VAT, which targets the supply of individual goods.⁸¹ However, not all transfer of business is excluded from the supply of goods. The acquirer must comprehensively inherit all or substantially all rights and obligations related to the business; the value-added production organization must be maintained and kept as it is; only the management entity may be changed.

The supply of services is defined in Article 7 of the Korean VAT Act of 1977. Accordingly, the supply of services means either the supply of services or making goods, facilities, or rights available pursuant to all contractual and legal titles.⁸² There is a deemed supply of services, namely, where an entrepreneur supplies services directly to his own business.⁸³ In such cases, these services shall be considered to have been supplied to him/herself.⁸⁴ The supply of services to others without consideration or the supply of labor under an employment relationship shall not be considered a supply of services.⁸⁵

The import of goods is defined in Article 8 of the Korean VAT Act of 1977. It has two requirements: (1) goods arriving in the Republic of Korea from a foreign country (including marine products caught and collected in high seas by a foreign vessel); and (2) goods licensed for export. In addition, the specific meaning of import is omitted because it is dealt with in the Customs Act.

In the EU VAT law of today, it is not only the supply of goods and services for consideration and the deemed supplies but also the import of goods subject to VAT. In addition, there is also a third category, the intra-Community acquisition of goods. Due to the establishment of the Internal Market in 1993⁸⁶, intra-Community acquisitions also require that a transfer by a taxable person of goods forming part of his/her business assets to another Member State shall be treated as the supply of goods for consideration.⁸⁷

The basic concepts of the supply of goods and services and imports have not changed substantially.⁸⁸ Over the years, EU VAT law has become increasingly complex, with special rules, which is also reflected in the definitions of the supply of goods and services. For instance, distance sales of goods were introduced as a particular category of supply of goods in 2017 and has been in effect in the Member States from 2021.⁸⁹ The introduction of call-off stocks necessitated that a transfer by a taxable person of goods forming part of his/her business assets to another Member State under call-off stock arrangements shall not be treated as a supply of goods for consideration, which they would otherwise have done.⁹⁰ The concepts of supply of services and of imports have been more stable since its introduction and have not changed substantially.⁹¹

The wording and the structure of the current Korean VAT Act have become more precise.⁹² The concepts of goods and services are stipulated in Article 2 of the VAT Act. In addition, the concepts of the supply of goods (Article 9) and the supply of services (Article 11) are also described separately in separate articles.Special cases concerning the supply of goods (Article 10) and special cases concerning the supply of services (Article 12) have been separated into distinct articles. The special cases concerning the supply of goods are almost the same, except that the order has been changed slightly, and a provision concerning trust property has been added.

The supply of services still does not include those provided free of charge, so it is not subject to VAT. The reason for this is of a practical nature, namely, that; the value of services is difficult to measure, and it is thus difficult for tax administrations to decide the value.⁹³

Article 13 of the VAT Act concerns the import of goods. Although the expression is slightly different, the requirements for the import of goods are almost the same as in the original Ko rean VAT Act .

Article 14 regulates the incidental supply of goods and services that, in EU VAT law, would be called composite supplies. An incidental supply shares the VAT faith of the main supply when goods and services are supplied for which the price is ordinarily included in the supply price of the main goods and services. This also applies to goods or services deemed to be ordinarily incidental to the supply of the main goods or services considering trade practices. Article 14 also defines when an independent supply is deemed as a separate supply. This is the case in two situations:

Goods or services which are supplied accidentally or temporarily in connection with the main busisness;

Wheat bran is a typical example of goods which are indispensably produced. Entrepreneurs that make and supply wheat flour can supply wheat bran, produced in the process of producing wheat flour, as goods. However, due to the exemption applied to wheat flour, the exemption also extends to wheat bran.⁹⁵

The challenge lies in the ambiguous determination of an “incidental” supply, as the Korean VAT Act lacks sufficient clarification. To ensure predictability for taxpayers, it is customary to address such ambiguities through specific provisions in the enforcement ordinance when legislative clarity is lacking. Regrettably, the Enforcement Decree of the Value-Added Tax Act fails to include provisions regarding the incidental supply of goods and services.

Consequently, it becomes imperative to meticulously examine the precedents set by the Supreme Court to discern the precise meaning of “incidental.” The Supreme Court’s interpretation holds significance, as it helps bridge the gaps within the legislation.

The Korean Supreme Court has ruled in a case where a school corporation, as a sideline activity, leased and operated a hospital funeral hall.⁹⁶ The dispute concerned food services that were supplied in connection with funerals. The corporation had declared the supply of food services exempt from VAT, assuming that this service was an incidental service that shared the same VAT faith as the main funeral service, which was exempt from VAT. The tax authority, however, imposed VAT. The lower court justified that, in practice, the supply of food services to a hospital funeral hall is normally incidental to the supply of funeral services subject to VAT exemption.^{97 98} In Korean funeral culture, it is a natural practice to have a meal at a funeral, so the necessary relationship between the main supply and the incident supply was recognized. Interesting in this case is that the ratio of the sales of the incidental service to the total sales is not a critical factor.

In this regard, the Supreme Court ruled that when determining whether the supply of goods or services is subject to tax exemption under the provisions of the VAT Act, a decision must be made based on various circumstances. Therefore, the incidence of the supply of certain goods or services (food services) is not necessarily denied only because it does not correspond to the original meaning of the main goods or services (funeral service) subject to tax exemption. In other words, it is not simply the numbers concerning the scale, size, frequency, etc. Still, it is a decision stipulating that certain circumstances should be considered when judging whether supply is incidental.

There are many similarities between the original Korean VAT Act of 1977 and the Second and Sixth VAT Directives. For example, VAT is levied on the supply of goods and services and on the import of goods. The supply of goods to others, but not the supply of services to others free of charge is subject to VAT both under the Korean VAT Act of 1977 and the Second VAT Directive. With regard to the supply of services free of charge, the Korean and EU systems have drifted apart, since already in the Sixth VAT Directive, services supplied free of charge were subject to VAT.

Under the Korean VAT Act, goods as collateral are not subject to VAT. This is not specifically regulated in EU VAT law, but the supply of goods requires the right to dispose of the goods as the owner to be transferred. This is not the case when goods are used as collateral, such as a lien or mortgage. Even though this seems like a difference at first sight, it is a similarity.

Under the Korean VAT Act of 1977, in the case of consignment trading or trading by an agent, the consignor or the principal shall be deemed to have directly supplied or received the goods. This provision seems to have a similar objective as the rule on commission agents in the Second Directive, which is to enable the intermediate to act in his/her own name, also for VAT purposes.

The transfer of business is not subject to VAT under the Korean VAT Act of 1977. Interestingly, there was no such provision in the Second VAT Directive, only the provision in Annex A dealing with an instance when the assets are given as a contribution to another company. It is possible that the Korean legislation has drawn inspiration from the draft Sixth VAT Directive in this regard, since we know that Duignan also examined the draft Sixth VAT Directive. Furthermore, the method of making the transfer of business free of VAT is the same in Korea as in the EU, which implies that there might be a link between the two systems. Instead of making the transfer of business VAT-exempt, which could have been an alternative, the transfer of business is not a supply of goods—it plays no role from a VAT perspective.

