Tax may knock Lone Star’s exit plan from Korea

By Kim Jae-kyoung

Lone Star Funds Chairman John Grayken may be popping champagne over the sale of its stake of Korea Exchange Bank (KEB) to Hana Financial Group as it has paved the way for the fund to exit the Korean market. The sale is also expected to relieve mounting pressure from investors on Grayken to step down.

Hana Financial said Tuesday that it will hold a board meeting to finalize the takeover of the nation’s fifth-largest lender Wednesday morning and Chairman Kim Seung-yu will call a press conference in the afternoon ahead of public disclosure.

Even if the two parties sign an official sales agreement, Lone Star is facing a bumpy road ahead as there are a number of issues that could stand in the way of the Dallas-based fund’s exit plan.

The biggest hurdle is taxation. There is a wide perspective gap between Lone Star and the National Tax Service (NTS) on the taxation of capital gains from the sale of KEB. Unless either of the two steps back, chances are that the fund will face another legal battle.

The nation’s tax agency has claimed that Lone Star should pay taxes on capital gains from the sale of its controlling stake in KEB, while the fund sees no reason why it has to pay taxes.

"It is too early to talk about taxation as Lone Star has yet to realize the capital gains and to report the transaction,” a ranking NTS official said on condition of anonymity.

“Once the fund reports the deal, we will levy taxes on the capital gains. If the fund does not report the case and leaves, we will seek ways to impose taxes,” he added.

In June 2007, the NTS levied taxes on the fund’s capital gains of 1.2 trillion won from selling its 13.6 percent stake, or 87.7 million stocks. At the time, the NTS imposed 119 billion won in corporate tax on Lone Star Advisors Korea, saying the local subsidiary of the U.S. fund is a permanent establishment.

Lone Star then filed complaints with the tax tribunal against the taxation. It argued that since LSF-KEB Holdings is based in Belgium, it is not subject to taxation under the Korea-Belgium tax treaty, demanding returns of the full amount being withheld for taxes.

But the tribunal rejected the claim, saying that LSF-KEB Holdings is a ``paper company'' established by Lone Star primarily for tax evasion. The KEB stake is held by LSF-KEB Holdings, a Belgian subsidiary of Lone Star. The fund took the case to court, and the case is still under review.

“We don’t think that we have to pay taxes on gains from the sale of KEB because we made the investment through a tax haven under the Korea-Belgium tax treaty,” said a source close to the U.S. fund, asking not to be named, hinting that the firm will not report the transaction to the tax authorities

“You have to remember that many Korean companies are also taking advantage of such tax benefits by making investments overseas through tax havens,” he added.

Was Lone Star a legitimate buyer?

Separate from the taxation issue, the financial regulator’s review of Lone Star’s legitimacy as a major stakeholder could emerge as a major obstacle. The FSC has yet to make a final decision on whether the company was ``fit and proper'' as the major shareholder of KEB.

Under the current banking law, those who invest over 25 percent of their capital in non-financial firms or those whose assets in such firms exceed 2 trillion won are not allowed to own up to 10 percent of a bank as they are classified as a non-financially focused company.

Civic groups have claimed that given Lone Star’s investment portfolio across the globe, the fund should be seen as a non-financially focused company.

If the FSC rules that Lone Star is a non-financially focused firm, the fund will be restricted to exercising its voting right to less than 9 percent of its 51.02 percent stake. The regulator can also force the fund to unload its holdings. The FSC refused to comment on the review process.

In addition, with the sale of KEB finalized, attention is also being paid to whether Grayken will keep his pledge to donate 100 billion won to Korean society.

At a press conference in April 2006, he said that the fund is willing to donate 100 billion won for the development of Korean society once it realizes capital gains from the sale of KEB.

Lone Star is expected to enjoy capital gains worth up to 4.7 to 4.8 trillion won from the sale of KEB as it has already recouped 2.12 trillion won, which is equal to 97.8 percent of its 2.15 trillion won investment in 2003.