Will Korea cut dividend income tax to mitigate Korea discount?

President Lee Jae Myung attends a meeting at the Korea Exchange in Seoul, June 11. Yonhap

The National Assembly's move to tax dividend income separately from other financial incomes to lower the tax burden on stock investors is gaining traction as a viable means to mitigate the so-called Korea discount, after the recent passage of the Commercial Act, market watchers said Monday.

The discount refers to a chronic undervaluation of Korean stocks, the main contributor to the drawn-out equity market stagnation overall. Comprehensive financial income includes income from stock dividends, and monthly interest from bank deposits and rent.

Highly likely to benefit are investors with significant holdings in shares of companies that give high dividend payouts of over 35 percent. Among such firms are SeAH Besteel Holdings, LS Electric, Samsung Card and CJ.

Experts say the move will foster a virtuous cycle whereby companies increase dividends, increasing shareholder returns which in turn will induce inflow of more capital into the stock market.

According to a bill proposed by Rep. Lee So-young of the ruling Democratic Party of Korea (DPK), the law governing income tax will seek a revision to tax dividend income, paid by companies with a dividend payout ratio above 35 percent, separately from other financial incomes.

Under the current law, a tax rate up to 49.5 percent is applied if income from dividends exceeding 20 million won ($14,614) per year are combined with other financial incomes. This is a main reason that investors with large stock holdings are reluctant to ask for greater dividend payouts.

The revision seeks to cap the withholding tax rate to up to 27.5 percent. The tax rate will be kept at 15.4 percent for dividend income of up to 20 million won. Incomes between 20 million and 300 million won will be subject to a tax rate of 22 percent. Over 300 million won in dividend income will be taxed 27.5 percent.

Whether and how the ruling party will be able to redefine the significance of the move remains to be seen.

In 2024, the previous Yoon Suk Yeol administration sought a similar separate taxation on dividend incomes to address the Korea discount, but it ended up losing momentum due to fierce DPK opposition that characterized the move as “tax cut for the rich.”

But President Lee Jae Myung is stressing the need to accelerate the move to revitalize the stock market.

He visited the Korea Exchange last month and said the new administration is preparing broad tax and institutional reforms to encourage greater dividend payouts.

This was a subtle yet clear shift from his previous stance where he said a number of simulations should precede the revision to factor in the potential tax revenue shortfall from the move.

Dongguk University professor Lee Jun-seo said the revision will lead to an overall healthier capital market.

“More funds will find its way into the long-stagnant stock market. This together with the recent passage of the Commercial Act will help the Korean capital market gain vibrancy,” he said.

Kim Woo-cheol, a professor of science in taxation at University of Seoul, said the revision will help many firms to raise dividend payout ratios.

“High tax rates on dividend incomes are one of the reasons for the Korea discount. Revision will prompt more firms to increase dividends, and in turn encourage more of them to be reinvested in the stock market.”