Improving Tax Audit Procedures and Practice

Introduction
Audit Procedure and Practice
Criminal Tax Audit
Tax Audit of Local Tax Issues


Introduction

In September 2005 the Independent Commission against Corruption provided the tax authorities (ie, the Ministry of Finance and Economy, the National Tax Service, and the Ministry of Government Administration and Home Affairs) with its recommendations to improve the tax audit procedure and make tax audits more transparent and accountable.

For more than a year the commission - an independent governmental organization established in 2002 to improve laws and government institutions through the prevention of corruption and implementation of anti-corruption policies - conducted its own internal study of the quality of tax audits conducted by the tax authorities, focusing on complaints from both Korean and foreign taxpayers. The recommendations are the result of the study and the tax authorities are required to take any necessary measures (including submission of proposed revisions to tax laws to the commission for review) by June 30 2006.

Audit Procedure and Practice

Codification of internal guidelines into law
The Basic National Tax Act and its associated enforcement decrees contain provisions which set forth certain rules and procedures that the tax authorities and tax auditors should follow in conducting tax audits. However, these provisions are broad and vague, allowing substantial room for interpretation. Therefore, the Korean tax authorities have relied on their own internal guidelines for the efficient management of tax audits. Unfortunately, such guidelines (eg, on selecting audit targets) are officially undisclosed to the public, so many taxpayers have found it difficult to prepare for tax audits and to comply with tax auditors' requests in an efficient and timely manner.

One key recommendation of the committee is the codification of internal guidelines into law in order to provide taxpayers with clearer and more practical guidelines. For instance, the committee recommends that internal guidelines on the examination period, scope of examination, collection of documents and information, protection of taxpayers' rights and so on be codified into law.

Auditor pool system
The Korean tax authorities have been implementing an auditor pool system on a trial basis. Under the system, tax officials with specific tax or industry expertise are pooled together from various departments within the tax authorities to form an audit team to examine that particular issue. The main purpose of the system is to bring greater expertise into tax audit processes and to utilize the tax authorities' human resources more efficiently. The system is also purported to provide a check and balance effect as well, since officials from different departments work together.

The commission recognizes the benefits of the auditor pool system and recommends that the tax authorities formally adopt this system by the end of 2005. It also recommends that the personnel and organization of a specific auditor pool be disclosed to taxpayers, which is not current practice.

Internal review of auditor conduct
Both Korean and foreign taxpayers have expressed their frustration at abuses resulting from the broad powers that have been exercised by tax auditors during tax audits. In particular, they have complained that there is no clearly established set of rules or procedures that regulate the conduct of tax auditors during tax audits.

Accordingly, the commission has tried to find ways to make the tax audit procedure fairer and more transparent. Therefore, the commission recommends that the tax authorities implement specific and stringent rules and procedures (including rules on ethics) that tax auditors must follow in conducting tax audits. It also recommends that stricter penalties be imposed on tax auditors who violate such rules and procedures or abuse their powers.

Criminal Tax Audit

Criminal tax audits are conducted in criminal tax fraud cases only. They are conducted in a manner similar to a criminal investigation, often in cooperation with the prosecution. Over the years, the Korean tax authorities have also relied on internally established guidelines in conducting criminal tax audits. However, such guidelines usually are not disclosed to the public.

In light of this, the commission recommends codifying the guidelines (eg, the selection process of taxpayers subject to criminal tax audits, standards for prosecution and investigation procedures) into law. Furthermore, it recommends that certain criminal penalties be relaxed so that they are not overly harsh. For instance, the commission recommends that a simple violation (eg, a violation of an administrative order) carry only a penalty without a prison term.

Tax Audit of Local Tax Issues

In general, local government bodies under the Ministry of Government Administration and Home Affairs have jurisdiction over local tax issues (eg, registration tax and acquisition tax that are imposed on transfer of real estate) and conduct relevant tax audits on these issues. However, in contrast to tax offices under the National Tax Service that have jurisdiction over national tax issues, local governments do not have sufficient resources and expertise to conduct local tax audits. Therefore, many taxpayers have often been disadvantaged from delays and unreasonable requests made by the tax auditors during field audits of local tax issues.

In order to improve the efficiency of local tax audits, the commission recommends that each local government body create a department exclusively dedicated to local tax audits. It also recommends introducing provisions into the Local Tax Act that would specifically allow desk audits - currently provided for tax audits of national tax issues - to avoid imposing an undue burden on taxpayers and provide clear standards in selecting tax audit targets. Finally, the commission recommends that local government bodies form a committee, including non-government personnel as well, which would be in charge of selecting targets for local tax audits.

For further information on this topic please contact Jay Shim, Sai Ree Yun or Sangmoon Chang at Woo Yun Kang Jeong & Han by telephone (+82 2528 5200) or by fax (+82 2528 5228) or by email (jjshim@wooyun.co.kr or sryun@wooyun.co.kr or smchang@wooyun.co.kr).