The term "Korea discount" made headlines of major newspapers for quite a while since 2022. Korea discount is a term used to describe a phenomenon in the stock market where equities traded on Korean stock exchanges are undervalued compared to global peers. In a bid to address this particular issue at least from the regulatory policy perspective, Korean government has recently eased compliance procedure for foreign investors trading in Korean bourses through so-called "omnibus account," which was introduced by the Korean Financial Supervisory Service ("FSS") in 2017 to allow foreign investors to have easier access to the Korean capital market. Although such measure may not be sufficient enough to significantly ameliorate the issue facing the Korean stock exchanges, i.e., Korea discount, it will definitely ease administrative burdens of foreign investors to a large extent with a caveat that there may be a significant withholding tax implication thereof.
1. Introduction to Omnibus Account in Korea
In 2017, The Korean Financial Services Commission introduced so-called "omnibus account for foreign investors" ("Omnibus Account") in a bid to ease foreign investors' trading of stocks in Korean bourses and facilitate more volume of trading by foreign investors. By definition, the Omnibus Account means a real account opened by a foreign securities company for the purpose of buying and selling shares on behalf of foreign investors under its name by means of bulk order and bulk settlement.
Prior to the introduction of the Omnibus Account, each foreign investor wanting to trade stocks listed in one of Korean bourses was required to (i) obtain an Investor Registration Certificate ("IRC") from the FSS ii) appoint a custodian bank in Korea, and (iii) open an account for trading purposes with one of Korean securities companies before being able to actually trade stocks. As stated earlier, the Korean government is trying to remove red tapes around the foreign investors' access to Korean stock exchanges in order to increase the trading volume.
However, when the Omnibus Account was firstly introduced in 2017, there remained a few impediments to the successful achievement of the foresaid objective of the Korean government as i) foreign investors still had to obtain the IRC from the FSS and ii) global securities companies holding the Omnibus Accounts were required to report the details of trades executed via their Omnibus Accounts immediately after the settlement (T+2).
2. Eased Compliance Burdens for Foreign Investors Trading through the Omnibus Accounts
The Korean government recently overhauled the Financial Investment Services and Capital Markets Act ("FSCMA") and repealed the IRC system to further streamline the compliance procedure involving the Omnibus Account in order to ameliorate the Korean investment environment for foreign investors. In a nutshell, the streamlined procedure i) exempts foreign investors from obtaining the IRC prior to trading Korea-listed stocks and ii) provided much more flexibility to the Omnibus Account holders, to wit: the Omnibus Account holders are now required to report the details of the trading executed via their Omnibus Account only once a month. Although this may not be sufficient enough to achieve the objective of the Korean government to tackle the Korea discount issue, it is highly envisaged that foreign investors' easier access to Korean capital market will facilitate more volume of trading in Korean stock exchanges and this will have a positive impact on the undervalued stocks to a certain extent.
3. Some Limitations of the Measure Introduced by the Korean Government (compared to the U.S. system)
In the U.S., a Qualified Intermediary ("QI") program was introduced in 2001 to ease the administrative burden of foreign investors and to secure foreign investors' confidential information. A QI refers to a financial institution or entity that has entered into a formal agreement with the Internal Revenue Service ("IRS") under the provisions of the QI program. The primary function of a QI is to facilitate the proper withholding and reporting of taxes on income derived from U.S. securities owned by foreign investors. Additionally, a QI acts as an intermediary by collecting and documenting the tax status of foreign investors to ensure compliance with U.S. tax law and the applicable treaty benefits.
Similar to the QI program in the U.S., the Korean government introduced in 2022 so-called Qualified Foreign Financial Institution ("QFFI"). Under this new regime, foreign investors are required to submit requisite supporting documents to the QFFI with respect to their investments in Korean sovereign bonds to benefit from a pertinent tax treaty. In turn, the QFFI should submit a simple summarizing statement to the relevant tax office to complete the compliance procedure. Besides, unless there is any change in the status of foreign investors, they do not need to submit the same supporting documents again to the QFFI to enjoy a pertinent tax treaty benefit.
However, as stated above, there is a limitation of this new regime in a sense that QFFI system is applicable only to a specific asset type, i.e., Korean sovereign bonds. Therefore, it is cautiously anticipated that the Korean government may expand the application of QFFI to all different asset types in near future, allowing foreign investor much easier access to Korean capital market in order to ultimately address the Korea discount issue.
4. Withholding Tax Implication on Korea-sourced Income Derived Through the Omnibus Accounts
In July 2023, the Korean government issued a proposed a tax bill where it includes a new rule for withholding tax in response to the recently streamlined compliance procedure concerning the Omnibus Account introduced above.
Effective from January 1, 2024, the Korea-source income payer to foreign investors is required to withhold taxes at Korean domestic rates (22% for dividends) without applying any tax exemption or reduced tax rate under a pertinent tax treaty at the time of withholding. If foreign investors would like to benefit from a pertinent tax treaty, now they should submit a separate request for a tax refund after-the-fact to the tax office within five years.
This change in the withholding tax compliance will have a significant impact on the foreign investors' cash flow going forward as they may need to pay taxes at a higher rate upfront and claim for the refund later. This will definitely entail the necessity of prudent advice and assistance from tax advisors.
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