Korean Tax Across the Investment Lifecycle

Tax review on a Korean investment is often treated as something done once, in the run-up to an exit.

In practice each stage has its own questions. And some of them cannot be reopened once the stage has passed – the shareholding put in place at acquisition, the records that should have been kept during the holding period.

This article walks through what can arise at acquisition, during the holding period and at exit. The detail on each sits in a separate article.

Acquisition – the tax is said not to exist, but there is an exception

Most investors understand that buying shares does not attract tax in Korea. As a general matter that is right. Korean acquisition tax applies only to assets the statute lists – real property, vehicles, machinery and the like – and shares are not on that list.

There is an exception, though, and the exception does bite.

Where a holding, aggregated with related parties, crosses a certain line and the rights attaching to it are substantively exercised, the shareholder is treated not as having bought shares but as having directly acquired the company’s taxable assets in proportion to that holding. A share transaction is taxed as though property had been purchased.

And this is not a determination made once. A first investment that falls short of the line can cross it later, through aggregation with affiliated funds or through participation in a follow-on round. It has to be re-tested at each round, and it arises at the moment the line is crossed – so finding out afterwards is finding out too late.

The amount, though, depends on what the company holds. Where the company owns no taxable assets, crossing the line produces nothing to pay. The shareholding percentage alone does not give the answer; the target’s asset composition has to be looked at alongside it. That is visible at diligence.

Holding – quiet without dividends, different once they start

A fund investing in a growth-stage company usually does not plan for dividends. Without them there is no Korean-source income during the holding period, and nothing to examine.

Dividends change that. And the conclusion reached for the exit does not carry over.

A dividend attracts withholding. A treaty may reduce the rate, but the rate differs from investor to investor, because it follows each investor’s own residence. Where the investor base spans several jurisdictions, a single dividend attracts several rates at once. Where there is no treaty, there is nothing to reduce.

So a dividend is a point at which proceeds leak. A capital gain can be outside Korean tax altogether under a treaty; a dividend usually leaves something behind. And how much of what is left behind can be recovered at home as a foreign tax credit is a separate question again.

You may have no plans for a dividend. It is enough to remember that plans change.

Exit – this is where it divides into three

The capital gain is the heaviest stage, and it separates into three distinct questions.

First, is it taxed? Domestic law decides, and then the treaty. Domestic law taxes by default, and the treaty exceptions differ by jurisdiction. This is dealt with in Capital Gains on Korean Shares.

Second, are you entitled to that treaty? Where the investment runs through a fund, whether the income belongs to the fund or to the investors behind it changes which treaty applies. And a vehicle that cannot substantiate its investors loses treaty relief altogether. This is dealt with in Does Korea Look Through Your Fund?

Third, will you actually receive it at closing? Being exempt does not stop a buyer that has an incentive to withhold. This is a question of documents and lead times, dealt with in Treaty Exemption at Closing.

The three run in order, and each is settled before the next.

One item the treaty does not reach

A transfer of unlisted shares attracts securities transaction tax.

This is a transaction tax, not an income tax. It applies whether or not a gain arose, and whether or not a treaty puts that gain outside Korean tax. It is usually the item an investor who has secured treaty exemption discovers at closing.

In summary – this is not settled once

Pulling the stages together:

Acquisition – does the holding cross the line, and does the target hold taxable assets? Re-test at each round.

Holding – dividends leak proceeds, at rates that differ by investor residence.

Exit – taxed or not, entitled to the treaty, realised at closing. The three run in order.

Securities transaction tax – applies regardless of the treaty.

Most of this can be established when the investment is decided. The treaty wording is the same then, the target’s asset composition is visible at diligence, and the fund’s investor base is already fixed. Deferring does not reduce what has to be confirmed; it reduces what can still be changed.

But the answer given then does not stay valid. Two things move.

The structure moves. A fund that was not going to take dividends takes them. A follow-on round lifts the holding. An affiliated fund enters the same company. Any of these removes a premise the earlier conclusion rested on.

The law moves. Korean tax legislation is amended annually and treaties are revised. An opinion obtained at the investment stage may rest on provisions that read differently by the time of the exit. An opinion stands on the law and the facts as at the date it was written. Change either, and the conclusion has to be revisited.

What is needed, then, is not a single review but a set decision about when to look again. When a follow-on round is taken up. When a dividend is discussed. When the exit process opens. And, absent any of those, once a year.

Worth checking

Of the four items above, how many can you answer today?

Is that answer in writing, or in memory? And if in writing, when was it obtained?

Have you fixed the points at which it gets looked at again – follow-on round, dividend decision, exit?

For a review of your position, please contact Star Tax & Legal at heebong@star-tax.kr.

Topics: Investment Lifecycle · Acquisition Tax · Dividends · Fund Exit · Securities Transaction Tax · Foreign Investors