South Korea: Proposed amendment to reduce capital gains exemptions for on-the-market transactions by foreign investors

The Ministry of Strategy and Finance announced its proposed tax law amendments for 2018 on August 2, 2017. This tax alert highlights the proposed change to the capital gains exemption currently available to foreign investors engaged in on-the-market transactions.

In general, capital gains earned by foreign investors upon the transfer of shares are generally subject to withholding tax at a rate equal to the lesser of 11% of the gross proceeds realized or 22% of the net realized gain, unless exempted by relevant tax laws or an applicable tax treaty which Korea has entered into with the foreign investors’ country of tax residence.

Under current provisions of the Korean tax law, a foreign investor that transfers shares through the Korean Stock Exchange are not subject to withholding tax on realized capital gains to the extent that the foreign investor has no permanent establishment in Korea through which the capital gains are derived and does not own 25% or more of the total issued and outstanding shares of the Korean company at any time during the calendar year in which the sale occurs and during the five calendar years prior to the calendar year in which the sale occurs.

This so-called 25% rule is applied as a threshold to impose capital gains taxation only on the transfer of shares by foreign investors that are majority shareholders in the Korean company. The proposed amendment reduces the threshold from 25% to 5%, such that any foreign investor with 5% or more ownership of the total issued and outstanding shares of a Korean company may be subject to capital gains taxation on the transfer of shares in such Korean company. The proposal indicates that all investments held prior to the implementation of the amended provision will be subject to the current 25% rule until December 31, 2018. The proposed amendments would otherwise apply to all other share transfers from January 1, 2018 onwards.

The proposal is aimed at increasing taxation on Korean-sourced income incurred by non-residents and foreign companies. If approved by the National Assembly and enacted, this amendment is expected to have a significant impact on the tax exposure for foreign entities making investments in Korean companies going forward.