All Gains from Foreign Currency Deposits Subject to Taxation

The government has launched an investigation after deciding to impose taxes on foreign exchange gains of foreign currency-related financial products.

Early last month, the government expanded the scope of taxation to the dollar, Euro, and other foreign currency accounts (instruments which deposit foreign currencies instead of the Korean won) and foreign bond funds (instruments which invest in foreign bonds or fixed income) following its decision to tax foreign exchange gains on yen deposits.

Consumer and financial companies are expected to raise objections if forex gains are subjected to taxation as they are currently known as non-taxable income.

The Ministry of Finance and Economy (MFE) announced on May 8 that consumers must pay a 15.4 percent of their foreign exchange gains as interest income tax if they signed a futures exchange contract with financial companies to avoid foreign currency risks and earned forex profits from the arrangement.

Accordingly, the National Tax Service has set out to single out taxable financial products. It plans to develop criteria for foreign currency deposits around the middle of this month, and to notify taxpayers of the results.

The criteria for foreign bond funds, currently undergoing the initial review stage, will be released after the second half of this year (from July to December).

If this plan goes as planned, individuals or corporations that earned foreign currency gains by purchasing financial products such as yen swap and dollar swap deposit accounts from 2002 to 2004, are subject to pay interest income taxes.

The MFE estimates the value of yen swap deposit accounts at 5.9 trillion won and annual forex gains at 236 billion won (annual four-percent rate of return) as of late August last year.

If the government levies interest income taxes (15.4 percent tax rate) on forex gains, clients of financial companies and FX accounts must pay more than 36.3 billion won in taxes. They are obligated to pay taxes even after the maturity of foreign currency deposit accounts.

The actual tax revenues will greatly increase when taxes are also imposed on foreign bond funds and other forex swap deposit accounts, including those of the dollar and Euro.

The MFE, however, has decided to exclude the interest income from futures exchange deals from the taxation list if businesses concluded such arrangements in order to avoid exchange rate risks in exchanging import and export payments.

In addition, it is likely that individuals or corporations who signed future exchange contracts for only principals, not the interests of forex accounts, will be exempt from taxation.

In response, banks and securities firms are expressing opposition by arguing that charging interest income taxes on forex gains, which is different from deposit interests in nature, is unfair.

“People are divided over whether imposing taxes on foreign exchange gains is legitimate as forex gains are not specified in the income tax law,” said Ahn Jong-seok, a researcher at the Korea Institute of Public Finance.

Futures Exchange-

Contracts to reduce risks associated with exchange rate fluctuations. The foreign exchange gains are determined at the point of signing the deal. Foreign exchange accounts related with this arrangement are forex swap deposit accounts

Eun-Woo Lee legman@donga.com libra@donga.com