KOREA CAPITAL MARKET INSTITUTE

Introduction

The Korean government’s national task of “establishing infrastructure and regulatory framework for digital assets” has been carried out through a two-track approach designed to create the ecosystem of both the virtual asset market and the security token market. In terms of the virtual asset market ecosystem, the Act on the Protection of Virtual Asset Users¹⁾ was enacted on July 18 and the government is actively preparing for related enforcement decrees and the second phase of legislation (including regulations on mandatory disclosure and stablecoins). As for the security token market ecosystem, amendments to the Financial Investment Services and Capital Markets Act (“FSCMA”) and the Act on Electronic Registration of Stocks and Bonds were proposed to the National Assembly on July 28. To establish an infrastructure and regulatory system tailored to each digital asset market, the policy direction based on the two-track approach can be considered desirable in that it can meet global standards and achieve regulatory efficiency.

However, relevant tax codes and rules have not been appropriately overhauled during the process of “establishing infrastructure and regulatory framework for digital assets.” Concerning the taxation of virtual assets, there is a lack of specific subsidiary regulations and authoritative interpretation regarding the tax treatment of earnings from mining or staking, hard forks and airdrops, and income from virtual asset lending. The taxation of capital gains from trading of virtual assets has already been postponed twice, which is scheduled to take effect from January 1, 2025.²⁾ Considering the current level and pace of regulatory reform on the tax treatment of virtual asset transfers and lending, public opinions may be formed next year to call for another delay in virtual asset taxation due to inadequate taxation reform.

Furthermore, it seems that the tax authority lacks a clear stance regarding taxation on capital gains from trading of atypical security tokens (investment contract securities and non-monetary trust beneficiary certificates).³⁾ Given the financial investment income tax regime set to be implemented on January 1, 2025, it is disappointing that the Income Tax Act amendment, which was proposed to the National Assembly on September 1, does not include tax treatment of capital gains from non-monetary trust beneficiary certificates, the main type of security tokens.

To seek a solution for the aforementioned issues, this article intends to examine the basic principles of capital gains taxation on security tokens under the Korean Income Tax Act (“ITA”). It will also explore capital gains taxation regarding investment contract securities and non-monetary trust beneficiary certificates and analyze relevant problems. Subsequently, improvement measures to address such problems will be proposed.


Basic principles for taxation of capital gains from security tokens

The tax treatment of security tokens conforms with the general principles and regulations of securities taxation. In the “Measures to Overhaul Regulations on Issuance and Trading of Security Tokens” (“Security Token Guidelines”) released by the Financial Services Commission (“FSC”), tokens and securities are likened to containers and foods, respectively. In other words, security tokens issued using distributed ledger technology are essentially considered securities, although they have a structural difference from paper securities and traditional electronic securities. Accordingly, under the ITA, security tokens are classified into one of the six types of securities (or collective investment securities) under the FSCMA based on their specific rights, and they are subject to the relevant taxation provisions.

The ITA has not treated gains from the transfer of investment contract securities and non-monetary trust beneficiary certificates as capital gains. This is partly attributable to regulatory constraints placed on the trading of these securities under the FSCMA. If the security token market grows, however, their issuance and trading are likely to increase at a rapid pace. The FSCMA amendment proposed to the National Assembly on July 28 eliminates the proviso that recognizes investment contract securities as securities under the FSCMA for limited purposes (mandatory disclosure in the primary market and prohibition of unfair trading practices). Instead, it comprehensively applies provisions of the FSCMA to them, as is the case with other securities.⁴⁾ This implies that atypical securities will be subject to the same regulatory principles as other securities. In-depth discussions are needed for capital gains taxation of relevant security tokens. In this respect, the following are key issues regarding the tax treatment of investment contract securities and non-monetary trust beneficiary certificates.


Taxation of capital gains from investment contract securities

The ITA does not tax capital gains from the transfer of investment contract securities. However, such capital gains will be subject to taxation as financial investment income under the financial investment income tax regime, starting from January 1, 2025. In addition, profits or losses of investment contract securities can be calculated collectively against those of other financial investment instruments (such as stocks, bonds, investment contract securities, collective investment securities and derivatives-linked securities), and remaining losses can be carried forward.⁵⁾ Therefore, capital gains from the transfer of tokenized investment contract securities, which are generated after January 1, 2025, will be taxed as financial investment income.