The concepts of goods and services differ in the Korean VAT Act of 1977 and the Second VAT Directive. Korean VAT includes intangibles in goods, whereas intangibles are services under EU VAT Law.

Besides the fact that services within the EU, but not under the Korean VAT Law, include intangibles, there are no significant differences between the Second VAT Directive and the Korean VAT Act of 1977 regarding the supply of services. Also, imports are regulated similarly in the two legal acts.

Another difference between the Korean and the EU VAT systems is that composite supplies are regulated in legislation in the Korean but not the EU VAT system. In Korean VAT law, the main rule is that each supply is separate. The original Korean VAT Act stipulated that the supply of goods or services essential to the supply of goods should be considered as being included in the main supply. In the current Korean VAT Act, goods or services should be considered as being included in the main supply if they are supplied accidentally or temporarily in connection with the main business and when they are indispensably produced in the process of manufacturing the main goods or in the process of offering services in connection with the main business. In EU VAT law, the principles on how to deal with composite supplies have been developed in the case law of the CJEU. A milestone case in the development of the doctrine of composite supplies is the CCP case.⁹⁹ To put it very simply, the doctrine of composite supplies could be described as follows. Splitting is the main rule.¹⁰⁰ From this main rule, there are two exceptions. The first exception occurs when there is a single supply from an economic point of view.¹⁰¹ This is the case where the elements of the composite supply are indispensable for carrying out the composite supply.¹⁰² The second exception occurs when a main supply absorbs a subordinated supply.¹⁰³ A supply is considered as ancillary to a main supply when it does not constitute an aim in itself for custumers, but a means to better enjoy the main supply.¹⁰⁴ An ancillary service shares the fate of the main supply.¹⁰⁵ Comparing the two VAT systems, you can see that the Korean system took notice of composite supplies earlier than the EU system, since it was stipulated already in 1977. Today, both systems have a primary rule that each transaction is taxed separately and have two exceptions. The exceptions are not the same, but both have one that takes an economic reality approach and a second where one part, which could have been a supply if it had been provided separately, is subordinated to another supply. Regarding VAT treatment of composite supplies, the two systems have moved toward each other.

Looking at the Korean VAT Act of today and the current VAT Directive, significant concepts such as the definition of the supply of goods and the supply of services and imports have remained much the same. The EU system has increased in complexity and has introduced intra-Community acquisitions following the realization of the Internal Market. In Korea, not as many special VAT regimes have been introduced, which is why it has not been necessary to redefine the supply of goods in a similar way to the EU.

A taxable person is, according to the main rule in Article 9 (1) of the VAT Directive, any person who independently carries out in any place an economic activity, regardless of the purpose or result of the activity. Taxable persons are closely connected to taxable transactions since “taxable person” is one of the requirements for many taxable transactions. For instance, the supply of goods for consideration within the territory of a Member State by a taxable person acting as such is a taxable transaction.¹⁰⁶ Taxpaying obligations are, in EU law, separated from being a taxable person. Only because a person is a taxable person, that person is not necessarily liable to pay the VAT. In the English official translation of the Korean VAT Act, the taxable person is called “entrepreneur”. In the Korean VAT Act of today, taxpaying obligations are, just as in EU law, separated from being an entrepreneur. Consequently, both entrepreneurs and persons who import goods are liable to pay the VAT.¹⁰⁷ This section focuses on the concept of taxable person/entrepreneur, and not on all the special rules for tax payment, such as special taxpayment rules for trusts in the Korean VAT Act.¹⁰⁸

In Article 4 of the Second VAT Directive, a taxable person is defined as any person who independently and habitually engages in transactions pertaining to the activities of producers, traders or persons providing services, whether or not for gain. In Annex A of the Second VAT Directive it is explained that it is possible for Member States not to consider as separate taxable persons, but as one single taxable person, persons who, although independent from the legal point of view, are organically linked to one another by economic, financial or organizational relationships.¹⁰⁹ Furthermore, in Annex A, it is explained that the expression independently is intended in particular to exclude from taxation wageearners who are bound to their employer by a contract of service.¹¹⁰

In Article 4 of the Sixth VAT Directive, the general definition of a taxable person was given its current wording. Accordingly, a taxable person means any person who independently carries out in any place any economic activity specified in paragraph 2, whatever the purpose or results of that activity. The requirements of being a taxable person are:¹¹¹

any person

The activities specified in paragraph 2 are all activities of producers, traders and persons supplying services, including mining and agricultural activities and activities of the professions. Also, the exploitation of tangible or intangible property for the purpose of obtaining income therefrom on a continuing basis shall be considered an economic activity. Furthermore, the Sixth VAT Directive allows the Member States to treat anyone who on an occasional basis carries out the activities specified in paragraph 2 as a taxable person. This applies in particular to the supply before the first occupation of buildings or parts of buildings and the land on which they stand and the supply of building land.¹¹²

VAT registration as such does not constitute an economic activity. In fact, the VAT Identification Number and the VAT registration were not EU harmonized until 1991.¹¹³

Article 4.4 of the Sixth VAT Directive comprises two novelties in relation to article 4 of the Second Directive: first, a clarification of what is meant by “independently” in the first paragraph and second, a group treatment regime. The word “independently” means that employed and other persons should not be regarded as taxable persons insofar as they are bound to an employer by a contract of employment or by any other legal ties creating the relationship of employer and employee as regards working conditions, remuneration and the employer’s liability. The group treatment regime is not mandatory for the Member States, but each Member State decides whether it shall implement it. Accordingly, the Member States may treat as a single taxable person persons established in the territory of the country who, while legally independent, are closely bound to one another by financial, economic, and organizational links. The details of the group treatment regime are up to the Member States to decide. For example, Germany applies a mandatory group treatment regime that applies to all kinds of companies as soon as they fulfill specific requirements. In contrast, Finland applies a voluntary group treatment regime to only certain sectors.¹¹⁴ The financial, economic and organizational links, however, apply in all Member States which have chosen to allow group treatment for VAT purposes.

Article 4.5 of the Sixth VAT Directive clarifies under which circumstances public bodies are taxable persons. They are not taxable persons regarding the activities or transactions in which they engage as public authorities, even where they collect dues, fees, contributions, or payments in connection with these activities or transactions. However, when they engage in such activities or transactions, they shall be considered as taxable persons in respect of these activities or transactions where treatment as non-taxable persons would lead to significant distortions of competition. Article 4.5 has its roots in Annex A of the Second VAT Directive.¹¹⁵

According to Article 2 of the Korean VAT Act of 1977, a person who independently supplies goods or services on a business basis, regardless of whether it is on a commercial basis or not, is liable to pay VAT. Taxable persons are called “entrepreneurs” in the English translation of the Korean VAT Act.¹¹⁶ The scope of Article 2 is broad. It includes not only individuals and corporations but also the state and local governments, local government associations and unincorporated associations and foundations, and other organizations.¹¹⁷

The Supreme Court has clarified that a person who independently supplies goods or services on a business basis refers to someone with a sufficient business to create added value and supplies goods or services with a continuous intention.¹¹⁸ In other words, “independence” and “repeatability” are the key factors determining whether you are an entrepreneur under the Korean VAT Act of 1977. Since VAT is not a tax on income but a tax on consumption, and the final consumer bears the VAT, the profit factor is not necessary in determining an entrepreneur who is liable for VAT.¹¹⁹ The concept of entrepreneur should be interpreted more broadly and flexibly than the concept is stipulated in the VAT Act.¹²⁰ In other words, it is reasonable to understand that the business registration system is operated for the purpose of tax administration. Therefore, the business registration system is a reporting system, not a permit system. This means that just because a business is not registered it does not necessarily mean that persons cannot do business.¹²¹ The Korean VAT Act of 1977 has no rules on group treatment.

