Rates spur ‘taxmageddon’ fears

After the Ministry of Strategy and Finance disclosed new tax rates to raise an additional 1.66 trillion won ($1.4 billion) in revenue over the next five years, the finance industry has taken to dubbing the move “taxmageddon.”

One derivatives expert at the Korea Exchange described the new rates as a ticking time bomb that will inevitably shrink the derivatives market.

Another source at a local credit card firm likened it to receiving a haymaker from a heavyweight slugger as the government has now lowered commission fees for small and midsized stores and scaled back tax deductions for people who use credit cards from 20 percent to 15 percent.

The new tax rates come as an especially heavy blow to life insurers, which have been reaping the rewards of robust sales of tax-free policies with immediate annuities.

As of May, six major life insurers collected a combined 1.11 trillion won in insurance fees with immediate annuity policies alone, almost matching in five months their total sales for 2011 of 1.28 trillion won.

Immediate annuity policies have been a cash cow for insurers largely due to the tax exemption benefits they offer.

Some critics complain that the well-to-do have been rampantly subscribing to such policies to dodge taxes as any profits generated by the policies become tax free when the contracts exceed 10 years.

In light of such criticism, the government said it will start taxing the profits from next year.

“These policies have become extremely popular among the super rich, especially the top 1 percent of income earners, as they prefer saving taxes over seeking profits due to the volatile state of the stock and real estate markets,” said Lee Jeong-geol, an employee at Kookmin Bank.

“When we lose ways for our customers to save on paying taxes, it gets significantly harder to create an attractive portfolio.”

Now insurers are desperately seeking a replacement to the immediate annuity policies.

“As the central bank is likely to keep the interest rate low, demand for tax-saving policies will stay high,” said Lim Jo-yeon, an employee at Samsung Securities’ Banpo-Seora branch in southern Seoul.

“As an alternative, the very rich may invest in insurance policies that offer long-term savings, as well as inflation-indexed government bonds and Indian bonds.

While tax deductions on card use have been lowered to 15 percent, however, consumers who use cash to pay their bills will soon be able to enjoy better deductions of 30 percent, up from 20 percent at present.

“Credit cards are the industry’s core source of revenue,” said Park Seong-eop, an employee at the Korea Credit Finance Association. “Scaling back tax deductions will cause profits in the sector to slide, and will come as a severe blow to credit card issuers, which are already feeling the pinch by complying with the government’s moves to lower commission rates for smaller stores.”

Industry sources at local derivatives firms are also concerned about the new tax rates. Starting from 2016, investors will pay a 0.001 percent transaction tax on futures trades, while a 0.1 percent tax will be levied on sales and purchases of options.

Daily average trading of derivatives slipped to 54.4 trillion won in August, down 35.4 percent from 84.2 trillion won in the same month last year due to the introduction of a slew of new regulations.

“When the transaction tax is introduced, the options market will likely shrink 24 percent, and the futures market will be reduced 19 percent,” said one local trader, who asked not to be identified.

The Finance Ministry said the new tax rates are here to stay despite mounting opposition from the moneyed class.

“Tax exemptions on immediate annuity policies must be restricted to make them fair and keep them on par with tax rates on other products,” said Baek Un-chan, deputy minister for tax and customs.

Jeong Jeong-hoon, another ministry official, said that lowering the tax deduction rate on credit card use was “inevitable to solve the mounting household debt problem, as well as to reduce the burden on SMEs that were concerned by high commission rates.”

By Lim Mi-jin [mijukim@joongang.co.kr]