National Assembly Legislative Research Office: "Retention Income Tax, Application Targets Must Be Clearly Defined"

National Assembly Legislative Research Office 'Survey on the Impact of Retained Earnings Tax' Results

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[Asia Economy Reporter Jang Sehee] As the government plans to tax the excess retained earnings of personal quasi-corporations as dividends starting next year, it emphasized that clear criteria for taxation and exclusion scopes must be established to avoid market side effects.

On the 20th, the National Assembly Legislative Research Office, commissioned by Yang Kyung-sook, a member of the Democratic Party of Korea, stated in the report titled "Investigation on the Impact of Retained Earnings Tax" that "if the retained earnings tax is introduced indiscriminately, it could lead to market side effects such as weakening corporate willingness."

The government's retained earnings tax proposal (Amendment to the Restriction of Special Taxation Act), submitted to the National Assembly on the 31st of last month after Cabinet approval, mainly involves taxing the retained earnings of quasi-corporations with high personal shareholding by deeming them as dividends.

The taxable companies are those where the largest shareholder and related parties hold 80% or more of the shares. Among these companies, the retained earnings subject to taxation are the amount exceeding the greater of 50% of the dividend income for the current fiscal year or 10% of equity capital. The amendment considers the excess portion as dividend income and taxes it accordingly.

However, if the deemed dividend amount is actually distributed to shareholders in the future, it will not be considered "dividend income" again to avoid double taxation, as it has already been taxed.

According to the "Survey on Small and Medium Enterprises' Opinions on Taxation of Excess Retained Earnings of Corporations" conducted by the Korea Federation of SMEs in August on 300 unlisted small and medium enterprises, 49.3% of companies had 80% or more of shares held by the largest shareholder and related parties.

Regarding this, the report explained, "Taxation on retained earnings is a system similar to the appropriate retained earnings taxation system implemented from 1990 to 2001."

It added, "Taxation on retained earnings exists only in a few countries such as the United States (retained earnings tax system), Japan (retained earnings taxation system for closely held companies), and Taiwan (taxation on undistributed profits). Other countries' 'appropriate retained excess income tax' applies only to non-operating asset income, not all retained earnings." It pointed out, "Therefore, there is a significant difference from the government's approach of deeming undistributed excess income as dividends for taxation."

Furthermore, it emphasized that there is a possibility of weakening corporate willingness to invest in follow-up projects, and to prevent indiscriminate introduction of the system to unlisted mid-sized and small enterprises leading to corporate contraction, clear distinctions must be made regarding the target and scope of application.