But it is uncertain whether and how capital gains from tokenized investment contract securities will be taxed before the financial investment income tax regime is implemented in 2025. The ITA adopts an enumerative approach for capital gains and a comprehensive approach for dividend incomes. Until the implementation of the financial investment income tax regime, capital gains from tokenized investment contract securities may not be taxed under the ITA because such capital gains are not listed as those subject to capital gains tax. However, there remains a possibility that capital gains from security tokens used for fractional investments in various assets could be taxed as dividend income.

Taxing capital gains from tokenized investment contract securities as dividend income can give rise to the following issues. First, the tax treatment contradicts the legislative purpose of the financial investment income tax regime. According to the regime set to take effect from January 1, 2025, capital gains from tokenized investment contract securities are treated as financial investment income, essentially as capital gains rather than dividends. If gains from the transfer of these securities are taxed as dividends based on the broad interpretation of Article 17 of the ITA (Dividend Income) and then later as financial investment income starting from January 1, 2025, it could cause confusion among taxpayers and lead to inconsistency of taxation principles under the ITA. Second, the taxation approach could discourage investors seeking asset growth from diversifying investment portfolios. If gains from the transfer of tokenized investment contract securities are classified as capital gains and are eligible for collective offsetting of profits or losses, investors intend to diversify their investments across various securities products for the purpose of risk management and long-term asset growth. In contrast, if such gains are deemed dividends, it eliminates the possibility of collective offsetting of profits or losses, which makes investors less motivated to diversify investments. Third, it may cause controversy over reverse discrimination against innovative financial investment products. Permitting the general-public trading of investment contract securities, which was previously restricted by regulation, is partly due to the innovative nature of distributed ledger technology. If dividend income tax is levied on capital gains from tokenized investment contract securities based on the broad interpretation of the ITA, thereby not allowing collective offsetting of profits or losses and deductions carried forward, it could lead to side effects, including hindering the issuance of innovative security token products.


Taxation of capital gains from non-monetary trust beneficiary certificates

As mentioned above, the FSCMA does not allow public trading of non-monetary trust beneficiary certificates. Consequently, the ITA has no clear taxation provisions for capital gains from the beneficiary certificates. The capital gains tax provisions based on the enumerative approach do not treat capital gains from non-monetary trust beneficiary certificates as taxable items. Notably, numerous fractional investment products are being issued and distributed in the form of tokenized non-monetary trust beneficiary certificates through the financial regulatory sandbox (innovative financial service) program. Under the substantial taxation principle, capital gains from these beneficiary certificates should be subject to the taxation provision for beneficiary certificates under the ITA, even when they are issued and distributed in a tokenized form.

Currently, Korean tax authorities are treating capital gains from non-monetary trust beneficiary certificates as dividend income even though there are no taxation provisions for such capital gains. In a Ministry of Economy and Finance Inquiry Response in 2020, the authorities interpreted “capital gains from the right to claim profits, being traded on stock exchanges”,⁶⁾ as dividend income.⁷⁾ It seems that this interpretation is based on the comprehensive approach adopted by dividend income taxation under the ITA. Article 17 of the ITA defines dividend income by listing relevant types and also stipulates that “similar types of income having profit distribution nature as listed therein” fall under the dividend income category. This tax treatment is referred to as the comprehensive approach, which could be broadly applied to income generated from various investment assets.

If profits are generated from the sale of tokenized non-monetary beneficiary certificates in the secondary market, it is uncertain whether the realized profits are classified as capital gains or dividend income. However, if the gains from the beneficiary certificates, which do not fall under the collective investment securities category, are treated as dividend income, it may pose issues regarding taxpayers’ perception, diversified investments, taxation simplicity and investor protection. Given the reality in the fractional investment market, it is reasonable to assume that most investors recognize the gains from the transfer of non-monetary trust beneficiary certificates as capital gains from the sale of one asset class within their portfolios, rather than as dividends of beneficiary certificates. The tax authority’s approach isolated from investors’ perception may hinder the relevant market’s growth and result in tax resistance. Taxing net profits generated from the transfer of various securities collectively can promote related securities markets and encourage investors to diversify investments. Conversely, if it is impossible to collectively calculate profits or losses, it may lead to market contraction and hinder investment diversification.