The general definition of a taxable person, the clarification of “independently,” the group treatment regime and the rules regarding public bodies have not changed substantially since the Sixth VAT Directive. However, they have been specified in greater detail. One provision, Article 9.2, is completely new compared to the original version of the Sixth VAT Directive. Under this provision, any person who supplies a new means of transport on an occasional basis, which is dispatched or transported to the customer by the vendor or the customer, or on behalf of the vendor or the customer, to a destination outside the territory of a Member State but within the territory of the EU, shall be regarded as a taxable person. This follows the fact that intra-Community acquisitions of new means of transport are taxable, also when carried out occasionally.¹²²

The CJEU has developed a rich case law on taxable persons and economic activities. For instance, in WEG Tevestrasse, the CJEU states: “It is apparent from the Court’s case-law that that definition shows that the scope of the term ‘economic activities’ is very wide and that the term is objective in character, in the sense that the activity is considered per se and without regard to its purpose or results. Thus, an activity is generally classified as economic where it is permanent and is carried out in return for remuneration which is received by the person carrying out the activity.”¹²³ The CJEU has stated, regarding independence, that a member of a supervisory board of a foundation is not independent of the foundation,¹²⁴ that a branch is not independent of the head office,¹²⁵ but that a member of a partnership is independent of the partnership¹²⁶

There is a systematic difference between the original and the current Korean VAT Acts. In the original VAT Act, the definition of the entrepreneur in Article 2 was directly linked to the liability to pay tax. In the current VAT Act, Article 3 regulates who is liable to pay VAT. The entrepreneur is still liable to pay VAT. Still, the concept of the entrepreneur is independently defined in Article 2, item 3 as “any person who supplies goods or services independently for business, regardless of whether the business aims to make profit.”

In Korea, independence is divided into human independence and material independence.¹²⁷ Human independence means that the person supplying goods or services may not be employed by others. According to a precedent in the Supreme Court, cosmetic salespersons are recognized as independent entrepreneurs when they have been supplied with cosmetics for a specific selling price from a cosmetic seller but still set their own selling price independently when the products are subsequently sold to the end consumer.¹²⁸

Material independence means that the business should not be incidental or subordinate to other businesses. In another precedent in the Supreme Court, an individual businessperson paid a deposit and rented the canteen of the hospital and provided meals independently. Here, the service had not been provided subordinated to the hospital. Since there was continuity and repeatability with the individual businessperson with his or her own accounts, it was deemed that the individual should be considered an entrepreneur.¹²⁹

When assessing continuity and repeatability, it is essential that a determination is not solely based on a certain number of transactions. Instead, it is also based on whether a business operates in such a way as to create added value, even if a transaction is made only once or twice.¹³⁰ In a precedent in the Supreme Court, the CEO of a company sold optical lens parts and machinery, which required a considerable degree of expertise, to other companies. It was necessary to mobilize four to five trucks to transport the goods, and the selling price was KRW 2.7 billion and KRW 380 million, respectively. The Supreme Court ruled that although the CEO did not have a formal business and made only two supplies, he was an independent supplier of goods for business as stipulated in the VAT Act.¹³¹

The original Korean VAT Act demonstrates similarities with the Second VAT Directive in regard of taxable persons, since it is brief and contains the three following elements: independence, a business basis and that it does not regard whether the activities are carried out on a commercial basis or not. The corresponding requirements in the Second VAT Directive are independence, economic activity and that it does not regard the purpose or result of the activity. The current Korean VAT Act still has almost the exact three requirements, namely independence, for business and regardless of whether the business aims to make a profit. EU VAT has diverged from Korean VAT, since the Korean legislation has been more stable. Already in the Sixth Directive, the activities of producers, traders and persons supplying services, including mining and agricultural activities and activities of the professions, as well as the exploration of tangible and intangible basis, were added. However, in both systems, the concept of a taxable person is perceived broadly, and thus a more profound study might well reveal more similarities or maybe even differences.

The main difference between Korean VAT and EU VAT is that there are no special rules for public bodies and no possibility to form VAT groups in Korean VAT. In EU VAT law, special rules for public bodies and VAT grouping rules were introduced through the Sixth VAT Directive, even though they first occurred in Annex A of the Second VAT Directive. From a legal transplants’ perspective, a cautious conclusion could be drawn that the Second VAT Directive seems to have had the main influence over the Korean VAT Act and that this is still the case.

Determining the place of supply is a fundamental aspect of VAT regulations, as it governs the jurisdiction in which VAT is levied and the associated compliance obligations. This section provides a concise overview of the place of supply rules within VAT frameworks in the EU and in Korea. By exploring the factors that influence the place of supply, such as the nature of goods or services, the location of the supplier and the recipient, and the type of transaction, we gain insights into the complexities of correctly allocating VAT liabilities.

The place of supply rules in the Second Directive are brief. The place of supply of goods shall be deemed as being where the goods are at the time of dispatch or transport if the goods are dispatched or transported by the supplier, the consignee or a third person. In all other cases, the goods are supplied where they are at the time of the supply. Under the Second Directive, services are supplied where the services are provided, the right is transferred or granted, the object is hired, or where the service is used or enjoyed.¹³²

The place of supply rules became more advanced already in the Sixth Directive. Goods installed or assembled by or on behalf of the supplier are deemed to be supplied where the installation or assembly is carried out.¹³³ Furthermore, special rules for goods where the place of departure of the consignment or transport of goods is in a country other than the country of import of those goods were introduced.¹³⁴ For services, a primary rule was introduced with several derogations.¹³⁵ This is a structural difference from the Second Directive, where no rule was superior or subordinate to another.

According to the new main rule in the Sixth Directive,¹³⁶ the place of supply of services was deemed to be where the supplier had established his/her business or had a fixed establishment from which the service was supplied. If there was no such place, the service was supplied where the supplier had his/her permanent address or usually resided. Through the Sixth Directive, the business establishment became a relevant proxy for the place of supply.¹³⁷ The main rule expressed the principle of origin for services. However, many derogations from the main rule were already included in the Sixth Directive¹³⁸. Services connected with immovable property were deemed to be supplied where the property was situated. Transport services were supplied where the transport took place, taking into consideration the distances covered. Services relating to cultural, artistic, sporting, scientific, educational, entertainment or similar activities, and where appropriate ancillary services, ancillary transport services such as loading, unloading, handling and similar activities, valuations of movable tangible property and work on movable tangible property were supplied where they were physically carried out. The hiring of movable tangible property, with the exemption of transport, was deemed to be supplied at the place of utilization.

