This is a case commentary on how to structure a company incorporation with an investor in South Korea so as to avoid gift tax liability. Atlas Legal published detailed commentary explaining the correct use of paid-in capital increase and bonus share issuance under Korean commercial and tax law.
Commentary Overview
When a founder (A) and an investor (B) wish to establish a 50/50 company with B contributing KRW 1 billion, the choice of structure is critical. If B pays the money directly to A personally and A incorporates the company, A effectively acquires KRW 500 million in equity for free — a transaction that Korean tax law may treat as a gift subject to gift tax (Inheritance and Gift Tax Act, Article 2(6)). Gift tax rates in South Korea range from 10% to 50% depending on the taxable amount (Articles 26 and 56), making correct structuring essential from the outset.
The Correct Structure: Sole Incorporation Followed by Paid-in Capital Increase
The correct approach unfolds in two steps. In Step 1, A incorporates the company alone using KRW 1,000,000 of personal funds (2,000 shares at a par value of KRW 500 per share). In Step 2, the company issues new shares and B subscribes to 2,000 new shares by paying KRW 999,000,000 into the company — a paid-in capital increase under the Korean Commercial Act (Article 416 et seq.). Because B invests into the company and receives shares as consideration, no personal transfer occurs between B and A, and no gift tax issue arises for A. The resulting shareholding is A 50%, B 50%.
Capital Stock and Share Premium Reserve
When B subscribes to 2,000 shares at KRW 499,500 each, only the par value portion (KRW 500 × 2,000 = KRW 1,000,000) is recorded as capital stock. The remaining KRW 998,000,000 is recorded as a share premium reserve (capital surplus) under the Korean Commercial Act Article 459(1). The Commercial Act prohibits disposing of this reserve except to cover an accumulated capital deficit (Article 460). Importantly, these restrictions apply to the accounting classification only — the cash itself is freely available for ordinary business operations such as payroll, rent, and procurement.
Bonus Share Issuance: Purpose and Tax Treatment
A bonus share issuance (capitalisation of reserves) transfers the share premium reserve to registered capital and allots new shares to existing shareholders free of charge (Korean Commercial Act, Article 461). Because the source is the share premium reserve — a statutory capital reserve under Article 459(1) — no dividend income tax is imposed on either A or B (Income Tax Act, Article 17(2)(ii)(a)). The shareholding ratio of A and B remains unchanged at 50% each after the bonus issue. The primary practical effect is that the company’s registered capital increases from KRW 2,000,000 to KRW 1,000,000,000, improving external credibility with banks, counterparties, and future investors.
Related Party Risk Under Article 39 of the Inheritance and Gift Tax Act
If A and B are genuine third parties with no special relationship under Korean tax law, Article 39 of the Inheritance and Gift Tax Act does not apply regardless of the share issuance price. However, where A and B are related parties — such as family members or close associates — the issuance price requires careful attention. Subscribing above market value may trigger gift tax for A; subscribing below market value may trigger gift tax for B. A tax advisor should be consulted before the transaction is executed in related-party situations.
Legal Expertise
Atlas Legal advises on corporate structuring matters at the intersection of Korean commercial law and tax law, including incorporation, paid-in and bonus capital increases, shareholder agreements, and corporate register filings. The firm is based in Incheon Songdo and has handled numerous incorporation and investment structuring matters involving domestic and cross-border investors. Getting the structure right at the outset prevents costly corrections — in tax, registration, and shareholder disputes — down the line.
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Avoid Gift Tax When Incorporating with an Investor in South Korea
This is a case commentary on how to structure a company incorporation with an investor in South Korea so as to avoid gift tax liability. Atlas Legal published detailed commentary explaining the correct use of paid-in capital increase and bonus share issuance under Korean commercial and tax law.
Commentary Overview
When a founder (A) and an investor (B) wish to establish a 50/50 company with B contributing KRW 1 billion, the choice of structure is critical. If B pays the money directly to A personally and A incorporates the company, A effectively acquires KRW 500 million in equity for free — a transaction that Korean tax law may treat as a gift subject to gift tax (Inheritance and Gift Tax Act, Article 2(6)). Gift tax rates in South Korea range from 10% to 50% depending on the taxable amount (Articles 26 and 56), making correct structuring essential from the outset.
The Correct Structure: Sole Incorporation Followed by Paid-in Capital Increase
The correct approach unfolds in two steps. In Step 1, A incorporates the company alone using KRW 1,000,000 of personal funds (2,000 shares at a par value of KRW 500 per share). In Step 2, the company issues new shares and B subscribes to 2,000 new shares by paying KRW 999,000,000 into the company — a paid-in capital increase under the Korean Commercial Act (Article 416 et seq.). Because B invests into the company and receives shares as consideration, no personal transfer occurs between B and A, and no gift tax issue arises for A. The resulting shareholding is A 50%, B 50%.
Capital Stock and Share Premium Reserve
When B subscribes to 2,000 shares at KRW 499,500 each, only the par value portion (KRW 500 × 2,000 = KRW 1,000,000) is recorded as capital stock. The remaining KRW 998,000,000 is recorded as a share premium reserve (capital surplus) under the Korean Commercial Act Article 459(1). The Commercial Act prohibits disposing of this reserve except to cover an accumulated capital deficit (Article 460). Importantly, these restrictions apply to the accounting classification only — the cash itself is freely available for ordinary business operations such as payroll, rent, and procurement.
Bonus Share Issuance: Purpose and Tax Treatment
A bonus share issuance (capitalisation of reserves) transfers the share premium reserve to registered capital and allots new shares to existing shareholders free of charge (Korean Commercial Act, Article 461). Because the source is the share premium reserve — a statutory capital reserve under Article 459(1) — no dividend income tax is imposed on either A or B (Income Tax Act, Article 17(2)(ii)(a)). The shareholding ratio of A and B remains unchanged at 50% each after the bonus issue. The primary practical effect is that the company’s registered capital increases from KRW 2,000,000 to KRW 1,000,000,000, improving external credibility with banks, counterparties, and future investors.
Related Party Risk Under Article 39 of the Inheritance and Gift Tax Act
If A and B are genuine third parties with no special relationship under Korean tax law, Article 39 of the Inheritance and Gift Tax Act does not apply regardless of the share issuance price. However, where A and B are related parties — such as family members or close associates — the issuance price requires careful attention. Subscribing above market value may trigger gift tax for A; subscribing below market value may trigger gift tax for B. A tax advisor should be consulted before the transaction is executed in related-party situations.
Legal Expertise
Atlas Legal advises on corporate structuring matters at the intersection of Korean commercial law and tax law, including incorporation, paid-in and bonus capital increases, shareholder agreements, and corporate register filings. The firm is based in Incheon Songdo and has handled numerous incorporation and investment structuring matters involving domestic and cross-border investors. Getting the structure right at the outset prevents costly corrections — in tax, registration, and shareholder disputes — down the line.
Click here for detailed information