Due Diligence Before Acquiring a Korean Company: Unpaid Severance, Ordinary Wages, and Hidden Tax Liabilities

Foreign buyers of Korean companies usually focus diligence on revenue, customers, and intellectual property. The liabilities that most often surprise them after closing are less visible: severance that was never funded, overtime calculated on the wrong wage base, and tax exposure from years before the deal. In a share deal, all of these stay with the company, and so with the buyer. A December 2024 Supreme Court decision on “ordinary wages” has made the labor side especially important. This article explains where these liabilities come from, how to find them, and how to protect against them in the transaction documents.

1. Why These Liabilities Matter in a Korean Deal

Three features of Korean law make these risks larger than buyers expect.

• Long look-back periods: Employees can claim unpaid wages and severance for three years. The tax authority can generally reassess tax for five years, longer for unfiled returns or fraud.
• Criminal exposure: Failing to pay wages or severance within 14 days after an employee leaves is a criminal offense for the employer and its representative director, not just a civil debt.
• Liabilities often missing from the financial statements: Smaller Korean companies frequently under-record severance obligations and do not provide for wage or tax disputes at all.

Key takeaway: The financial statements are the starting point, not the answer. Most of these liabilities are found in payroll records, employment contracts, and tax filings.

2. Severance: Unfunded and Miscalculated

The basic obligation

Under the Employee Retirement Benefit Security Act, an employee with at least one year of service is entitled to severance of at least 30 days’ average wages for each year of service. This applies to workplaces of all sizes.

Where the risk lies

① Unfunded or under-recorded severance

• Companies may provide for severance through a defined benefit (DB) pension, a defined contribution (DC) pension, or the legacy severance system with no external funding.
• Under the legacy system and DB plans, the company carries a growing liability that is often under-recorded in smaller companies’ accounts.
• DB plans may also be underfunded compared with the statutory minimum funding level.

② Miscalculated average wages

• Severance is based on average wages, which include regular bonuses, allowances, and overtime pay, not just base salary.
• Companies that leave out recurring bonuses or allowances under-calculate severance for every departing employee. If ordinary wages rise (Section 3), overtime pay and therefore average wages rise too.

③ Invalid “severance included in salary” arrangements

• Some companies pay a monthly amount described as “severance included” and then pay nothing on departure. Korean courts generally treat these arrangements as invalid: the employee can still claim full severance, and the company’s ability to recover the amounts already paid is limited.
• Interim severance settlements made without a statutory reason (such as buying a home or medical expenses) are similarly at risk.

④ Misclassified workers

• Workers engaged as freelancers or contractors (often paid with 3.3% withholding) may be found to be employees based on how they actually work. If so, the company owes severance, annual leave pay, and social insurance retroactively.

3. Ordinary Wages After the 2024 Supreme Court Decision

What changed

“Ordinary wages” are the base for calculating overtime, night work, and holiday pay, as well as some leave allowances.

In December 2024, the Korean Supreme Court sitting en banc dropped the long-standing “fixedness” requirement. In practice, this means bonuses and allowances that are paid only to employees still employed on the payment date, or only to those who work a minimum number of days, can now count as ordinary wages if they are paid regularly and uniformly.

Why it matters for buyers

• Many Korean companies designed their pay structures so that large regular bonuses were excluded from ordinary wages. After the decision, many of those bonuses are included.
• The ordinary wage base rises, and so does every hour of overtime, night, and holiday work paid since the decision.
• The Court applied the new rule prospectively from the date of the decision, apart from cases already pending on the same issue. Companies that have not adjusted their pay calculations since December 2024 have been building up underpayment liability since then.

What to check

• Every regular bonus and allowance in the pay structure, and the conditions attached to it
• Whether payroll has been recalculated since December 2024
• Overtime, night, and holiday hours actually worked, especially under fixed overtime pay schemes, which Korean courts and the labor ministry increasingly scrutinize
• Collective agreements and union demands on ordinary wages

Key takeaway: For companies with large regular bonuses and substantial overtime, such as manufacturers, logistics companies, and service businesses, the post-2024 ordinary wage exposure can be material. It should be quantified, not just noted.

4. Other Labor Liabilities to Check

• Unused annual leave pay, often unpaid on departure
• Working hours: compliance with the 52-hour weekly limit
• Fixed-term workers: employees on fixed-term contracts for more than two years are generally deemed to be on indefinite contracts
• Illegal dispatch: if workers from a staffing or subcontracting company are effectively directed by the target, the target may be required to employ them directly
• Social insurance: unpaid or under-reported contributions
• Changes to work rules: changes that disadvantage employees, made without the required majority consent, are invalid, so the old, more favorable terms may still apply
• Unions and collective agreements: change-of-control provisions, employment security clauses, and pending disputes
• Executives: registered directors are generally not employees, but unregistered “executives” may be employees entitled to severance

5. Tax Contingencies

Reassessment periods

The tax authority can generally reassess tax for five years from the filing deadline. The period extends to seven years if no return was filed and ten years for fraud, with longer periods in some international transaction cases.

