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The National Tax Service (NTS) has completed a probe of overseas equity funds operating in Korea and decided to slap five of them, including Lone Star and the Carlyle Group, with a W214.8 billion (about U.S.$214.8 million) tax bill. The most remarkable aspect is that the NTS for the first time vetoed tax avoidance by companies nominally based in a tax haven.
Foreign funds evade tax in Korea by establishing paper companies in tax havens. Thus the U.S.-based fund Lone Star has a subsidiary in Belgium, and the W280 billion profits from real estate it made in Korea were made in the name of that firm, so Lone Star did not pay a penny in tax on account of a dual taxation avoidance treaty between Korea and Belgium.
But the NTS now operates on a principle of "real taxation,Ħħ which says that tax can be levied on the actual investor. However, it taxed not Lone Star's affiliate in Belgium but its headquarters in the U.S., because although it bars dual taxation, the Korea-U.S. tax agreement provides that profits from transferring real estate can be taxed.
The real taxation principle, though leaving room for legal conflict, is an international criterion recognized by the OECD. Korea had all but given up taxing foreign funds on account of dual taxation avoidance accords. It has been so engrossed in wooing foreign capital since the financial crisis that it has paid little attention to its dark side, such as the harm speculative funds can do. That is why it matters that the NTS has now invoked the principle.
What we must guard against is the danger that this step is seen as an outgrowth of a general disapproval of foreign funds reaping their just rewards, even where those amount to billions. There is no reason we should be unconditionally friendly toward foreign capital, but we cannot discriminate between foreign and domestic funds. The NTS should clarify that it is wholly impartial in taxing capital, domestic or foreign, and hurry to plug the legal and institutional gap with reality, assuming there is one.
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