There was also a list of services which were deemed to be supplied where the customer had established his/her business or had a fixed establishment to which the service was supplied or, in the absence of such a place, the place where he/she had his permanent address or usually resided in accordance with the destination principle.¹³⁹ These are the listed services: –

transfers and assignments of copyrights, patents, licenses, trademarks and similar rights,

The Korean VAT Act of 1977 has provisions on place of supply in Article 10. However, although the title of the Article is “Transaction Place”, the content is the place of supply.

Article 10 (1) of the VAT Act of 1977 stipulated the place of supply of goods. Article 10 (1) Item 1 states that where the movement of goods is required, the place where the movement of the goods starts is the place of supply for goods. In the case of exports, even if the goods are used or consumed abroad, the exporter is, in principle, liable to pay VAT in Korea because the place where the movement of goods starts is in Korea. However, as mentioned above, exports are zero-rated in Korea.¹⁴⁰ Article 10 (1) Item 2 states that where the movement of goods is not required, the place of supply for goods is the place of the goods when the goods are supplied. When goods do not need to be moved, the supply period is when the goods are available. Hence, if the goods are available in Korea, the place of supply will be domestic.

Article 10 (2) of the VAT Act of 1977 stipulates the place of supply of services. The place of supply of services is the place where services are supplied or goods, facilities or rights are used. International transportation services in Korea and abroad, where the entrepreneur is a non-resident or a foreign corporation, the place of supply is where passengers are boarding, or cargoes loaded.

In the current EU VAT system, many rules are the same as in the Sixth VAT Directive, but many more rules have been added, making the system more complex. The most important change regarding the supply of goods is the distance sales scheme implemented in the Member States on 1 July 2021. The distance sales scheme applies when goods are sold to private consumers (B2C), mostly over an internet platform. In that situation, the taxable persons are required to pay the VAT of the country of the consumers. This applies to intra-Community trade when the distance sales, together with electronic, telecommunication and broadcasting services, within the EU exceed EUR 10 000, but also, under some circumstances, when the goods are sold from a third country. To reduce the compliance costs and the administrative burden for the companies, taxable persons that are established within the EU have the option to register for one-stop-shop (EU OSS), or the Import One Stop Shop (IOSS) for distance sales of low value goods not exceeding EUR 150 which are imported from third territories or third countries.¹⁴¹ If they do, they fulfill all reporting and payment obligations in one Member State. ¹⁴² Taxable persons that are established outside the EU have three options, the EU OSS and the IOSS like the taxable persons that are established within the EU, but also the non-EU OSS. Under the non-EU OSS, non-EU businesses may choose in which EU country they want to register.

Goods supplied onboard ships, aircrafts or trains during the section of a passenger transport operation effected within the EU are deemed to be supplied at the point of departure of the passenger transport operation.¹⁴³ The place of supply of gas, which is supplied through the natural gas distribution system, or of electricity, to a taxable dealer, is the place where that taxable dealer has established his/her business or has a fixed establishment for which the goods are supplied, or, in the absence of such a place of business or fixed establishment, the place where he/she has his/her permanent address or usually resides.¹⁴⁴ In all other situations, such as when the gas or electricity is not supplied to a taxable dealer, the place of supply is where the customer effectively uses and consumes the goods.¹⁴⁵ The same applies for the supply of heat or cooling energy through heating or cooling networks to a taxable dealer.¹⁴⁶

There are more new rules regarding the supply of services than regarding the supply of goods. The previous main rule on the supply of services is divided into two main rules: one for business-to-business (B2B) supplies and one for business-to-consumer (B2C) supplies.¹⁴⁷ For cross-border B2B supplies, the destination principle applies. The supply is subject to the reverse charge mechanism, meaning that the acquirer declares the output VAT.¹⁴⁸ The old main rule for the supply of services from the Sixth Directive based on the origin principle still applies for B2C supplies.¹⁴⁹

Besides the main rules, the VAT Directive has no clear structure, meaning that separate rules apply for B2B and B2C transactions. Some rules apply only to B2B transactions, others to both B2B and B2C transactions, and again others only to B2C transactions.

The establishment of the seller or purchaser as proxies for the place of supply has become even greater focus than in the Sixth VAT Directive.¹⁵⁰ Compared to the original version of the Sixth Directive, a new rule is that services rendered to a non-taxable person by an intermediary acting in the name and on behalf of another person are deemed to be supplied where the underlying transaction is supplied.¹⁵¹ The place of supply of transportation services has become more sophisticated with different rules for B2B and B2C, as well as for passenger transportation and transportation of goods, and intra and extra-Union transports.¹⁵² Furthermore, the place of supply rules for hiring means of transport have become more detailed, differing between short and long-term hiring.¹⁵³

The list of services supplied where they are physically carried out has been extended to include restaurant and catering services.¹⁵⁴ When such services are physically carried out on ships, aircraft and trains, the point of departure is the place of supply.¹⁵⁵ This applies to both B2B and B2C.

Telecommunications, broadcasting, and electronic services supplied to non-taxable persons (B2C) are supplied where that person is established.¹⁵⁶ Since the main rule applies when they are supplied to taxable persons (B2B), they are always supplied in the country of destination.

After the main rule for B2B supplies of services was introduced, the list of services supplied where the acquirer is established was given a slightly different function than in the Sixth VAT Directive. It applies to services to a non-taxable person who is established, has his/her permanent address, or usually resides outside the EU. The place of supply is where that person is established, has his/her permanent address or usually resides. The list has been extended and now includes the following items.¹⁵⁷ –

the hiring out of movable tangible property, with the exception of all means of transport

In the current VAT Act, the regulations on the place of supply have not changed significantly. The place of supply of goods is stipulated in Article 19 of the VAT Act. Article 20 of the VAT Act stipulates the place of service supply. The content is, however, almost the same. In particular, the place of supply and tax rate are provisions that have maintained their contents despite many revisions. Even though the tax rate has been explicitly changed from 13% to 10% in the VAT Act, it has always been 10% in the law in action, and the content of the place of supply has not changed at all.

The place of supply in Korea seems to be primarily understood as a criterion for judging whether a transaction is a taxable transaction under the jurisdiction of Korea. This is because the VAT Act of 1977 limits the scope of the Korean government’s right to tax VAT to Korea (specifically, the territory of South Korea in the Korean Peninsula). In other words, it has a dichotomous standard that views the place of supply of goods or services as domestic/foreign. In Korea, if the place of supply of goods or services is simply domestic, VAT is levied at a rate of 10%; if the place of supply is overseas, VAT is not levied. Similarly, imports are subject to VAT, and exports are subject to zero VAT.

