How to Avoid Gift Tax When Setting Up a Company with an Investor in South Korea
Table of Contents
- 1. What is the correct structure for a 50/50 incorporation with an investor in South Korea?
- 2. Why does the wrong structure trigger gift tax in South Korea?
- 3. How is the invested amount split between capital stock and capital reserve?
- 4. What is a bonus share issuance and when is it necessary in South Korea?
- 5. How does the full structure look at a glance?
- 6. FAQ
A real case: A had the business idea and the drive to execute it. B had KRW 1 billion to invest and wanted 50% of the company. The deal seemed straightforward — until their attorney flagged a problem. Under the proposed structure, A would be acquiring KRW 500 million in equity without contributing a single won, potentially triggering a gift tax assessment. Was there a cleaner way to reach the same outcome?
The key question: who is the money going to?
※ This case is based on an actual advisory matter. Certain facts, including the investment amount, have been modified for illustrative purposes. Client confidentiality has been maintained throughout.
Under the Inheritance and Gift Tax Act of South Korea, a gift is defined as any transfer of tangible or intangible assets or economic benefits to another person free of charge, regardless of the form or name of the transaction (Article 2(6)). If B pays money directly to A and A uses it to set up a company, A has effectively received half of that money as a gift. The solution is straightforward: instead of transferring money to A personally, B invests directly into the company by subscribing to new shares. The company receives the funds, B receives shares, and A receives nothing personally — eliminating the gift tax exposure at the root.
1. What is the correct structure for a 50/50 incorporation with an investor in South Korea?
The correct structure unfolds in two steps. First, A incorporates the company alone using a small amount of personal funds. Second, the company raises capital from B through a paid-in capital increase, with B subscribing to newly issued shares. B becomes a shareholder of the company — not a lender or donor to A personally.
Step 1: A incorporates the company alone
A incorporates Company X using KRW 1,000,000 of personal funds.
- Par value per share: KRW 500
- Shares issued: 2,000
- Registered capital: KRW 1,000,000
- Shareholder: A only (100%)
Step 2: Company X raises capital from B (paid-in capital increase)
Company X issues new shares and B subscribes to them. Under the Korean Commercial Act, a company may issue new shares and have investors subscribe for consideration (Article 416 et seq.).
- B’s investment amount: KRW 999,000,000
- Issuance price per share: KRW 499,500
- New shares issued: 2,000 (= KRW 999,000,000 ÷ KRW 499,500)
- Shares subscribed by B: 2,000
After the paid-in capital increase, the shareholding structure is as follows.
| Shareholder | Shares Held | Ownership |
|---|---|---|
| A | 2,000 shares | 50% |
| B | 2,000 shares | 50% |
| Total | 4,000 shares | 100% |
Because B has invested in the company and received shares in return, no personal transfer has occurred between B and A. The gift tax issue does not arise.
2. Why does the wrong structure trigger gift tax in South Korea?
If B pays KRW 1 billion directly to A, and A then incorporates a company with that money and shares it 50/50 with B, A has received KRW 500 million worth of equity without contributing anything. Korean tax law treats this as a gift.
The legal basis for gift tax
The Inheritance and Gift Tax Act defines a gift as any transfer of tangible or intangible assets or economic benefits to another person free of charge, including situations where one person’s contribution increases another person’s asset value (Article 2(6)). Because A acquired 50% equity using B’s funds, the tax authority may treat A as having received a gift equivalent to KRW 500 million.
Gift tax rates in South Korea range from 10% to 50% depending on the taxable amount (Inheritance and Gift Tax Act Articles 56 and 26). On KRW 500 million, the tax liability would be substantial — making it essential to structure the transaction correctly from the outset.
