Korea Needs to Overhaul Tax Systems to Attract Foreign Investment

Singapore cut its corporate tax rate from 20 percent to 17 percent in 2009 in order to attract more foreign investment through tax cuts. In two years of time, Singapore was picked out by the People’s Bank of China as a hub of yuan-based financial transactions. Now, it is a yuan hub comparable to Hong Kong.

Global financial hubs, ranging from traditional powerhouses like London and Hong Kong to emerging players such as Taiwan and Thailand, are in a tax cut war. They are reducing their corporate tax rates one after another to lure international investors and financial capital.

The Park Geun-hye administration has recently jumped into the competition as well, agreeing on the establishment of a direct trading market during the bilateral summit talks as of late. However, Korea’s tax system and yuan hub strategy have no appeal at all. For example, the corporate tax rate has gone up since the financial crisis, and the other quasi-taxes and charges associated with financial transactions are moving in the same exact direction. In short, the Korean government is trying to attract international financial capital while holding shackles in hand.

One of the most urgent problems lies in the financial tax. The development and trading of derivatives, with which investors can protect their earnings rates from foreign exchange and interest rate risks, have to be smooth if more yuan capital is to flow into Korea. Nonetheless, the government and the National Assembly are planning to discuss the enactment of a bill for heavier taxation on derivatives from the latter half of this year.

“The derivatives market is likely to be shrunk a lot if the tax comes in all of a sudden,” said a high-ranking executive at a major stock firm, adding, “Efforts for the attraction of yuan will be limited at best, unless the derivatives market is allowed to properly function as a prop.”

Another obstacle is its system for taxation on bonds, in which only an interest income tax with a rate of 14 percent is imposed. Foreign investors in Korea used to be subject to tax exemptions in the past when it came to bond interest income, but the exceptional clause was repealed four years ago. Transfer gain is likely to become taxable in a similar way, too.

Quasi-taxes could impede the yuan hub strategy as well. The Korean government has imposed a so-called bank tax since 2011 on banks that have non-deposit foreign currency debts in order to prevent foreign exchange fluctuations attributable to an excessive increase in short-term loans. “Sufficient yuan enough for financial institutions to meet the domestic demand has to be supplied to the market when the yuan hub is set up, but the bank tax is a kind of burden on those banks wishing to procure yuan,” a local commercial bank explained.

Under the circumstances, the minimum rate for corporate taxes has been raised to accelerate tax increases, and conditions for the attraction of financial institutions are becoming more and more unfavorable. “Most of the financial hub countries have attracted foreign capital and investors with low tax rates,” said Dr. Lee Yun-suk at the Korea Institute of Finance, continuing, “This means that we need to overhaul the tax system with reference to those countries.”

One of the options is the exemption of the interest income tax on won-denominated bonds. The government was trying to adopt the same measure regarding Sukuk bonds back in 2009, but failed for religious reasons. In contrast, London has recently attracted a yuan clearing house and issued Sukuk bonds for the first time as a Western country last month. Other options include non-taxation on yuan-related derivatives, an overall decrease in corporate tax rates, and the establishment of special economic zones for exclusive tax cuts for those housed in the zones.