Although the provision on the place of supply of goods is determined based on the necessity for movement, there is no mention of the provision on the place of supply of services except that it is the place of consumption of the service. Even delegation of legislation cannot be found in the Enforcement Decree for the place of supply of goods or the place of supply of services. So, the only source is the Supreme Court’s interpretation. Therefore, looking at the following two Supreme Court precedents is necessary.

In a transaction with an overseas bank using a dedicated communication network operated by the Society for Worldwide Interbank Financial Telecommunication (SWIFT), the plaintiff’s bank was provided with transaction message transmission services such as fund settlement, financial transaction, and letter of credit opening from SWIFT. The plaintiff bank had paid a fee to SWIFT for the transaction message transmission services as consideration. The Supreme Court judged that even if the mechanical or technical work of message transmission and storage using the SWIFT communication network was performed abroad, the place where the SWIFT communication network was connected and where the message was transmitted was a domestic store. Thus, the service was provided in Korea. In addition, in this case, since the place of supply of services was centered on the recipient, the place of supply was judged based on the place of consumption of the service.¹⁵⁸

The place of supply of services, which serves as a criterion for determining whether a transaction is within the scope of domestic taxation rights, shall be subject to Article 20 (1) of the VAT Act. However, if an important and essential part of the service provided by the foreign corporation was made in Korea, the place of supply of the service should be regarded as domestic, even if part of the service was performed abroad.¹⁵⁹

According to Article 53-2 of the VAT Act, electronic services provided by foreign corporations or nonresidents in Korea are deemed to be supplied and subject to taxation. Foreign corporations or non-residents pay VAT through simplified business registration in accordance with Article 53-2, paragraph 2 of the VAT Act. If they use a third party, such as an electronic marketplace, the third party must register for VAT. Electronic services include games, sound and video files, electronic documents, cloud computing, advertising services and mediation of renting, using, consuming, supplying and purchasing services in Korea.

The Korean VAT Act of 1977 has more similarities with the Second Directive than the Sixth. The principle of origin applies to the movement or transportation of goods both in the Second Directive and in the Korean VAT Act of 1977. When the goods are not transported, the place of supply is where they are at the time of the supply. The rules on the supply of services are also very similar.

Whereas the Korean VAT legislation on the place of supply has been very stable since the introduction of VAT up until now, the place of supply rules in the EU VAT system have become increasingly complex. The Korean Supreme Court case law has complemented the statutory law in Korea when needed. The only difference since the introduction of the Korean VAT is the scheme for electronic services provided by foreign corporations or non-residents in Korea. The destination principle applies for these services, which is similar to the EU system.

It seems from this comparison that place of supply is not a very difficult issue in Korean VAT but one of the most complicated areas of EU VAT. A possible explanation could be that all the VAT systems of the EU Member States need to be coordinated in detail to prevent double or non-taxation, which has the potential to distort competition within the EU, and to fairly share the tax base for VAT between the Member States. As things stand in the EU now, many different proxies are used for determining the place of supply. It seems, however, as if the EU is moving more and more towards taxation in the country of destination, which is also the objective of the current EU VAT policy.¹⁶⁰ If the place of supply could be in the country of destination for all transactions, the place of supply rules could be more straightforward. It would, however, require a technical change in the system regarding crossborder transactions of goods since they, according to the current law, are supplied in the country of origin,¹⁶¹ the supply is exempt,¹⁶² and the transaction is taxed in the country of destination as an intra-Community acquisition or an import of goods.¹⁶³

This section serves as a guide for understanding the complexities of VAT rates within the EU and Korea. By providing an overview of the legal frameworks and historical developments, readers will gain a deeper understanding of the factors shaping VAT rates and their implications for taxation within these jurisdictions. It is essential to remember that VAT rates are the least harmonized field in EU VAT Law, where the Member States have much flexibility and discretion. They are allowed to apply one standard rate and several reduced rates or only apply one rate, which is the case in Denmark.¹⁶⁴ There is normally no flexibility in the national VAT Acts of the Member States, but the VAT rates there are fixed. This is also the case in Korea.

When VAT was harmonized in the EU, the harmonization of the VAT rates was a sensitive issue. Article 9.1 of the Second VAT Directive stipulates that each Member State shall fix the standard rate of VAT at a percentage of the basis of the assessment, which shall be the same for the supply of goods and for the provision of services. Article 9.2 of the Second Directive allowed the Member States to apply increased or reduced rates in some instances. According to Annex A of the Second VAT Directive, reduced rates for transport services must be applied as to ensure equality of treatment between the different modes of transport.¹⁶⁵ The reduced rates should be determined so that the amount of VAT resulting from the application of this rate should usually permit the deduction of the whole of the input VAT. The rate applicable to the importation of goods should be the same, which was applied in the territory of the country to the supply of the same goods. In the original version of the Sixth VAT Directive, almost identical rules were to be found in Article 12. Consequently, both the Second and Sixth VAT Directives had a flexible approach towards VAT rates. Member States, motivated by political and practical considerations, predominantly exercised their freedom to adopt rate structures that closely resembled those implemented in their previous turnover tax systems.¹⁶⁶

The Korean VAT Act of 1977 stipulates that the tax rate is 13% in Article 14(1). Considering this provision only, it could be assumed that Korea’s VAT system has been operated on a flat rate from the very beginning. However, Article 14(2) stipulates that 3% may be added or subtracted. Therefore, when the first VAT system was introduced, the flexible tax rate system was probably what the legislators had in mind.

The government’s concerns about the actual tax rate can, however, be found in an interview with former Prime Minister Nam Duk-woo, who dispatched the investigation team to the EC region at the time. In his memoirs, the following content can be read: “The most important thing among the reports of high-ranking officials and university professors (scholars) dispatched to the EC region as a research team was that it was the EC’s the biggest error that it levied different tax rates on each good and service. Therefore, if Korea introduces a VAT system, it should be the flat tax rate, and the tax rate recommends choosing a number that is easy to calculate.”¹⁶⁷

However, due to fears of rapid inflation and adverse effects, the actual tax rate was applied at 10% by subtracting 3% from the basic tax rate of 13% when the VAT system was implemented on 1 July 1977. Article 14 (3) of the VAT Act of 1977 stipulates that the period of application of the 3% increase or decrease in the tax rate shall not exceed two years. However, Article 14 (3) of the VAT Act, which is the provision period for the application period of Article 14 (2) of the VAT Act was rendered practically useless.

In conclusion, at the time of the enactment of the VAT Act, there was a flexible tax rate system that could be adjusted by enforcement decree within the range of adding or subtracting 3% to the tax rate (flexible range of 6%). Still, it has never been applied since enactment. In addition, the flexible tax rate system was abolished through the tax law revision in December 1988.

The EU VAT rules on the VAT rates were amended in 1992 when the common market was realized.¹⁶⁸ From 1 January 1993, the minimum rate has been 15 %.¹⁶⁹ The member states may apply two reduced rates, not lower than 5 %, for specific goods listed in Annex H to the Sixth VAT Directive.¹⁷⁰ Annex H included the following items:

Foodstuffs (including beverages but excluding alcoholic beverages) for human and animal consumption; live animals, seeds, plants and ingredients normally intended for use in preparation of foodstuffs; products normally intended to be used to supplement or substitute foodstuffs.

