[Inside Chodong] A Desirable Reduction in Separate Taxation Rates for Dividend Income

Highest Dividend Tax Rate Likely to Drop from 49.5% to 27.5%
Tax Revenue Could Rise if Dividend Payout Ratios Increase
Maintaining Lower Tax Rates Key to Addressing Korea Discount
Inheritance and Gift Tax Act: The Next Issue Requires Calm Deliber

President Lee Jaemyung's policy shift from real estate to stocks faced stronger opposition within the government and ruling party than from the opposition party, especially regarding tax issues. Both the major shareholder requirements and the separate taxation of dividend income, which had a significant impact on the stock market this year, were met with resistance. The government cited concerns over 'decreased tax revenue,' while some ruling party lawmakers argued that it amounted to a 'tax cut for the wealthy.'

Initially, the government proposed lowering the threshold for major shareholder status, which determines the imposition of capital gains tax on stocks, from 5 billion won to 1 billion won. Some ruling party lawmakers supported the government's proposal, arguing it would eliminate tax breaks for the wealthy. However, the plan was ultimately scrapped after a sharp stock market decline triggered by disappointed investors.

The government's proposal for the separate taxation of dividend income was also only a passive relaxation. The plan set the highest separate tax rate, including local taxes, at 38.5%, which is lower than the current top rate of 49.5%. However, when considering the effective maximum comprehensive tax rate after dividend tax credits, which is 42.85%, the difference is not significant. As a result, there is little incentive for major shareholders to increase dividends to benefit from separate taxation.

Additionally, the government's proposal set the minimum requirements for separate taxation as a 'dividend payout ratio exceeding 25% and a dividend increase of at least 5% compared to the three-year average.' These criteria are too easily met, giving companies little reason to actively increase dividends. Accordingly, many critics argued that the government’s proposal was likely to meet the same fate as the 'Dividend Income Increase Tax System' that failed during the Park Geunhye administration.

With the KOSPI index struggling to stay above the 4,000 mark, on November 9, the ruling party and government agreed to 'rationally adjust the top tax rate to maximize the effect of promoting dividends without significantly affecting tax revenue.' As a result, the proposal by Lee Soyoung, a lawmaker from the Democratic Party of Korea, which sets the top tax rate at 27.5% including local taxes, now has a high chance of passing during the regular National Assembly session.

Previously, Lee's proposal faced strong opposition within the ruling party. Jin Sungjoon, another Democratic Party lawmaker, argued that 'the top 10% receive 91.2% of dividend income,' framing it as a tax cut for the wealthy. This overlooks the fact that when dividends are promoted, the benefits are shared among all investors. In contrast, for high-value real estate transactions in Gangnam worth billions of won, only the wealthy receive 100% of the income.

Concerns over reduced tax revenue were also somewhat exaggerated. According to an analysis by Align Partners Capital Management, an activist fund, if the dividend payout ratio among KOSPI 200 companies remains unchanged from last year, total tax revenue would decrease by 70 billion won under the government’s plan and by 140 billion won under Lee’s proposal, from a baseline of 5.6 trillion won. On the other hand, if the average dividend payout ratio rises by just 0.6 percentage points from the current 22.1%, total tax revenue from dividends would increase by 150 billion won. If the average dividend payout ratio increases by 5 percentage points, total tax revenue from dividends would soar by 1.12 trillion won.

The reduction of the top tax rate for the separate taxation of dividend income is now a foregone conclusion. However, the lowered tax rate must be maintained over time. The 'Dividend Income Increase Tax System' under the Park Geunhye administration was abolished after only two years, limiting its effectiveness. Assuming the reduced tax rate is sustained, major shareholders should be encouraged to develop long-term plans to increase their dividend payout ratios.

The remaining issue in stock market-related tax law revisions is the Inheritance and Gift Tax Act. Currently, when major shareholders of listed companies pay inheritance or gift taxes, the tax is calculated based on the four-month average share price, leading to criticism that this encourages intentional price suppression. To address this, a bill has been introduced in the National Assembly to apply the valuation method for unlisted companies to listed companies with a price-to-book ratio (PBR) below 0.8, thereby imposing taxes based on asset value.

Amending the Inheritance and Gift Tax Act involves even more complex interests than the issues of major shareholder requirements or separate taxation of dividend income. For fast-growing companies with rapidly increasing assets and profits, the tax burden would rise. Unlike the United States, where dual listings are not allowed, holding company share prices in Korea are inevitably lower. Therefore, careful and thorough discussions, including various simulations, are necessary to address these issues.

Jo Siyoung, Deputy Editor, Securities and Capital Markets Department ibpro@asiae.co.kr

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