Public Interest Foundations Shackled by Fair Trade Act and Inheritance and Gift Tax Act [Clipped Wings of Public Interest Corporations]

Introduction of Non-Taxable Stock Holding Limit for Public Interest Foundations in 1991
Preventing Indirect Corporate Control
The ‘5% Rule’ for Mutual Investment Restriction Groups
A Strong Shackle for Large Conglomerates
Introduction of Voting Rights Restriction under the Fair Trade Act in 2020
A Unique Regulation Worldwide
United States Allows 20%, Japan 50%, Germany ‘Unlimited’

Amid mounting difficulties for public interest foundations in securing funding due to excessive regulations, there is growing consensus that the current Inheritance and Gift Tax Act’s (IGTA) ‘5% rule’ needs to be revised. Experts argue that, since Korea already alleviates concerns over indirect control by restricting voting rights for public interest corporations affiliated with large business groups (mutual investment restriction groups) under the Fair Trade Act, the high level of tax regulation is excessive. Currently, the IGTA limits the gift tax exemption for stock donations to public interest corporations affiliated with such groups to 5%.

The business community contends that regulations on corporate public interest foundations are hindering the revitalization of private donations. On August 13, the Korea Chamber of Commerce and Industry released the results of its ‘Survey on Institutional Improvement Tasks for Corporate Public Interest Corporations,’ conducted from July 15 to August 2, targeting 219 public interest foundations belonging to 88 business groups subject to disclosure. According to the survey, more than half (61.6%) of the responding public interest foundations stated that regulations under the IGTA and Fair Trade Act are negatively affecting the finances of corporate public interest foundations that rely on donations.

Introduction of Non-Taxable Stock Holding Limit for Public Interest Foundations in 1991... Preventing Indirect Corporate Control

The cap on tax-exempt stock donations to public interest foundations in Korea was introduced after 1991. This measure was taken in response to concerns that major shareholders of large corporations were using stock contributions to public interest corporations as a means of indirect control (an expedient succession method) without incurring inheritance or gift tax. As calls grew to impose taxes to prevent such expedient practices, the IGTA began to introduce limits on the amount that could be donated tax-free.

Over time, the intensity of regulations has increased. In 1991, public interest foundations could receive up to 20% of shares tax-free, but this limit was reduced to 5% in 1994. At the end of 2007, the law was amended to relax the limit to 10% only for ‘faithful’ public interest corporations. However, in 2017, for ‘faithful’ public interest corporations with special relationships to large business groups, the limit was tightened again from 10% to 5%. Then, starting in 2021, the distinction between ‘faithful’ and general public interest corporations was abolished, setting the basic holding limit at 10%, but reducing it to 5% if certain requirements were violated.

The ‘5% Rule’ for Mutual Investment Restriction Groups... A Strong Shackle for Large Conglomerates

The current IGTA imposes particularly strict regulations on public interest corporations affiliated with mutual investment restriction groups. For these ‘chaebol conglomerates,’ tax-free stock donations to their corporate foundations are allowed up to only 5% without exception. For other companies, the limit ranges from 10% to 20%, depending on the case. General public interest corporations can receive up to 10% of shares tax-free, while those established for charity, scholarship, or social welfare purposes can receive up to 20% if they agree not to exercise voting rights. The imposition of gift tax on public interest corporations affiliated with mutual investment restriction groups effectively prohibits them from acquiring large amounts of group company shares through foundations.

Of course, if the gift tax is paid, public interest foundations can receive more than 5% of affiliate shares. This allows them to secure more funding for their activities, such as receiving dividend income. However, it is rare for donations to occur under such additional tax burdens. According to Lim Dongwon, Senior Research Fellow at the Korea Economic Research Institute, in his report ‘Improvement Plan for Inheritance Tax System to Revitalize Public Interest Corporations,’ since the 5% rule was applied to mutual investment restriction groups in 2017, most public interest corporations (71.1%) now hold less than 5% of affiliate company shares.

Attorney Park Changsoo of Bae, Kim & Lee LLC explained, “In reality, most public interest foundations do not have sufficient resources, so if they receive more than 5% and have to pay taxes, they ultimately have to liquidate the donated shares.” He added, “If the owner family contributes cash, they will have to liquidate shares or other assets to raise that cash, which would then be subject to capital gains tax.” For these reasons, the 5% rule acts as a strong restriction on stock donations.

Introduction of Voting Rights Restriction under the Fair Trade Act in 2020... A Unique Regulation Worldwide

In addition, the restriction on voting rights for public interest corporations is strictly enforced. At the end of 2020, the Fair Trade Commission amended the Fair Trade Act to prohibit public interest corporations from exercising voting rights on domestic affiliate company shares. This followed a 2018 survey and analysis of public interest corporation operations, in which the Fair Trade Commission found that, as of the end of 2017, most of the 165 public interest corporations affiliated with business groups subject to disclosure were established with tax benefits and controlled by owner families through executive positions such as chairman.

The Fair Trade Commission allows exceptions only in limited cases (such as appointment or dismissal of executives, amendments to articles of incorporation, or mergers), permitting voting rights up to a combined 15% with related parties. This effectively blocks public interest corporations from intervening in the routine decision-making of affiliates. Attorney Park commented, “The 2020 amendment to the Fair Trade Act has effectively eliminated the risk of indirect corporate control. However, the IGTA remains unchanged, so the limits set to prevent such control before voting rights restrictions were introduced are still in place.” He pointed out that this is a ‘Galapagos’ regulation unique to Korea.

United States Allows 20%, Japan 50%, Germany ‘Unlimited’

This stands in stark contrast to most other countries, which broadly allow tax exemptions for stock donations to public interest corporations. In the United States, nonprofit organizations are subject to federal tax only on holdings of voting shares exceeding 20%. Germany imposes no separate restrictions on the acquisition or holding of shares by public interest corporations. In Japan, tax exemptions apply to stock donations up to 50% of the recipient corporation’s shares. Sweden imposes no limit on share ownership if certain requirements are met. Austria also imposes no special restrictions.

However, major overseas countries rigorously verify the public interest activities of such organizations. In the United States, the IRS thoroughly tests public interest corporations for eligibility for tax benefits through organizational and operational tests, granting exemptions only to those that pass. Japan also rigorously screens public interest foundations for tax benefits, requiring them to conduct public interest projects in fields such as academia, the arts, charity, or religion, and to ensure that at least 50% of their activities serve the public interest. These strict requirements are designed to ensure that the transferred assets are used for public purposes, in exchange for broader tax exemptions.