Derivatives products in South Korea will be subject to a 10% transfer income tax which will eventually increase to 20%, according to new amendments to the income tax law approved today by the country’s regulators.
The amendments to the law impose a transfer income tax on the profits earned through trading derivatives products but will not include carry forward deductions.
SungLin Na, deputy at Saenuri Party proposed an amendment to the income tax law in November 2013 to introduce a 10% transfer income tax on the profits earned via trading derivatives products as well as a basic deduction up to KRW2.5m ($2,202) with an expected start date in 2016. The move was aimed at addressing an increasing number of cases involving tax avoidance, delays in tax payments as well as inheritance and donations through derivatives products.
However, the proposal has received strong opposition from some quarters as the transfer income tax will reduce transactions from individuals and will drive away foreign investors due to the reduced liquidity and arbitrage opportunities.
“The taxation law will possibly be misused by some countries that do not follow Korean taxation law as the amendment will only be applicable to local nationals as well as certain companies registered under countries such as the United States, Singapore, the Netherlands and Australia that are subject to local taxation,” said Sangbun Sim, analyst at Daewoo Securities, in a report. “However, as foreign investment banks can easily change the country where they are registered, this law is mostly applicable to individual investors.”
Structured products
The impact of the new amendments in the structured products market will be limited as derivatives trading on exchange is becoming less frequent. Kihyun Cha, head of equity derivatives trading at Woori Investment & Securities, told SRP that most of the hedging for structured products is done with foreign investment banks or brokerage firms via over-the-counter (OTC) trades.
“I understand that this taxation issue has been discussed for quite a few years,” he said. “It would have been a problem if the tax was imposed on the futures or options over recent years when we did a lot of hedging trades through exchange-listed instruments.”
According to Cha, the choice of OTC products is expanding and regulators have lifted restrictions on block trading of derivatives products which has helped to increase the variety of hedging tools.
“Thus the structured products market will be less impacted by the taxation,” said Cha.
The South Korean derivatives market was the world’s third-largest marketplace in terms of transactions in 2012, but dropped to ninth position in 2013 and has slipped out of the top ten this year.
According to the Korea Exchange (KRX), the total trading value as of November 28 was KRW27tr ($2.3m). In the derivatives market, individual investors trading Kospi200 futures accounted for 29% of the transactions, with foreign investors accounting for 50% and financial institutions behind 18% of the trades.
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