Changes in the financial environment

Kyungbong An, Professor, College of Law, Kookmin University

Since the value added tax system was first introduced in 1977, Korea has maintained a tax free system for financial services. It was difficult to impose a high tax rate of more than 10% on interest, which was charged at 1% under the business tax system at the time of introduction. At the time, loans from financial institutions were mainly made to companies. So, it is expected that the purchase tax amount deduction will have a slight impact on tax revenue. In addition, the separate taxation method for each lender was contrary to the simplification of taxation and tax administration for the introduction purpose.

For financial services, to exempt VAT, theoretically, interest is not value added, but interest is a reward for previous expenditures between current and future expenditures. Therefore, there is also a view that it is reasonable not to tax. Even if the tax exemption is converted to taxation, the tax revenue effect isn't great due to the refund, and only the tax administration cost increases. In terms of taxation technology, it is difficult to separate taxation only for fee-based services.

Tax exemption on financial services increases the burden of tax administration costs. It is necessary to distinguish between duty-free transactions, taxation transactions, and zero-rate transactions. As a result, the cost increases, and as the transaction is incorrectly recognized, there is an obligation to pay additional taxes. As financial services are exempted from tax, companies do not receive purchase tax amount deduction for financial services. Companies select to supply all services internally. Or some or all of the burden is passed on to the price of financial and insurance services they provide to the end consumer. In addition, attempts are made to convert the tax-free supply into the taxation supply through packaging(e.g., in the case of a travel package, insurance is purchased together).

However, the financial environment changed. Internationalization and relaxation of regulation, deregulation eased restrictions on entry into the financial industry and business areas. And new financial techniques and product services appeared. In addition, some functions were externalized due to the execution of diverse additional tasks such as consulting and the establishment of a financial holding company. With these changes in the financial environment, the need to review the VAT taxation system for financial services came to the fore.

Check the details: Korea Financial Times

(https://fntimes.com/html/view.php?ud=20220819184035472c1c16452b0_18)