Comparison: wrong structure vs. correct structure
| Item | Wrong Structure | Correct Structure |
|---|---|---|
| Flow of funds | B → A (personal) → incorporates company | A → incorporates company / B → subscribes to new shares |
| Gift tax exposure | A may be taxed on KRW 500M gift | No gift — B receives shares as consideration |
| Shareholding | A 50%, B 50% | A 50%, B 50% |
| Tax risk | Gift tax assessment risk for A | No gift tax risk |
3. How is the invested amount split between capital stock and capital reserve in South Korea?
When B subscribes to 2,000 shares at KRW 499,500 each, the full amount paid does not become registered capital. Only the portion corresponding to the par value (KRW 500 per share) is recorded as capital stock. The excess is recorded as a share premium reserve (capital surplus).
Breakdown of capital stock and share premium reserve
| Item | Calculation | Amount |
|---|---|---|
| Total payment by B | KRW 499,500 × 2,000 shares | KRW 999,000,000 |
| Increase in capital stock | Par value KRW 500 × 2,000 shares | KRW 1,000,000 |
| Share premium reserve | (KRW 499,500 − KRW 500) × 2,000 shares | KRW 998,000,000 |
After the paid-in capital increase, Company X has registered capital of KRW 2,000,000 and a share premium reserve of KRW 998,000,000.
What restrictions apply to the share premium reserve?
The share premium reserve must be set aside as a statutory capital reserve under the Korean Commercial Act (Article 459(1), Enforcement Decree Article 18). The Korean Commercial Act prohibits the disposal of statutory reserves except to cover an accumulated deficit in capital (Article 460). This means the reserve cannot be distributed to shareholders as a dividend or refunded to them directly.
Exceptionally, the reserve may be reduced by shareholders’ resolution where the total of capital reserves and earned reserves exceeds 1.5 times the registered capital (Article 461-2).
It is important to note that these restrictions apply to the accounting entry, not to the cash itself. The KRW 999,000,000 paid by B is already sitting in Company X’s bank account and can be used freely for day-to-day business expenses such as payroll, rent, and procurement. Whether an amount is classified as capital stock or capital reserve is purely an accounting distinction — it does not restrict cash use for ordinary business operations.
4. What is a bonus share issuance and when is it necessary in South Korea?
A bonus share issuance (capitalisation of reserves) is the process of transferring capital reserves or retained earnings to registered capital and issuing new shares to existing shareholders free of charge. The legal basis is Article 461 of the Korean Commercial Act.
Is a bonus share issuance required?
No. As noted above, the invested cash can be used for business operations regardless of whether a bonus share issuance is carried out. If losses arise from business operations, the resulting deficit can be covered by drawing on the capital reserve — so in situations where deficits do occur, whether the reserve has been capitalised may not make a material difference in practice. However, as long as no deficit arises, the capital reserve cannot be touched, making a bonus share issuance the more common route to restructure the capital accounts.
What changes with a bonus share issuance?
| Item | Without Bonus Issue | With Bonus Issue |
|---|---|---|
| Registered capital | KRW 2,000,000 | KRW 1,000,000,000 |
| Share premium reserve | KRW 998,000,000 | KRW 0 |
| Total shares (A + B) | 4,000 shares | 2,000,000 shares |
| Share transfer flexibility | High price per share; larger transfer units | Lower price per share; more flexible transfers |
| External credibility | Registered capital shown as KRW 2M | Registered capital shown as KRW 1B |
The practical effect of a bonus share issuance is that the registered capital figure shown on public records increases significantly — from KRW 2,000,000 to KRW 1,000,000,000. Banks, business counterparties, and potential investors often use registered capital as one indicator of financial soundness, so a larger capital figure can improve the company’s credibility. The total net assets of the company do not change — this is purely an accounting reclassification.
Is the bonus share issuance taxable?
No, not in this structure. Because the source of the bonus share issuance is the share premium reserve — a statutory capital reserve under Article 459(1) of the Korean Commercial Act — it falls within the exclusion from deemed dividend treatment under Article 17(2)(ii)(a) of the Income Tax Act. No dividend income tax is imposed on A or B. Note, however, that the acquisition cost of shares received through a bonus issuance is treated separately for capital gains tax purposes upon a future disposal, and a tax advisor should be consulted at that stage.
