The government has announced that it will introduce 'separate taxation of dividend income' to increase dividends in the stock market, but analyses suggest it may have little effect. This is because the total shareholder or major shareholders, who influence the determination of corporate dividend amounts, benefit from a dividend tax credit that applies an effective tax rate similar to that which the Ministry of Economy and Finance will set this time.
According to the Ministry of Finance on the 11th, taxpayers subject to comprehensive income tax receive a dividend tax credit. This means they receive a reduction on part of the taxes owed as a result of receiving dividends.
In announcing a tax reform plan on the 31st of last month, the Ministry of Finance stated that any dividends, when combined with interest, exceeding 20 million won annually would face comprehensive taxation on financial income, while simultaneously separating the taxation of dividend income and reducing the highest rate from 45% to 35%. The key reason is to lower the tax burden on major shareholders and encourage increased dividends.
However, considering the dividend tax credit, the effective tax rate for existing taxpayers subject to comprehensive income tax is around 40%. While the nominal highest tax rate on dividend income was lowered by 10 percentage points, the actual tax reduction effect is only about half that amount.
Given the circumstances, analyses around the stock market suggest that separate taxation of dividend income may not lead to an increase in dividends. Lee Chang-hwan, CEO of Align Partners Asset Management, noted, "If the dividend tax credit is applied, there is about a 4 percentage point difference between the highest tax rate in the government's proposal and the effective tax rate," and added, "From the perspective of controlling shareholders, there is no incentive to increase dividends."
Lee Dong-geun, a professor of accounting and taxation at Hanbat University, stated, "If the highest tax rate had been set at 25% as proposed by Democratic Party of Korea lawmaker Lee So-young, there would have been more incentive to increase dividends."
An official from a listed company also said, "Given the uncertainty of how the typical environment will change next year, it is unlikely that there will be an increase in dividends just to receive that level of benefit," adding, "The best option for corporations is to retain earnings rather than distribute dividends."
The dividend tax credit was introduced to address the issue of double taxation. When a corporation earns money through business activities, it pays corporate tax, and the remaining funds are then distributed to shareholders as dividends. Shareholders are also required to pay dividend income tax because they receive income from the dividends, resulting in the utilization of income already taxed by corporate tax. Therefore, the government provides a tax credit for shareholders who receive substantial dividends.
When adjusting for double taxation on dividend income, two steps are followed. First, the amount obtained by multiplying the dividend income by the dividend gross-up rate (currently 10%) is added to calculate the income tax. The gross-up amount added earlier is then deducted from the income tax calculated this way. After calculating the tax on the dividends by including the gross-up, the final tax is derived by subtracting the gross-up.
Assuming Mr. A earned 100 million won in dividend income and, including other income, incurred the highest comprehensive tax rate of 45%. Mr. A's first tax liability would be 49.5 million won, calculated as 45% of 110 million won, which includes a gross-up of 10 million won. After deducting the gross-up (10 million won), Mr. A's final tax liability would be calculated at 39.5 million won, resulting in an effective tax rate of 39.5%.
Another issue is that the Ministry of Finance has raised the current dividend gross-up rate of 10% to 11% starting next year in this tax reform proposal. An increase in the dividend gross-up rate also increases the amount eligible for the dividend tax credit, thereby lowering the effective tax rate. The Ministry explained that the dividend gross-up rate moves in tandem with the corporate tax rate, which is why both were increased by 1 percentage point.
A Ministry of Finance official stated, "The dividend tax credit reduces individual dividend income taxes by taking corporate taxes into account," adding, "There is a technical issue that requires raising the gross-up rate when the corporate tax rate increases."
There are expectations that it will be difficult to anticipate an increase in dividends given the conditions for listed companies under separate taxation of dividend income. According to the Ministry of Finance's tax reform proposal, only those listed companies whose cash dividends have not decreased compared to the previous year and meet the criteria of 'corporations with a payout ratio of 40% or higher' or 'corporations with a payout ratio of 25% or higher and an increase in dividends of at least 5% compared to the past three years' will be eligible for separate taxation of dividends. The top two companies by market capitalization, Samsung Electronics and SK hynix, do not meet these requirements.
Oh Mun-seong, president of the Korean Tax Policy Association and a professor at Hanyang Women's University, remarked that "the separate taxation requirements are designed in a very complicated way, making it difficult for the policy to yield effective results," adding, "It is not easy for companies to increase dividends every year."