If the tax treatment of security tokens with the same underlying assets varies depending on whether they are investment contract securities or beneficiary certificates, it undermines the simplicity and certainty of taxation. Also, it is not desirable to apply a less favorable tax regime to tokenized beneficiary certificates, compared to tokenized investment contract securities. Notably, beneficiary certificates provide a higher level of investor protection than investment contract securities thanks to bankruptcy remoteness and the involvement of financial investment service providers.

Considering these aspects, it is more beneficial to adopt the financial investment income tax regime, based on the principles of securities portfolio investment, for capital gains from non-monetary trust beneficiary certificates. Under the financial investment income tax regime set to take effect from January 1, 2025, beneficiary certificates falling under collective investment securities are subject to financial investment income taxation,⁸⁾ but this is not the case for beneficiary certificates not falling under collective investment securities. Therefore, legislative discussions are needed to include capital gains from beneficiary certificates—not falling under collective investment securities—in taxable items under the financial investment income tax regime, through the amendment to the ITA.


Conclusion

Currently, fractional investments are promoted through the financial regulatory sandbox program and the issuance and trading system for security tokens are being overhauled. At this juncture, uncertainty and unfairness in security tokens taxation should be addressed within the framework of the financial investment income tax regime to be implemented in 2025. Under the existing ITA, capital gains from tokenized investment contract securities are exempted from taxation, but they will be taxed as financial investment income starting from January 1, 2025. Accordingly, tax authorities should avoid unreasonably applying tax provisions for underlying assets such as works of art, digital music files and others, or the comprehensive approach to capital gains from relevant security tokens.

Considering the tax gap concerning the taxation of capital gains from tokenized non-monetary trust beneficiary certificates not falling under collective investment securities, it is essential to promptly revise the ITA to incorporate such capital gains into the scope of financial investment income. If efforts to improve the taxation system for capital gains on tokenized securities are neglected, there is a possibility that public opinion might favor postponing the related taxation due to inadequate tax preparations. It can instigate taxpayer resistance, further increasing uncertainty over the implementation of the financial investment income tax system. Until the new tax regime is put in place in 2025, it is desirable to exempt capital gains from tokenized investment contract securities and non-monetary trust beneficiary certificates from taxation. Currently, security token instruments recognized for their “financial innovativeness” become eligible for the financial regulatory sandbox program. This policy direction could justify a temporary⁹⁾ tax exemption on capital gains from security tokens until 2025, as a means to promote financial innovation.
 

---

1) In this context, Virtual Asset Users mean investors in virtual assets.
2) The taxation of income generated from the transfer and lending of virtual assets (categorized as miscellaneous income) was introduced on December 29, 2020 through an amendment to the Income Tax Act and it was supposed to be implemented on January 1, 2022. However, the implementation was postponed to January 1, 2023 with the amendment to the Income Tax Act on December 8, 2021. Since such postponement, market participants have continued to call for a delay in taxation, leading to another amendment to the Income Tax Act and pushing back the implementation date to January 1, 2025.
3) The securities transaction tax regarding the transfer of tokenized investment contract securities and beneficiary certificates hardly poses any issue to the Securities Transaction Tax Act. The existing Securities Transaction Tax Act specifies that the tax is levied only on the “transfer of stocks or shares” (Article 1 of the said Act). Therefore, the securities transaction tax is imposed only on tokenized equity securities, not on other securities.
4) Article 4 Paragraph 1 of the Financial Investment Services and Capital Markets Act (proposed by representative lawmaker Yoon Chang-hyun on July 28, 2023) (with the proviso clause deleted).
5) See Article 87-4 to 87-7 of the Income Tax Act.
6) It also includes trading on over-the-counter (OTC) markets.
7) The Ministry of Economy and Finance, May 27, 2020, Tax Law Application Division-0667, Inquiry Response.
8) Article 87-6 Paragraph 1 Subparagraph 4 of the Income Tax Act (scheduled to take effect on January 1, 2025)
9) The term “temporary” means the period leading up to the implementation of the financial investment income tax regime on January 1, 2025.