Tax on Interest Income due to Debt Repayment

When cancelling a real estate contract, a penalty may be incurred depending on who cancels the contract, and it may be necessary to repay a portion of the penalty or not to return the already paid contract deposit.

 

Those who benefit from the penalty must declare and pay 22% of the amount of profit generated as other income tax (detailed information can be found here).

 

In the case of creditor-debtor relationships, could such other income be generated? Let's take a look at an example below.

 

Debtor A borrowed 2 billion won from Creditor B and wrote a loan agreement as follows:

 

• Loan amount: 20 billion won, total repayment of 40 billion won upon expiry
• Collateral: 16 plots of land outside X-X, OO-dong, OO-gu, Seoul (pledged up to a maximum of 40 billion won)
• Loan period: November 20, 19XX
• First repayment date: May 20, 19XX
• Second repayment date: July 20, 19XX
• Late payment: Monthly 3% late fee payment after the second repayment date on the 20th of every month
• Repayment ①: Total repayment of 40 billion won by November 20, 19XX
• Repayment ②: Transfer of ownership of the above-entioned real estate collateral by November 25, 19XX if not fulfilled for the first item

[Source: National Tax Law Information System "Income, Regulations, and Laws-685, June 18, 2012"]

 

When debtor A failed to pay the money within the deadline, creditor B applied for an auction of the property on which the lien was set and received a total of KRW 2.02 billion. The principal of KRW 2 billion has been recovered. However, some money is still outstanding. They agreed to receive KRW 4 billion at the expiration date, so they have not yet received the remaining KRW 2 billion and the interest on it. So, creditor B sued debtor A and won. The result is as follows:

 

1. Debtor A demanded that they pay KRW 7 billion in interest that has accrued up to the decision date.
2. If they fail to pay KRW 7 billion, they must pay interest of 20% per year until complete repayment.

 

This case is an actual case where creditor A earns a considerable amount of interest income. In that case, when should creditor A report the interest income for tax?

The National Tax Service answered that income is generated on the day that creditor B receives payment. They also said that this income corresponds to "penalties and compensation received due to breach or cancellation of a contract", which is classified as other income. The tax rate for other income is 22%. After reporting to the relevant tax office, 20% should be paid and after reporting to the local government, 2% should be paid.

 

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