Through a revision of the tax enforcement decree, South Korea expects to levy capital gains tax on a wider range of foreign investors, as the revision defines those holding 5 percent or more of a firm as a “large shareholder” -- the target of taxation -- from the previous threshold of 25 percent. The revision was announced on Jan. 7 by the Ministry of Strategy and Finance and is set to take effect in July.
Under the new rule, however, it would cause a cumbersome process of all parties concerned, including foreign investors -- mostly funds -- and their tax withholder securities firms, due to the lack of infrastructure to track and calculate net capital gains, according to a leading figure of an Asia-wide advocacy group for financial institutions.
Such an approach by the government would trigger a “huge disruption in the market,” said Patrick Pang, managing director and head of fixed income and compliance of the Asia Securities Industry & Financial Markets Association, in a telephone interview with The Korea Herald.
“It’s the huge impact on the cash flow of funds,” said Pang, who is based in Hong Kong.
Patrick Pang of the Asia Securities Industry & Financial Markets Association. (ASIFMA)
The current Korean tax code stipulates that a securities firm in Korea -- either a local brokerage or a foreign brokerage with a Korean branch -- is a withholder of foreign investors’ capital gains tax, and therefore is responsible for reporting large shareholders’ tax to the government.
Also by law, the capital gains tax amounts to the lower of the two -- 22 percent of net capital gains, or 11 percent of gross sales proceeds.
The lowering of the threshold from 25 percent to 5 percent would mean a securities firm must keep track of who owns exactly how much in order to calculate whether the investor is a target of taxation. And it is something that a majority of securities firms are well aware of, but cannot handle. One of the reasons would be that an investor may be involved with multiple securities firms for transactions.
“The whole system requires many parties to go through a long and operationally cumbersome process of paying a large amount of tax in the first instance to the government.”
A brokerage that may not be able to estimate the acquisition cost of investors’ stock purchase -- and therefore cannot calculate net capital gains -- would only have the choice of applying 11 percent of sales proceeds, which is ”likely to be a larger number than 22 percent of the actual capital gain,” Pang explained.
“(In such a case) Even if the investor makes the loss, the tax is still withheld by the securities broker,” Pang said. “Then the foreign investors would have to go to the Korean government and claim a refund.”
Pang said the revised measure might trigger a capital flight. “Funds might decide they don’t want to bear the risk.”
An option could be a centralized infrastructure system prepared by the government or platforms like the Korea Exchange, Pang said. But time is short, he added, referring to the six-month grace period given by the Finance Ministry to the securities industry.
“If everyone in the industry and the Korean government come together and set up a centralized infrastructure, it will probably need more than six months,” he said.
In Pang’s opinion, the last thing that should happen is that a tax-withholding securities firm is held accountable when there is a lack of infrastructure.
According to the International Tax Division of Tax & Customs Office of the Finance Ministry, a foreign investor can report net capital gains, including acquisition costs and gains or losses from the investment, etc. to the tax-withholding securities firm, and the brokerage can estimate tax accordingly.
“(But) the law needs to be amended to remove the legal liability of the brokerage in the event the information received by the brokerage (from investors) is inaccurate or not provided in a timely manner,” he said.
All in all, the “impact to (tax) revenue is low but impact on the operations and efficiency is huge and negative,” he said.
Out of foreign investors and funds from some 90 countries, those from countries like Luxemburg, Singapore, Cayman Island, Japan, Taiwan and Germany are subject to Korean tax code, according to the Financial Supervisory Service. Over 15 percent of shares are held by stock buyers from either Luxemburg, Singapore, Cayman Island or Japan.
“The most significant investor class is funds,” he said. “Funds are usually set up in countries that do not have tax treaties and yet many also fall under the threshold and thus exempt.”
ASIFMA is an independent advocacy organization comprising financial institutions ranging from banks, asset managers, law firms and market infrastructure service providers.
By Son Ji-hyoung