Common issues

① Shareholder and executive loans

• Funds taken out of the company by shareholders or executives, often without documentation
• The tax authority can impute interest to the company and treat the amounts as bonuses or dividends to the individuals, with tax consequences for both

② Related-party transactions

• Transactions with shareholders, affiliates, or family companies at non-arm’s-length prices can be disregarded and recalculated under the unfair transactions rules
• For targets with foreign affiliates, transfer pricing exposure (see our earlier article on transfer pricing and permanent establishment risk)

③ VAT invoice problems

• Purchase invoices without real underlying transactions (fictitious invoices) lead to disallowed input VAT, heavy penalties, and potential criminal liability

④ Withholding tax

• Failure to withhold on payments to freelancers, non-residents, or employees

⑤ Non-business expenses

• Personal use of corporate cards, entertainment expenses above the statutory limit, and other costs that should not have been deducted

⑥ Tax audit history

• When the target was last audited, and whether a periodic audit is likely soon after closing

A cost buyers often overlook: deemed acquisition tax

When a buyer acquires more than 50% of the shares of a company that owns Korean real estate, vehicles, or other taxable assets, the buyer is generally treated as having acquired those assets in proportion to its shareholding, and must pay acquisition tax as a majority shareholder (과점주주 간주취득세). This is a cost of the deal for the buyer, not a liability of the target, and should be priced in from the start.

Secondary tax liability

A shareholder holding more than 50% that actually controls the company can become secondarily liable for the company’s unpaid taxes, generally in proportion to its shareholding. This applies to taxes arising while the buyer is the controlling shareholder. It makes post-closing tax compliance the buyer’s concern too.

6. Share Deal or Asset Deal: Who Bears What

	Share deal	Asset (business) transfer
Labor liabilities	Remain with the company, effectively borne by the buyer	Employment relationships generally transfer with the business, together with accrued wage and severance obligations
Tax liabilities	Remain with the company	Generally stay with the seller. The buyer’s secondary tax liability as a business transferee now arises only in limited cases
Acquisition tax	Deemed acquisition tax if more than 50% of the shares are acquired	Acquisition tax on each transferred asset

Key takeaway: An asset deal helps separate tax history, but it does not cleanly separate labor liabilities, because Korean courts treat employment relationships as transferring with the business.

7. Protecting the Buyer in the Transaction Documents

• Specific indemnities for identified issues, such as the ordinary wage shortfall since December 2024, unfunded severance, or a known tax exposure, rather than relying on general warranties
• Price adjustment: treat unfunded severance and quantified wage shortfalls as debt-like items deducted from the purchase price
• Escrow or holdback sized to the identified exposure
• Survival periods that match Korean limitation periods: at least three years for labor claims and five to seven years for tax
• Pre-closing remediation: require the seller to recalculate and pay wage shortfalls, fund pension shortfalls, or file amended tax returns before closing
• Warranty and indemnity (W&I) insurance, increasingly available for Korean deals, though known issues are typically excluded and must be covered by specific indemnities
• Disclosure schedules that list every bonus and allowance, pension arrangement, contractor relationship, and tax audit

8. Diligence Checklist

Labor

• Employee census: hire dates, pay components, contract types
• Payroll for the last three years, with bonus and allowance details
• Severance method (DB, DC, or legacy) and actuarial or funding reports
• Work rules, collective agreements, and records of consent to changes
• Contractor and freelancer agreements
• Labor ministry inspections, complaints, and pending disputes

Tax

• Corporate tax, VAT, and withholding returns for five years
• Tax audit history and correspondence
• Shareholder and executive loan balances
• Related-party transaction list and transfer pricing documentation
• List of real estate and vehicles, for deemed acquisition tax

9. Conclusion

In a Korean acquisition, the liabilities that cause the most trouble after closing are often not on the balance sheet: severance that was never funded, overtime calculated on an ordinary wage base that the December 2024 Supreme Court decision has made too narrow, and tax positions that can be reopened for five years or more. Because these liabilities generally stay with the company in a share deal, the buyer needs to find them in diligence, quantify them, and allocate them in the transaction documents.

A buyer who identifies these issues before signing can price them, require the seller to fix them, or cover them with specific indemnities and escrow. A buyer who finds them after closing usually pays for them.