“It’s a Bad Law”… A Complete Overview of the Financial Investment Income Tax Debate and Its Problems

According to the National Consent Petition on the National Assembly website, the number of citizens who agreed to the “Petition to fully abolish the Financial Investment Income Tax and enact a National Right of Refusal Act” exceeded 50,000 as of the 10th, once again meeting the review threshold.

The petition will go through the consent process until the 16th, after which it will be referred to the relevant standing committee for deliberation.

The so-called Financial Investment Income Tax is a tax levied on income generated from financial investments.

It applies not only to profits from stock trading, but also to dividends and gains from trading financial products such as bonds and funds.

The Financial Investment Income Tax is imposed when income from such financial investments exceeds 50 million won.

If your income is 300 million won or less, 50 million won is deducted and a total tax rate of 22% (20% financial investment income tax + 2% local income tax) is applied.

If your income exceeds 300 million won, 50 million won is deducted and a combined tax rate of 27.5% (25% financial investment income tax + 2.5% local income tax) is applied.

Overseas stocks are not exempt from taxation either.

For overseas private equity funds, foreign stocks, bonds, ELS, and derivatives, the basic deduction is set at 2.5 million won, which is lower than for domestic stocks. Any income exceeding this amount is taxed, putting investors in overseas assets at a disadvantage compared with those trading domestic stocks.

On May 31, after a closed-door meeting with representatives of the securities industry, Financial Supervisory Service Governor Lee Bok-hyun expressed concern to reporters that once the Financial Investment Income Tax is implemented, it will intensify short-term trading and drive more money into overseas stocks.

Both domestic and overseas stocks will be subject to this tax, and the deduction for overseas stocks is even smaller. So why is there concern that capital will flow more heavily into foreign markets?

First, let’s touch on one of the reasons the Korean market is unattractive: the shareholder return ratio.

The shareholder return ratio is the amount a company spends on dividends and share buybacks divided by its net income.

Shareholder returns refer to giving money back to shareholders, either by paying dividends or by buying back shares to reduce the number of shares in the market and thereby increase their value.

Put simply, a high shareholder return ratio means that the company is spending a lot of money for the benefit of its shareholders.

From a shareholder’s perspective, if the company you invested in doesn’t return its profits to you, the investment may not feel very appealing.

However, the logic that a lack of shareholder returns makes stocks less attractive, which then drives shareholders away and pushes stock prices down, is not sufficient on its own.

If the company is in a situation where it needs capital, raising dividends can actually be inefficient.

(Reference: Why dividend investing can hurt you)

The problem is that the situation can be different for Korean equities.

In the video above, the speaker notes that Korean companies are properly valued in the M&A market, unlike in the stock market.

They point to the large gap between total corporate value and market capitalization, and go on to discuss control premiums.

A high control premium implies that the value of your shares in the stock market is being undervalued, which leads into the topic of the Korea discount.

In other words, for the KOSPI or KOSDAQ to break out of their decades-long sideways trend, the control premium needs to be addressed. And to address that, companies need to return profits to shareholders in proportion to their ownership—5% of the profits to a 5% shareholder, 10% to a 10% shareholder, and so on.

Historically and even today, Korea’s shareholder return ratio is far below one-third of the US level.

This is already a market suffering from a discount. If a financial investment income tax is imposed on top of that, large-scale investors will have even less reason to stay in the domestic market. As these “whales” exit, more companies will struggle to attract capital, and their stock prices may fall.

We already can’t shake off the nickname “boxpi,” and now it feels like we’re looking at a future where we’ll have to say goodbye to a market with no prospects.

Taxes are usually introduced in the name of tax fairness, under the principle that “where there is income, there is tax.”

But there is something odd if we really claim this is being done for tax fairness.

Korea imposes a securities transaction tax. This tax, levied on the seller when stocks are traded, is collected even when there is no income to tax.

The United States abolished its securities transaction tax in 1965, Germany in 1991, and Japan in 1999. Instead, they only levy capital gains tax on profits when investors sell stocks and actually make money.

In most countries, only one of the two is generally applied: either capital gains tax or a securities transaction tax.

Once again, the financial investment income tax is broader in scope than capital gains tax. It bundles together capital gains tax, dividend tax, and others under the single label of “financial investment income” and then taxes that combined amount.

The ruling and opposition parties had agreed to postpone the introduction of the financial investment income tax while keeping the capital gains tax threshold for large shareholders at 1 billion won. But once that threshold was relaxed to 5 billion won, the financial investment income tax was put back on the table.

Now, even if you are not a large shareholder, you will have to pay tax once your investment gains exceed a certain amount. Naturally, retail investors have every reason to be unhappy.

Against this backdrop, the government announced that it would cut and eventually abolish the transaction tax when introducing the financial investment income tax.

From 2025, the transaction tax will appear to “disappear,” but once you factor in the special tax for rural development, you still end up paying 0.15%.

In the end, we still haven’t escaped double taxation.

The opposition party has consistently maintained its stance on introducing the financial investment income tax, based on the view that if you make a lot of money, you should pay a corresponding amount of tax.

However, because only individual investors—not institutions or foreign investors—are subject to the tax, many of the investors who have actually made large profits are already corporations or are in the process of setting one up. In substance, they become institutional investors and may fall outside the scope of the financial investment income tax.

(Reference: [Exclusive] "Is this how you dodge the financial investment tax?"... Banks’ PBs urging clients to set up corporations)

Taxes are collected as planned, yet the system fails to meet its original goal of fairness.

Taxes are being collected, and the system deviates from its original intent—so why has it still not been scrapped?

One explanation is the argument that the tax treatment of collective investment schemes may be influencing the situation.

Previously, when investment income arose from funds investing in bonds, real estate, and similar assets, it was taxed as part of comprehensive income tax. In other words, the top marginal rate was 49.5% for income exceeding 1 billion won. Once the financial investment income tax takes effect, however, this income will be taxed separately.

The claim is that, excluding equity funds, other types of funds will shift from the existing dividend income tax regime to the financial investment income tax, lowering the effective tax rate to 27.5% and thereby benefiting from the change.

As of April 2024, roughly 97% of the total size of private equity funds (PEFs) falls into this category.