South Korea's ISA incentive becomes a boomerang as tax system faces collapse

South Korea's financial tax system is in disarray due to the lingering effects of a policy designed to appease investors. Six years ago, the government significantly enhanced the benefits of the Individual Savings Account (ISA) as a sweetener for the impending introduction of a financial investment income tax (FII). The FII was intended to tax stock gains exceeding 50 million won at rates of 20-25%, a move that passed the National Assembly in late 2020 for implementation in 2023.

To mitigate anticipated investor backlash against the FII, the government expanded ISA benefits. This included tax-free treatment for interest and dividend income up to 2 million won within a 100 million won contribution limit, with earnings above that subject to a 9.9% separate tax. The accompanying tax law revision also allowed direct stock trading within ISA accounts, previously limited to funds, savings, and deposits. Eligibility was broadened, removing income requirements so that housewives and students could also open accounts. Provisions for virtually unlimited maturity extensions and the carry-over of unused contribution limits were also established during this period.

However, the FII was ultimately postponed and then completely abolished under the Yoon Suk-yeol administration in 2024. This left the expanded tax benefits and reduced transaction taxes in place without the original condition of comprehensive financial income taxation. When the Lee Jae-myung administration took office, the stock transaction tax rate was restored to 0.2% in 2023 under the guise of 'normalization,' but the ISA's tax benefits remained untouched. A recent attempt to reform the tax system by abolishing the carry-over of contribution limits and unlimited maturity extensions was met with strong investor opposition and a directive from President Lee for reconsideration, effectively returning the issue to square one.

The failure to normalize taxation after the FII's abolition has led to criticism that the overall financial tax system has become a patchwork. The current administration's policy goals for normalizing the domestic stock market have involved excessive use of tax benefits, creating significant distortions in fairness compared to other income sources. With no taxation on stock capital gains for most investors (excluding major shareholders holding over 5 billion won in a single stock), a layered system of tax exemptions and separate taxation, including the recently passed separate taxation of dividend income and the ISA, is now in effect. This situation starkly contrasts with President Lee's recent remarks about the disparity between real estate capital gains tax and the progressive tax rates on earned income, highlighting how financial income has strayed far from the principle of fair taxation where income is taxed.

Kim Hyun-dong, a professor of business administration at Paichai University, noted, "As the introduction of the FII did not proceed as planned, financial taxation has virtually ceased under the pretext of boosting the domestic stock market." He added, "With the normalization of ISAs also facing setbacks due to opposition, the normalization of financial taxation appears distant."

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As the introduction of the FII did not proceed as planned, financial taxation has virtually ceased under the pretext of boosting the domestic stock market. With the normalization of ISAs also facing setbacks due to opposition, the normalization of financial taxation appears distant.