HOW TO INVEST IN KOREAN SHARES

Guide to Portfolio Investment by Foreigners in Korean Company Shares

Although it is reported that the Korean economy is presently not in good condition, many notable foreign institutional investors have continued to show interest, as they have for the past 10 to 20 years, in the performance of Korean companies as targets for investment. To meet such needs from abroad, the Korean government has broadened foreign access to the equity of Korean companies in the past 10 years by gradually allowing foreign ownership of shares in Korean companies. Despite continuous efforts by the Korean government to open the market, however, foreigners are still subject to various restrictions and procedures with respect to their portfolio investment in Korean shares. If you are a foreigner who desires to invest in Korean company shares, you should be familiar with such restrictions prior to making any investment decisions.

I. In What Type and How Many Shares Can You Invest?

A. Shares Open to Investment by Foreigners
Under Korean securities regulations, foreigners may invest in common or preferred shares of any company listed on the Korea Stock Exchange ("KSE") unless it is otherwise restricted by law. Foreign ownership of equity in certain public companies is currently not permitted.
Foreigners can also obtain indirect ownership by investing in shares of Korean companies through acquisition of equity-linked securities like bonds convertible into, and bonds with warrants entitled to subscribe for, and equity related securities in depositary receipt form exchangeable for, shares of Korean companies. Under the current foreign exchange and securities regulations, eligible companies are only permitted to issue such overseas equity-linked securities to foreign investors outside Korea. Moreover, foreigners are currently allowed to acquire convertible bonds denominated in Won (Korean legal currency) and listed on the KSE, with foreign investors being allowed to invest up to an aggregate of 30% of the listed value of each of such series (in case of convertible bonds issued by small and medium-sized companies, 50%) and 6% in the case of a single foreign investor (in case of convertible bonds issued by small and medium-sized companies, 10%).
B. Limits on Shareholding by Foreigners
Although limits currently exist as to the aggregate foreign shareholding and individual foreign shareholding for each class of shares of any single company, the Korean government plans to gradually relax such investment limits in the future. Presently, a single foreign investor may acquire beneficial ownership of up to 6% of any class of shares of a listed company, whereas multiple foreign investors may acquire up to 23% of such ownership, in the aggregate. There is an aggregate 18% limit, however, for shares acquired by foreigners in certain designated public corporations such as the Korea Electric Power Corporation and Pohang Iron Steel Co., Ltd. that is placed in their articles of incorporation. Another exception exists for foreign invested enterprises established under the Foreign Investment and Foreign Capital Inducement Act or the Foreign Exchange Management Act that have successfully filed a report in advance to the government regarding an increase in the aggregate limit on ownership of shares by foreigners.
The Korean Securities and Exchange Commission ("KSEC") may increase or decrease the above limits if it is deemed necessary for the public interest, protection of investors or industrial policy.

II. Procedures Governing Foreign Investment in Korean Company Shares

A. Administration and Monitoring of Foreign Investment
A foreign investor who wishes to invest in the shares listed on the KSE is required to register its identity with the Korean Securities Supervisory Board ("SSB") prior to initiating any such investment. Upon registration, the SSB will issue an Investment Registration Card to the foreign investor, which must be presented each time the foreign investor opens a brokerage account with a securities company in Korea.
Once a foreign investor purchases shares through the KSE, no separate report by the investor is required because the Investment Registration Card system is designed to monitor foreign investment in Korea by means of a unique computerized system. Notwithstanding such a system, a foreign investor must ensure that any direct acquisition from or sale of shares outside the KSE to other foreigners is reported by the securities company that is facilitating such transaction.
B. Standing Proxy
A foreign investor must appoint one or more standing proxies to exercise shareholders' rights and to conduct the orders and execution of their trades as well as to direct the custody and withdrawal of the share certificates in the event that the foreign investor does not plan on engaging in any of these activities himself.
C. Bank Account for Investment
The Foreign Exchange Management Regulations ("FEMR") requires a foreign investor who intends to acquire shares of Korean companies, to designate a single foreign exchange bank where it must open a foreign currency account and a Won account that is to be exclusively used for stock investments. No governmental authorization is required for remittance into Korea and deposits of foreign currency funds into such foreign currency account and vice versa.
Upon confirmation from a designated foreign exchange bank, such foreign currency funds may be transferred from the foreign currency bank account to a Won account at a securities company for purposes of placing a deposit for, or settling the purchase price of, a stock purchase transaction. Funds in the investor's Won bank account may also be transferred to its foreign currency bank account or withdrawn for local living expenses up to certain limits and subject to reporting to the designated foreign exchange bank in Korea.
D. Trading Markets
A foreign investor must effect its stock transactions only through the KSE, except in such cases as odd lot trading of shares, acquisition of shares by conversion of equity-linked securities, acquisition by inheritance, gift or bequest, acquisition by the exercise of shareholder's rights and direct trading among foreigners of shares in categories which are held by foreigners in excess of the aggregate limit imposed by government regulations.

III. Tax Considerations

A. Tax on Dividends
Dividends on the shares of Korean companies are generally subject to withholding of Korean income or corporation tax at the rate of 25% for a non-resident if any tax treaty which is favorable for such non-resident with respect to the tax rate does not apply to the payment of dividends. In addition, a tax surcharge, called a residence tax, will be imposed at the rate of 10% of the income or corporation tax until December 31, 1998 and 7.5% thereafter.
B. Tax on Capital Gains
Capital gains made from the sale of shares in a Korean company by a non-resident without a permanent establishment in Korea to another non-resident without a permanent establishment in Korea) are exempt from Korean tax unless the seller owned 10% or more of the total issued and outstanding shares of the Korean company at any time during the five years prior to such transaction. The applicable tax rate in other transactions that yield capital gains will be the lower of either 11% of the gross realization proceeds, effective until December 31, 1998 and 10.75% thereafter or 27.5% on the gains made, effective until December 31, 1998 and 26.875% thereafter.
C. Securities Transaction Tax
A securities transaction tax must also be paid on the transfer of shares issued by a Korean company under the special tax legislation. Such tax is generally assessed at the rate of 0.15% of the sale price of the shares, but is subject to certain specified exceptions. An additional agricultural and fishery special tax has been imposed on securities transactions in the KSE at the rate of 0.15% of the sales price since July 1, 1994. Such special tax is expected to be abolished on June 30, 2004.

IV. Further Opening of Korean Equity Market

The Korean government announced that it will increase the aggregate foreign ownership limit by 3% per year from 1997 to 1999 with respect to Korean company shares and abolish such limit entirely in 2000. This government plan means that the restrictions and procedures relating to stock investment by foreigners will continue to exist until that time, and thus, foreign investors will need to be advised thereof.

Writer: Eui-Jong Chung
Member of Korean Bar
LL.M. (Columbia Law School, 1996)