The general rules are overall the same in the VAT Directive, although the list of items subject to reduced rates has been updated and are now located in Annex III. A new item is the reception of radio and television broadcasting services. Furthermore, item 6 was changed in 2018 to include publications supplied “either on physical means of support or supplied electronically or both”.¹⁷¹

The most recent amendment to the VAT Directive in regard to tax rates is Directive 2022/542 of 5 April 2022.¹⁷² This Directive grants more flexibility to the Member States regarding VAT rates. It also aims to ensure all Member States have the same possibilities to apply reduced rates and to realize the EU environmental commitments on decarbonization and with the European Green Deal. Thus, the list of items subject to reduced rates includes, for example, rental of immovable property for residual use, solar panels, electric bikes, first-aid services, live plants and other floricultural products and children’s clothes, footwear and supply of children’s′ car seats. All Member States may, according to this Directive, apply two reduced rates of a minimum of 5 %, one super-reduced rate below 5 %, as well as an exemption with the right to deduct input VAT. The list of items for the reduced rates has been substantially expanded. There is, however, a limit of 24 items with reduced rates and seven items with zero-rating and the super-reduced rate. Furthermore, this Directive allows the Member States to apply a rate not lower than 12 % on some items.

The vast use of reduced rates in the EU raises questions about how reduced rates affect consumer prices and VAT revenue. Research shows that VAT changes affect rich more than poor households and that reduced rates are only partly reflected in consumer prices. Reduced rates have, however, further financial consequences than influencing the consumer price. They do not necessarily have any significant impact on state revenue.¹⁷³

The VAT rate of 10% has continued until today. In short, there has been much discussion regarding the VAT rate, but the VAT rate in Korea is still 10%.¹⁷⁴ The VAT rate is currently stipulated in Article 30 of the VAT Act.

EU VAT and Korean VAT started similarly, with flexible VAT rates. Introducing flexible VAT rates in a national VAT system is unusual, but a possible reason could be the strong European influence. A national VAT system, however, requires more precise rules on VAT rates without any discretion. This is also the path the Korean VAT system took quite soon after introducing VAT.

A flexible system is suitable for a legal framework, such as EU VAT law, which is implemented into different national legal systems. A flexible system, where individual countries determine the reduced rates, enables the Member States to use reduced rates for their fiscal policies and economic priorities. This reflects a degree of tax sovereignty, allowing the Member States to decide on the VAT rates that align with their unique circumstances. The Member States have insisted on retaining sovereignty in tax matters overall and have not been willing to harmonize the VAT rates in detail.¹⁷⁵ The Member States’ sovereignty is, however, to some extent, restricted not only by the list of items but also by the principle of neutrality because goods and services that compete may not be subject to different VAT rates.¹⁷⁶

The Korean VAT system is a flat rate system, compared to the EU system, which allows for reduced rates and has recently extended the scope of reduced rates. One reason for the increased flexibility in the preamble of Directive 2022/542 is that when the current VAT rate rules were introduced, the EU VAT system was based on the origin principle.¹⁷⁷ The system with intra-Community acquisitions was considered as a transitional system that should be abolished when the tax rates were harmonized to a greater extent.¹⁷⁸ Now, the intention is that the definite VAT system for crossborder trade in goods shall be based on the destination principle.¹⁷⁹ In such a system, different reduced VAT rates neither disrupt the functioning of the Internal Market nor create distortions of competition.¹⁸⁰ A more practical reason why the Member States have reduced rates is that the average standard rate in the EU is approximately 21%, a major difference compared to the Korean 10%.

Exemptions result in suppliers, importers, and acquirers not having to charge VAT.¹⁸¹ The main two categories are exemptions with and without the right of deduction.¹⁸² The zero-rated supplies mentioned above in the chapter on tax rates are exemptions with the right to deduct input VAT. Most exemptions are exemptions without the right of deduction. However, exemptions in connection with cross-border trade are often associated with a right to deduct input VAT. Exemptions without deduction shall, according to the established case law of the CJEU,¹⁸³ as a general rule, be interpreted strictly.¹⁸⁴ Exemptions with the right of deduction are the only transactions that are in fact VAT-exempt. The most common exemptions, those without the right of deduction, are taxed until the supply chain’s final stage.¹⁸⁵

As is the case for reduced rates, the approach to VAT exemptions is flexible in the Second VAT Directive. Under Article 10, the following are exempt:“(a) the supply of goods consigned or transported to places outside the territory in which the State concerned applies value-added tax; (b) the provision of services relating to goods covered by (a) or in transit.”

Through these exemptions, together with the fact that the import of goods was a taxable transaction, the Second VAT Directive realized the destination principle as a basic principle for cross-border trade in goods.

The Member States were also allowed to exempt the provision of services relating to imported goods.¹⁸⁶ Finally, each Member State was allowed to determine other exemptions that it considered necessary.¹⁸⁷ Before implementing such measures, the Member States were obliged to consult the Commission.¹⁸⁸ In Annex A of the Second VAT Directive, it was clarified that where the exemptions were applied to the transport and storage of goods, they must be applied as to ensure equality of treatment as between different modes of transport.¹⁸⁹

A list of exemptions was introduced In the Sixth VAT Directive.¹⁹⁰ The aim of the list was for resources to be collected in a uniform manner,¹⁹¹ which required a harmonized tax base for VAT. The examples were divided into exemptions within the territory of the country,¹⁹² other exemptions,¹⁹³ optional exemptions,¹⁹⁴ exemption on importation,¹⁹⁵ exemption on exportation and similar transactions and international transport,¹⁹⁶ and special exemptions linked to international goods traffic.¹⁹⁷

Among the exemptions within the territory, hospital and medical care and closely related activities, the supply of services and of goods closely linked to welfare and social security work, educational services, and activities of public radio and television bodies other than those of a commercial nature can be mentioned. The other exemptions include, for example, financial and insurance services.

The optional exemptions are optional both for the Member States and taxpayers. This means that the Member States are not obliged to implement the optional exemptions. If they are implemented, the taxpayers can opt for taxation. This is stipulated in the Sixth VAT Directive in that the Member States may allow taxpayers an option for taxation that applies for the letting and leasing of immovable property and some financial services.¹⁹⁸

The exemption for exports is in practice a zero rating, provided that the supply of goods is not exempt for other reasons. There is a right to deduct input VAT when the transactions are exempt under Article 15, which is the exemption for exports.¹⁹⁹

The Korean VAT Act of 1977 includes provisions on exemptions in Article 12. Since VAT is a general consumption tax, it is in principle levied on all goods or services. However, there are exemptions implemented to alleviate the economic burden of the low-income bracket and achieve policy goals in the public interest. Therefore, according to the Supreme Court, a strict interpretation of exemptions is required.²⁰⁰ In the end, the exemption cannot be applied except for those that have been laid down in the VAT Act.

