As early as from July this year, offshore private equity fund in Korea need to submit the list of investors on their funds in order to avoid tax hike from their capital gain. Recently National Tax Service (NTS) announced that the agency has finalized the revision of taxation practice on foreign based private equity fund in Korea. Since it had been heavily controversial issue for years derived from the outstanding capital gain of LoneStar, Texas based private equity fund, from selling major share of Korea Exchange Bank (KEB) after acquiring one of the major local banks during financial crisis in 2003 allegedly under the less-than-expected price range, without paying appropriate amount of tax, which is not considered to be a tax evasion, NTS began to review current taxation practice on the limited tax rate based on tax treaties between Korea and certain countries Under the amendment, private equity fund in Korea, which legally registered on countries where either tax-free or lesser tax rate is offered, also known as, ‘tax haven’ based on tax treaties, need to disclose the investors’ list of their funds to continue its tax benefit from now on; otherwise, the fund shall not only lose its privilege of tax benefit, but also it is eligible to impose general tax rate from capital gain up to 22%.
Typically private equity fund itself tends to raise its fund by attracting investors who are not necessarily willing to reveal their identities in public. In order to maximize capital gains from investment as well as operate the management more freely, the fund prefers to setting up the legal entities on certain countries where offer less tax rate by tax treaties with target countries. According to the tax treaties, offshore private equity funds are eligible to pay the tax payment at limited tax rate regardless of investors’ identities, i.e. nationality, residence. At presents, Korea has agreed with 78 countries in treaties to mitigate the effects of double taxation including United States, Japan, China, U.K, Australia, Germany, Swiss, Belgium, and Singapore etc.
So until now, current foreign based private equity funds who invested in Korea enjoyed this generous tax benefits from their investment in Korea as an offshore private equity fund; however, according to the amendment, they should consider revealing the investors’ list to avoid tax hike from their capital gain. NTS mentioned that it is expected to prevent offshore private equity fund from possible tax evasion and able to identify the rich who intend to evade the tax payment via investing offshore private equity funds.
As for fund managers of offshore private equity fund, the current change of taxation practice would not be welcomed because they should either sacrifice the investors’ identities to keep tax benefit, the limited tax rate or take a significant risk of tax burden from not disclosing the investors’ list. The former would be able to retrieve the expected capital gain from keeping the applied tax rate under the current tax treaty; in return, it is possible to lose the current and potential investors for fear of revealing their identities. The latter would have to pay more tax payment than the estimated, which the rate of return will decline. Eventually underperformance and lower return will eat away the investors no matter what.
As for national tax agency, it will be absolutely effective for them to access and review the list of investors of offshore private equity fund for taxable purpose. However, tougher restriction on offshore private equity fund may discourage investing activities and opportunities in Korea.
Jin Mok Kim(firstname.lastname@example.org)