We view the latest stock market slide as being mainly driven by investors (mainly foreigners)’ overblown concerns about the potential negative impact of Korea’s 2017 tax law amendments. We note that: 1) even if non-residents and foreign corporations become subject to a stricter taxation on capital gains (from share transfer), a majority of them should remain unscathed, given that they are protected by a clause on avoidance of double taxation under the tax treaties signed between Korea and 91 countries; and 2) even if the scope of major shareholders of domestic listed companies is extended (so that a larger number of major shareholders will be subjected to stricter taxation on capital gains), such a change should take time to materialize (in order to fend off shocks to the market).
Widening scope of non-residents/foreign institutions subject to capital gains tax
With regards to capital gains which non-residents/foreign institutions earn via trading stocks in the Korean market, the current tax law specifies that the tax is imposed only when the benefiting parties are major shareholders with a 25% or higher stake in a company. However, according to the tax law amendment released by the Korean government yesterday, the scope of major investors will be drastically widened by lowering the stake ownership standard from current 25% to 5%.
Following yesterday’s announcement, concerns have risen sharply that the latest tax code modification would prompt foriegn investors with a 5% or higher stake in a company to sell their stakes before the amendment takes effect.
That being said, we note that even if non-residents and foreign corporations become subject to a stricter taxation on capital gains (from share transfer), a majority of them should remain unscathed, given that they are protected by a clause on avoidance of double taxation under the tax treaties signed between Korea and 91 countries
For instance, a majority of foreign investors in the Korean stock market come from countries (91 countries, including US, U.K., and France) with which Korea has already signed a double taxation avoidance agreement. This means that foreign investors from these agreement-signed countries currently pay capital gains tax on profits earned from investments in the Korean stock market to their countries of origin, and they will remain spared from any impacts of the recent tax law changes in Korea. We note that foreign investors from countries which require their nationals to comply with local tax law (such as Germany and Japan) represents only a minor portion of foreign trading in the Korean stock market.
Expansion in scope of major shareholders in listed firms
The government announced expanding the scope of major shareholders of listed firms in Korea, thereby subjecting a higher number of shareholders to heavy capital gains tax on securities transactions. Under the current law, when shareholders own 1% or more of stake in a Kospi-listed company and the stake is valued at 2.5 billion won (US$2.2 million) or more, they are deemed as major shareholders. But the standard for major shareholders will be lowered to 1.5 billion (US$1.3 million) or more in 2018 and one billion won (US$900,000) or more in 2020.
Taiwan had changed the standard for major shareholders in Jan 1989. But it had revealed the plan only three months before the change was implemented, resulting in sending the Taiwanese stock market on a downward spiral. However, we foresee that such a stock market crash won’t occur in Korea, given that the country plans to strengthen the standard for major shareholders in phases through 2021. Also, issues such as securities transaction taxes are likely to be discussed over a long term.
In conclusion, as the latest stock market plunge has mainly stemmed from the market’s misunderstanding about the impact of the 2017 tax law amendments, we advise investors not to reduce their exposure to equity. Yet, as for the Kosdaq, affected by weakened sentiment, Kosdaq investors are highly likely to sell off their stocks, in a bid to avoid the greater tax burden to come.
Contributed by Lawrence Kim, Analyst at NH Investment & Securities