Procedure for a bonus share issuance
In principle, a board of directors’ resolution is sufficient. However, if the articles of incorporation designate this as a matter for the shareholders’ meeting, a shareholders’ resolution is required (Korean Commercial Act Article 461(1)). The board resolution should record the following.
- Source of capitalisation: share premium reserve (capital surplus)
- Amount to be capitalised: KRW 998,000,000
- Class of new shares: registered common shares
- Number of new shares: 1,996,000 (= KRW 998,000,000 ÷ KRW 500)
- Record date for new share allotment
- Allotment ratio: 1 new share per 1 existing share (1:1)
Shareholding after the bonus share issuance
| Shareholder | Before Bonus Issue | New Shares Received | After Bonus Issue | Ownership |
|---|---|---|---|---|
| A | 2,000 shares | 998,000 shares | 1,000,000 shares | 50% |
| B | 2,000 shares | 998,000 shares | 1,000,000 shares | 50% |
| Total | 4,000 shares | 1,996,000 shares | 2,000,000 shares | 100% |
5. How does the full structure look at a glance?
| Stage | Item | Detail |
|---|---|---|
| 1. Incorporation (A alone) |
Par value | KRW 500 |
| Shares issued | 2,000 shares | |
| Registered capital | KRW 1,000,000 | |
| Shareholders | A 100% | |
| 2. Paid-in Capital Increase (B subscribes) |
B’s investment | KRW 999,000,000 |
| Post-increase shareholding | A 50%, B 50% | |
| Share premium reserve | KRW 998,000,000 | |
| 3. Bonus Share Issuance (optional) |
Source | Share premium reserve |
| Amount capitalised | KRW 998,000,000 | |
| Post-issuance registered capital | KRW 1,000,000,000 | |
| Post-issuance shareholding | A 1,000,000 shares (50%) / B 1,000,000 shares (50%) |
Key points to watch when structuring this transaction in South Korea
This structure sits at the intersection of the Korean Commercial Act, the Inheritance and Gift Tax Act, and the Income Tax Act. The following matters require careful attention in practice.
- Share issuance price and gift tax (Article 39 of the Inheritance and Gift Tax Act):
If A and B are not related parties under Korean tax law, Article 39 does not apply regardless of the issuance price.
However, if A and B are related parties (e.g. family members, close associates), the following issues may arise.
① If B subscribes above market value: B is paying more than the shares are worth. This increases A’s equity value, and A may be treated as having received a gift — triggering gift tax for A (Article 39(1)(ii)(c) of the Inheritance and Gift Tax Act).
② If B subscribes below market value: B acquires shares at a discount. B may be treated as having received a gift — triggering gift tax for B (Article 39(1)(i)(c) of the Inheritance and Gift Tax Act).
Where A and B are related parties, the issuance price should be reviewed by a tax advisor in advance.
- Articles of incorporation: The company’s purpose, share transfer restrictions, and board composition should be tailored to the agreed investment terms.
- Shareholder agreement: Voting arrangements, director appointment rights, and exit provisions are best documented in a separate shareholder agreement to prevent future disputes.
- Corporate minutes: Board and shareholder meeting minutes for each step must be drafted without procedural defect.
- Change registrations: Following each capital increase, the relevant corporate register entries must be updated.
Atlas Legal has advised on numerous incorporation and investment structuring matters for companies in the Incheon Free Economic Zone and the broader IFEZ area. Getting the structure right at the outset avoids costly corrections later.
6. FAQ
Atlas Legal is a corporate law firm based in Incheon Songdo, South Korea, advising foreign-invested companies and high-net-worth individuals on corporate structuring, commercial disputes, and white-collar criminal defence. The firm has advised on incorporation and capital structuring matters involving investors across multiple jurisdictions and is familiar with the intersection of Korean commercial law and international investment practice.
※ The information in this article is provided for general informational purposes only and does not constitute legal advice. The applicable law and the legal outcome may differ depending on the specific facts of each case. Please consult a qualified attorney before taking any action.