Government s stand on Amendment bills to restore withholding tax
November, 2010
Disclaimer: This note is provided as a supplementary material to the
official press release to help non-Korean speakers understand the press
release.
. Amendment bills to restore withholding tax
For the measures to revive the tax on foreigners’ (foreign corporations and non-residents) capital gains and interest income from Korean government bonds (KTBs) and monetary stabilization bonds (MSBs), two separate bills to amend the Personal Income Tax Law (PITL) and Corporation Tax Law (CTL) have been submitted to the National Assembly.
Rep. Kim Song Sik and Rep. Kang Ghil Boo respectively submitted bills to the National Assembly on November 12, 2010. Both of the proposed bills require the special tax treatment in article 119-2 of the PITL and article 93-2 of the CTL to be removed (re-imposing the withholding tax). In addition, Rep. Kang’s proposal is designed for the government to adjust tax rate depending on financial market conditions. As for the effective date, Rep. Kim’s bill is to come into effective at the promulgation of the amendment while Rep. Kang’s is on January 1, 2011. Both proposals clarify that the bonds purchased up to November 12, 2010 will not be subject to the withholding tax.
The purpose of the bills is to respond to the concerns that excessive capital inflows could threaten economic stability.
< Amendment Bills >
Proposal by Rep. Kim Proposal by Rep. Kang
Withholding tax
Special tax treatment (article 119- 2 of the PITL, article 93-2 of the CTL) to be removed
Special tax treatment (article 119- 2 of the PITL, article 93-2 of the CTL) to be removed
Flexible tax rate Not available
Withholding tax rate can be lowered up to zero if necessary to urgently stabilize financial
markets (e.g. for interest income, the rate varies from 14% to zero) Effective date From the day of promulgation Jan. 1, 2011
. Governments stand on the bills
The government supports the amendment bills.
The Korean government has the view that restoring the withholding tax is appropriate to mitigate the risk of excessive volatility in capital flows, given the rapid increase in foreign investment in Korean bonds.
Excessive capital inflows could damage the stability of economy.
Recently, global excess liquidity posed by Quantitative Easing measures (QE) and the exceptionally low interest rate environment created in the developed economies has led to large capital inflows into Emerging Market economies (EMs). This shift in global liquidity has brought with EMs large swings in capital flows.
Korea, in particular its bond market, is becoming an attractive destination for foreign investors. In the first 10 months of 2010, net investment in Korean bonds stands at KRW 21.1 trillion, which accounts for 55% of net foreign portfolio inflows of KRW 38.4 trillion. As a consequence, foreigners hold 7.1% of outstanding bonds and 14.9% of Korean Treasury Bonds (KTBs) as of the end of October, 2010. There has been a significant increase from 4.3% and 8.4%, respectively, at the end of 2008. The recent trend of the increase in foreign holdings of Korean bonds is expected to continue due to the expansion of global liquidity.
< The trend of foreign holdings of Korean bonds (unit: KRW 100 million) >
It should be noted that tax benefits to foreign investors have also attributed to the recent surge of capital inflows. In May 2009, Korea abolished a 14% withholding tax on interest income and 20% tax on capital gainsearned by foreign investors on KTBs and MSBs. The exemption of such taxes on foreign holdings of KTBs and MSBs would be considered as one of the reasons behind the surge in foreign bond investment.
Excessive inflows could make both the bond market and foreign exchange market more volatile. Moreover, a surge of capital inflows could lead to inflation and asset price bubbles, and a possible sudden reversal of such inflows could result in a systemic risk. Therefore, precautionary and preemptive measures are needed to curb excessive foreign capital inflows into the bond market.
Restoring a withholding tax is in line with “Seoul Consensus.”
Such macro-prudential measure is in line with the agreement reached at the G20 Seoul Summit. The G20 leaders have agreed that policy responses in EMs may also include carefully designed macro-prudential measures in circumstances where countries are facing undue burden of adjustment posed by the risk of excessive volatility in capital flows. In this context, the withholding tax could be a reasonable measure as a “minimum safety net” to avoid potential disruption of financial markets.