The Korean VAT Act of 1977 deals with the supply of goods or services exempt from VAT (Article 12 (1)) and the import of goods exempt from VAT (Article 12 (2)) separately. Moreover, it is not stipulated in detail which areas are exempt from VAT. Therefore, it has thereafter been narrowed down through many tax law amendments.

The Korean VAT Act of 1977 includes provisions for zero rating in Article 11. The zero-rating system is a system that applies zero rating (0%) to the supply of certain goods or services, which, according to the Supreme Court, means complete tax exemption.²⁰¹ According to the Supreme Court, the zero-rating system aims to prevent international double taxation and promote exports.²⁰² Items to which zero rating is applied are listed in Article 11(1), Item 1 to Item 4, all of which are related to overseas transactions.

Article 11 (Application of Zero Tax Rate)

(1) The zero tax rate shall apply to the supply of goods or services under the following subparagraphs:

goods for export;

The VAT Directive has maintained the system of listing the exempt transactions. The exemptions are listed in Articles 132–165 of the VAT Directive. The exemptions are very much the same as in the Sixth VAT Directive. The VAT Directive makes a difference between exemptions with and exemptions without the right to deduction of input VAT.²⁰³ These exemptions with the right to deduct input VAT applied previously generally to cross-border transactions.²⁰⁴ As mentioned above, the Member States now have the possibility to zerorate up to seven items. In this regard, the exemptions have expanded compared to the Sixth VAT Directive.

Since the VAT Act was enacted in 1977, the scope of VAT exemptions, which was for nineteen items, has been partially adjusted every year. The current VAT Act stipulates the exemptions in Articles 26 to 27. Article 26 is the regulation of the supply of tax-free goods or services. Article 27 is the regulation on the importation of tax-free goods. The VAT Act of 1977 stipulated this separately in the same Article, but the current VAT Act separates it into two different Articles.

The significant tax exemptions listed in the current VAT Act apply to basic daily necessities such as feminine hygiene products and passenger transportation services; public welfare, such as medical health and education services; books, newspapers, broadcasting, and other areas related to culture; finance and insurance; and production factors such as human services; and other goods and services supplied by the state and local governments. In addition, under the Restriction of Special Taxation Act, tax exemption is provided for national housing construction services, diapers and formula for infants, petroleum products for agriculture, fisheries and coastal ships, and care products for homes for senior citizens.

Conversely, in 1982, real estate rental services and housing supplied by the Korea Housing Corporation, which had been tax-exempt, became taxable.²⁰⁵ In 2004, human services for marriage counseling and animal training became taxable.²⁰⁶ In 2011, plastic surgery for cosmetic purposes other than therapeutic purposes and medical services for pets became taxable.²⁰⁷ In 2014, medical and health services for cosmetic purposes, like plastic surgery, became taxable.²⁰⁸ Interestingly, it presents the standards of the OECD and EU as the basis for switching to taxation.

Although the scope of application of zero rating has increased, the reason for applying zero rating is the same as before. In the past, all zero-rating applications listed in the same article were dealt with separately. Specifically, Article 21 of the VAT Act regulates the exportation of goods, Article 22 provides for services supplied overseas, Article 23 regulates the supply of overseas navigation services, and Article 24 regulates the supply of goods or services for acquiring foreign currencies.

Similar to tax rates, the Second VAT Directive applied a flexible approach towards exemptions. Exports were the main exemption in both the original Korean VAT Act and the Second VAT Directive. Besides exports and services related to exports, the Second VAT Directive left it up to the Member States to decide which exemptions they wished to apply. The original Korean VAT Act did not stipulate exemptions other than those connected to international trade. Consequently, the original Korean VAT Act did not adopt a list of exemptions, such as those in the Sixth VAT Directive.

In Korea, different exemptions were implemented subsequently. Interestingly, some exemptions, like the ones for feminine hygiene products, passenger transportation services, books, newspapers, the reception of broadcasting services and many services related to culture, are on the list for reduced VAT rates in the Sixth VAT Directive and in the VAT Directive but are exempt under the Korean VAT Act. Most other transactions that are exempt under the Korean VAT Act are also exempt under the VAT Directive. It may be that EU VAT law has influenced Korean VAT law regarding exemptions. However, the similarities may also be coincidental and are found in many VAT systems, since there is a rationale behind exempting services that are largely funded by public means, that are of public interest, or where it may be challenging to establish a fair taxable amount, such as financial and insurance services.

The deduction of input VAT constitutes a crucial element of VAT systems in both the EU and Korea. It is the right to deduct input VAT that makes an indirect tax a VAT.²⁰⁹ Within the EU, the general rules are harmonized, meaning, for instance, that the right to deduct input VAT is connected to taxable output transactions. The Member States have, however, a lot of latitude to set their own rules.²¹⁰ One example is the apportionment of input VAT between economic and noneconomic transactions, which is at the discretion of the Member States.²¹¹ Also, in the VAT Acts of the Member States and in the Korean VAT Act, the apportionment rules are not very specific. This does not mean that the tax authorities apply a flexible approach in relation to the taxpayers. Still, the technical rules are often found in lower-level acts, such as acts adopted by the executive power.²¹² This chapter explores the principles, procedures, and considerations involved in deducting input VAT, and analyzes the similarities and differences between these two jurisdictions. As in the other sections, the focus is on the EU Directives and on the Korean VAT Act and not on technical issues within the discretion of the Member States.

The Second VAT Directive contains the central components for the deduction of input VAT. The right to deduct applies where goods and services are used for the purposes of a taxable person’s undertaking. The taxable person is allowed to deduct the VAT invoiced to him/her in respect of goods supplied to him/her or in respect of services rendered to him/her, the VAT paid in respect of imported goods, and VAT on some deemed supplies of goods. The Second Directive clearly states that input VAT on goods and services used in nontaxable or exempt transactions shall not be deductible. However, if the transactions are not taxed because the supply takes place abroad or they are exempted because it is an export or some other cross-border supplies, the taxable person is allowed to deduct input VAT.²¹³

The Second Directive includes a general rule on the mixed use of goods or services for both transactions that do give entitlement to deduction and those that do not give entitlement to deduction. The rule is called the “pro rata rule.” It stipulates that a deduction shall only be allowed for the part of the input VAT, which is proportional to the amount relating to transactions giving entitlement to a deduction.²¹⁴ According to Annex A of the Second VAT Directive, the pro rata figure shall generally be determined in respect of all the transactions carried out by the taxable person but may exceptionally be determined for specific sectors.²¹⁵

The Second Directive connects the right to deduct input VAT to the period in which the deductible tax is invoiced. A five-year period, including the year when the goods were acquired, is required to adjust the input VAT for capital goods. The adjustment applies each year to one-fifth of the tax borne by the capital goods.²¹⁶

The Sixth Directive has a different approach to the deduction of input VAT than does the Second Directive. Instead of connecting the right to deduct input VAT to the taxable person’s undertaking, it connects it to the purposes of the taxable person’s transactions.²¹⁷ A direct and immediate link between the costs and the taxed output transactions must exist.²¹⁸ Consequently, the Sixth Directive introduces a transaction-based approach. Hence, no rule that excludes the right to deduct when the goods and services are used for nontaxable or exempt transactions is needed.

