[Tax Story] Financial Tax System Reform Plan and Dual Income Tax System

Baek Jeheum, Lawyer at Kim & Chang

On the 22nd, the Ministry of Economy and Finance held the Tax System Development Deliberation Committee and announced the 2020 tax law amendment plan. Among various amendments, the financial tax reform plan that introduced a separate tax item for financial investment income tax and reduced the securities transaction tax stood out. The basic deduction amount for financial investment income tax is 50 million KRW, and the current securities transaction tax of 0.25% will be gradually reduced to 0.23% in 2021 and 0.15% in 2023. From 2023, all income and losses realized from financial investment products under the Capital Markets Act during the taxable period will be aggregated and taxed at a rate of 20% (25% for amounts exceeding 300 million KRW), classified as financial investment income. Financial investment income is distinguished separately from comprehensive income considering that profits accumulate over multiple years and the possibility of losses in financial investments. It is also notable that if a deficit occurs in financial investment income, a carryforward deduction for five years is allowed. Financial investment income is, in principle, withheld semi-annually through financial companies. Furthermore, from 2023, all gains and losses of funds will be included in financial investment income, and the offsetting of gains and losses between funds and other investment incomes will also be permitted.

Under the current Income Tax Act, six types of income?interest income, dividend income, business income, earned income, excluding retirement income and capital gains which are taxed separately?are aggregated and taxed as 'comprehensive income.' However, if the total financial income from interest and dividends arising from financial investments is 20 million KRW or less, taxation is concluded by a final withholding tax at a rate of 14%, called 'separate taxation on financial income.' If the total exceeds 20 million KRW, the excess amount is combined with other income and subject to the progressive comprehensive income tax rate. Meanwhile, capital gains from financial investments are taxed only on gains from unlisted stocks and listed stocks held by major shareholders, with differential capital gains tax rates ranging from 10% to 30% depending on listing status, holding period, and shareholding ratio.

Regarding stock transfers, securities transaction tax is imposed on the transferor, with a rate of 0.25% for listed stocks such as KOSPI and KOSDAQ, and 0.45% for unlisted stocks. According to the 2019 National Tax Statistics Yearbook, the combined amount of securities transaction tax and the related special rural tax on securities transaction tax was about 8.2 trillion KRW, accounting for nearly 3% of the annual national tax revenue of 293.5 trillion KRW, making securities transaction tax an important tax item.

The global trend in financial taxation today is the introduction of a dual income tax system based on an integrated taxation framework for financial income. Integrated taxation of financial income involves gradually integrating interest income, dividend income, and capital gains from financial assets to introduce or expand comprehensive taxation, while reducing or abolishing securities transaction tax. Based on this, income is divided into capital income and labor income, with a flat tax rate applied to the former and a progressive tax rate to the latter, which is the dual income tax system. It originally started in Nordic countries such as Sweden and expanded to Western European countries like the UK, Germany, and France, reaching Japan. The dual income tax system is evaluated as having achieved both revenue security and efficiency by withholding tax at a uniform rate, recognizing that it is impossible to consistently apply progressive tax rates to financial income attributed to specific individuals over a certain period in a context where income earners and financial assets move freely.

The financial tax reform plan, which subjects capital gains from listed stocks of small shareholders previously exempted from taxation to tax and classifies capital gains from financial assets as separate financial investment income for taxation, lays the foundation for integrated taxation of financial income and holds significant meaning in the history of income tax in Korea. The annual basic deduction amount of 50 million KRW, reduction of securities transaction tax, full offsetting with losses, and five-year carryforward deduction align with global standards favoring friendly taxation on financial income and are considered to have opened the door to the dual income tax system.

However, for the dual income tax system to be properly established, further reduction or abolition of securities transaction tax is necessary first. Germany and Sweden abolished securities transaction tax in 1991, and Japan did so in 1999. The United States has never imposed a transaction tax and only taxes capital gains. While it is understandable that immediate abolition of securities transaction tax is difficult due to uncertain revenue effects of the financial investment income tax, maintaining both tax items simultaneously may impose excessive burdens on financial asset transactions.

Next, abolition of major shareholder taxation on listed stocks is also requested. This system was introduced to expand the scope of taxation on listed stocks, but with comprehensive taxation on listed stocks now implemented, there is little practical benefit in maintaining it. Additionally, in the long term, maintaining neutrality in taxation between dividend income, interest income, and capital gains is important. Although dividend income, interest income, and capital gains are economically similar forms of financial income differing only in the method of collection, the former is taxed progressively on amounts exceeding 20 million KRW, while the latter applies a flat tax rate on amounts exceeding 50 million KRW, creating a strong incentive to choose the latter method.

Criticism of the financial tax reform plan includes that the reduction in securities transaction tax is insufficient and the expansion of the basic deduction narrows the taxable scope, making it a half-hearted reform. However, the plan is significant in that it presents a major direction for taxation of financial income. Like other countries that have introduced dual income tax systems and proceeded gradually considering their unique market conditions, Korea should also adopt a step-by-step approach to address emerging issues. The future trajectory of the financial tax reform plan is highly anticipated.

This content was produced with the assistance of AI translation services.