Calls are growing to overhaul the tax treatment of fractional investment products ahead of the institutionalization of security token offerings (STOs) in February. Small shareholders in South Korea pay no tax on capital gains from exchange-traded listed stocks, but gains on fractional investments are subject to dividend income tax — a gap that industry officials say could deter investors. Protecting investors against issuer insolvency and securing trading volume in the secondary market are also cited as challenges.
According to the financial investment industry on the 30th, income generated from fractional investment products such as non-monetary trust beneficiary certificates and investment contract securities is subject to 15.4% withholding, including local income tax. If annual interest and dividend income exceeds 20 million won, making it subject to comprehensive taxation, a rate of up to 49.5% may apply depending on the tax base combined with other income.
The burden falls especially on wealthy investors with large financial income, for whom even capital gains are added to the comprehensive tax base. Industry officials said tax support should be considered in light of parity with listed stocks in order to draw investors to the nascent market. The difference in tax treatment, they noted, stems not from the token format of issuance but from the type of security and the nature of the income. An official at a major brokerage said, "There is a problem in that even when transfer gains arise from buying and selling in the secondary market, they are taxed as dividend income, and this is an area that will require regulatory improvement going forward."
Protection of rights attached to investment contract securities also needs shoring up. Unlike beneficiary certificates, which use a trust structure, the level of protection for investment contract securities varies with the joint business contract and the ownership structure of the underlying asset. The Financial Services Commission (FSC) sees a significant problem of "bankruptcy remoteness" between the issuer and the joint business assets in the case of business-type investment contract securities, which do not establish joint ownership rights for investors. If the issuer goes bankrupt, the invested assets risk being used to repay debts, and a mechanism is needed to block that, the commission explained.
For existing co-ownership products such as beef cattle and artworks, the issue is the transfer of rights during distribution. Even when the security is sold, the co-ownership stake in the underlying asset must be transferred separately, which constrains trading. The FSC is reviewing procedures for transferring rights in co-ownership products and standards for investor protection in business-type products.
It also remains uncertain whether sufficient trading volume will be secured even once a secondary market opens. The products the FSC has permitted in the first phase are institution-only private money market funds (MMFs) and bonds, along with unlisted shares held in trust form, meaning the products individual investors can access early on are expected to be limited to small-scale public offerings of fractional investments, or trust beneficiary certificates. Authorities are pursuing a soft landing centered on private, interest- and dividend-yielding products with stability as the top priority, but some observers say this could be shunned by retail investors looking for a big, thrilling payoff. Many of the products under discussion are structured to pay dividends or interest while held, so frequent trading is hard to expect, the industry says.
On top of that, the annual net purchase cap for ordinary investors is set at 100 million won per over-the-counter exchange, raising concerns about a shortage of liquidity in the early stage. If bid and ask quotes are thin, cashing out can be delayed and prices can swing sharply on small trades, so the conditions for participation by liquidity providers (LPs) that continuously supply quotes, as well as market-making plans, also need to be spelled out. Market participants advise designing functional incentives for the secondary market carefully, drawing on the precedents of equity-linked securities (ELS), which are largely held to maturity and thus see limited exchange trading, and equity-linked warrants (ELW), whose trading value plunged under excessively strict regulation.
Innovative products that brokerages are contemplating — from large physical assets such as ships and real estate to intellectual property (IP) rights for Korean content — also face the task of clearing away policy uncertainty before they can actually come to market. The government has yet to set a specific timeline or details for the second phase, the tokenization of publicly offered securities for ordinary investors, which would have a far greater market impact, leaving the industry in continued confusion.
Regulatory groundwork must follow if products are to diversify, industry officials said. For brokerages to identify and structure more attractive assets, the scope of eligible underlying assets should be widened in stages through steps such as revising the Trust Act, they said. Detailed business rules and guidelines for the review of securities registration statements also need to be fleshed out urgently. A digital and IT executive at a major brokerage said, "We are reviewing countless underlying assets in the field and pushing ahead with distributed ledger development, but we can only finalize the scope of design and development once the Financial Supervisory Service's criteria for reviewing securities registration statements are made specific, so the reality is that momentum for development is flagging at this point."