The Sixth Directive has a slightly different approach to the time of the deduction. Instead of connecting it to when the VAT is invoiced, the time when the tax becomes chargeable is the relevant point in time.²¹⁹ Under the main rule in the Sixth Directive, the VAT becomes chargeable when the goods are delivered or the services are performed.²²⁰ Another novelty in the Sixth Directive is that the refund of input VAT is expressly stated and the list of exemptions with deduction is expanded.²²¹

The pro-rata rule became more detailed in the Sixth Directive.²²² The deductible proportion shall be made up of a fraction having as a numerator, the total amount, exclusive of VAT, of turnover per year attributable to transactions in respect of which VAT is deductible under, and as a denominator, the total amount of the turnover.²²³ Furthermore, the Sixth VAT Directive allows the Member States to derogate from the pro rata rule to a certain extent. For example, the Member States may authorize or compel the taxable person to make the deduction based on the use of all or part of the goods and services or provide that where the VAT is not deductible by the taxable person is insignificant, it shall be treated as nil.²²⁴

The adjustment of a deduction was further developed in the Sixth Directive. In the Second Directive, it refers only to capital goods. The Sixth Directive includes a general rule stating that the initial deduction shall be adjusted where the deduction was higher or lower than that to which the taxable person was entitled.²²⁵ The input VAT shall also be adjusted where, after the return is made, some change occurs in the factors used to determine the amount to be deducted, particularly where purchases are canceled or price reductions are obtained.²²⁶ An extended adjustment period for immovable property was introduced in the Sixth Directive, allowing the Member States to have an adjustment period of up to ten years.²²⁷

The Korean VAT Act of 1977 deals with the deduction of input VAT in Article 17. To be more precise, rather than specifying the conditions for receiving an input tax credit, the conditions for an input tax credit can be inferred by listing cases where input tax credit is not received.²²⁸ Among them, if approached from the theoretical aspect of the VAT Act, item 1 and item 2 are essential. Item 1 is a case where there is a defect in the tax invoice, and item 2 is a case where business relevance is not satisfied. Furthermore, input VAT related to the business supplying goods or services, which are exempt from the VAT as well as input VAT before the VAT registration, is not deductible (items 4 and 5).

A defective tax invoice not only concerns a tax invoice that has not been issued, but it also concerns an invoice where the requisite entry items of the tax invoice are incorrect. The requisite entry items of the tax invoice are in Article 16. There are four in total: the registration number and name or denomination of the entrepreneur who makes the supply, the registration number of the person receiving the supply, the value of the supply and the amount of VAT, and the date of preparation. Since registration numbers can be issued only after a business has been registered, the business registration must be preceded by the input tax credit. There are entry items other than requisite entry items in the tax invoice, but whether they are entered or not does not affect the input tax credit. This condition is perceived as a procedural requirement for the input tax credit.²²⁹

Regarding business relevance, a correct invoice is perceived as a practical requirement for input tax credit. This requirement aims to credit only the amount an entrepreneur purchases for his or her business as an input tax. If this is not recognized, the tax burden of VAT will fall not only on the end consumer but also on the normal entrepreneur. Also, an amount unrelated to a business transaction cannot be called an input tax amount, and there is no justification for subtracting that amount.²³⁰

Moreover, the Korean VAT Act of 1977 Article 14(4) stipulates that goods subject to VAT (goods to which input tax credit has been applied) can be recalculated as tax payable when used in a tax-free business (when no output tax amount is generated). However, there is no provision on how to recalculate tax payable. Thus, it is entrusted to the Presidential Decree.

Conversely, Article 14(3) of the Korean VAT Act of 1977 describes the fictitious input tax credit. It stipulates that goods²³¹ exempt from VAT may be deducted as input tax if they are used for a taxable business (where input tax credit is not applied). However, provisions on how to recalculate input tax credit specifically is entrusted to the Presidential Decree.

To conclude, the Korean VAT Act of 1977 does not have many regulations on the deduction of input VAT, and the existing regulations are not systematic. It seems that the input tax credit is stipulated only from the perspective of simply subtracting it. Above all, there is no regulation on goods subject to depreciation.

In the current VAT Directive, all the above-mentioned rules on the deduction of input VAT in the Sixth Directive have remained, but there are some novelties. There are optional rules on cash accounting in Article 66(b). Consequently, when cash accounting is applied, the right to deduct input VAT arises at the time of the payment,²³² not when the transaction occurs.²³³ Following the case law of the CJEU, starting with C97/90 Lennartz,²³⁴ which entitles taxable persons to a full deduction even when the assets are used partly for private purposes, a new Article 168a was introduced. Accordingly, in the case of immovable property, the Member States may restrict the right to a full deduction and grant only a partial deduction when the property is used partly for private purposes.

The current VAT Act has detailed provisions on input tax amounts. Article 38 is a provision regarding input tax amounts to be deducted. Article 39 stipulates when input tax amounts may not be deducted. Article 40 deals with situations when taxable and tax-free operations are combined. Article 41 regulates the recalculation of common input tax amounts on depreciable assets. Article 42 is a provision on fictitious input tax credit. At the same time, Article 43 has a provision that allows the input tax credit to be applied when depreciable assets for tax-free businesses, for which input tax is not deducted, are used or consumed by taxable businesses.

Where an entrepreneur carries out both a taxable business and a tax-free business, an input tax amount related to the taxable business or tax-free business shall be calculated based on the actual attribution. An input tax amount for which the actual attribution is not clear shall be calculated on a pro rata basis, as prescribed by Presidential Decree, by applying the criteria prescribed by the Presidential Decree, including the ratio of the value of tax-free supplies to the total value of supplies. In summary, the input tax amount is divided and deducted based on turnover. Further details, such as the inability to divide input tax by turnover, are stipulated in Article 81 of the Enforcement Decree of the VAT Act.

Both the Second VAT Directive and the Korean VAT Act of 1977 have a business-, not a transaction-oriented approach to the deduction of input VAT. Input VAT on business-related acquisitions are deductible. In both these systems, a provision stipulates that if the goods or services are used for exempt activities, the right of deduction is excluded. There are general rules on the adjustment of input VAT and for goods acquired for taxable and tax-free activities.

Whereas the Sixth Directive made the rules on the deduction of input VAT more detailed and also moved from a business to a transaction-oriented approach, the Korean VAT Act has very much remained the same. However, the Enforcement Decree of Value-Added Tax contains detailed provisions both on the pro rata calculation and the adjustment (recalculation) of input VAT on capital goods. Another difference is that the Korean VAT focuses on calculating the nondeductible proportion, whereas the VAT Directive focuses on calculating the deductible proportion. Besides that difference, the rules demonstrate a significant similarity with the Sixth and the current VAT Directives.

Another difference is that the Korean VAT Act focuses on calculating the nondeductible proportion, while the VAT Directive focuses on calculating the deductible proportion. This indicates a difference in the approach to determining the extent to which input VAT can be deducted or excluded when goods or services are acquired for both taxable and exempt activities.