The South Korean government’s latest proposal to levy taxes on capital gains of a foreign investor with a 5 percent stake or higher in a local firm has stoked concerns that offshore investors would dump Korean shares, but such worries may be exaggerated.

Last week, the new Korean government under liberal President Moon Jae-in announced its first tax revision plan that mainly aims to up taxes on high-earning individuals and big companies to address inequality. But it also calls for redefining the foreign major shareholder who is subject to capital gains tax.

Currently, an offshore investor with a 25 percent stake or more is considered a major stakeholder and is subject to tax on gains from selling shares. But with the tax revision plan, the Korean government is seeking to impose taxes on a non-resident or foreign entity with a 5 percent stake or more in a listed Korean firm for profits from the disposal of their shares. This means foreign investors who are currently considered minority shareholders would become major shareholders to be slammed with up to a 42 percent tax on capital gains under the new tax code requiring approval from the cabinet.

This may sound very alarming to some foreign investors who own Korean eruities, but market analysts noted that overseas investors in only 12 countries will be affected by the upcoming tax revision. Those 12 countries are Luxembourg and Turkey in Europe; Singapore, Hong Kong, Australia, and India in Asia; United Arab Emirates and Saudi Arabia in the Middle East; Brazil, Venezuela, Peru, and Chile in South America.

Investors in the other nations would be exempted from the new tax code thanks to double taxation treaties that are designed to protect against the risk of double taxation where the same income is taxable in two states. Double taxation agreement is an international tax treaty that is prioritized over a domestic tax code.

For instance, investors from the United States and United Kingdom - the two largest investors in Korean stocks by volume as of the first half of this year - will not be subject to the upcoming amendment in Korean taxation because their countries have double taxation treaties with Korea. They only pay taxes on their profits from the disposal of assets in the country where they currently reside, not Korea.

The definition of a major shareholder also differs by bilateral tax treaties. The 5 percent rule for a major shareholder is applied to those in only seven countries - Luxembourg, Turkey, Singapore, Hong Kong, India, Australia, and Brazil. But according to conventions with Venezuela, Peru, and Chile, investors should have a 20 percent stake or higher to become major shareholders. In the United Arab Emirates, investors are considered large shareholders if they own 10 percent or more shares and in Saudi Arabia with 15 percent.

Given the fact that it is impossible to revise such a major shareholder ratio in the tax convention that two nations have already agreed, only a small number of offshore individuals or entities would be added as large shareholders subject to Korea’s new tax code. According to the Financial Supervisory Service, about 40 foreign investors would newly become major shareholders based on their holdings as of the end of last year.

By Choi Jae-won and Kim Se-woong

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