US firms facing tax hit in Korea

While private equity firm Lone Star appears closer to finally unloading its contentious 2003 investment in Korea Exchange Bank, the deal appears to be having longer-term ramifications for US private equity firms, which may now be facing a new capital gains tax when exiting deals in the country.

According to reports, the proposed tax – the amount of which is still undecided – has come up partly in response not only to the Lone Star investment, but to recent exits by US firms The Carlyle Group and TPG, which made billions of dollars on Korean investments without paying taxes. Investments by US private equity firms are currently not subject to any capital gains tax under a bilateral treaty, which authorities from Washington are reportedly reluctant to amend.

At the same time, US firms are potentially facing a large capital gains tax hike in their own country, with Congress currently mulling legislation that would double the rate to as high as 36 percent. Such an increase would put the US behind countries such as France and the UK in terms of favourable tax regimes.

South Korea’s move also comes a month after Australia’s tax authority proposed that gains from asset sales by private equity firms be taxed at higher rates, amid accusations by the government that private equity firm TPG owes A$452.2 million ($422.7 million; €282.3 million) in unpaid capital gains taxes from the recent public listing of portfolio company Myer Group. Much like South Korea’s treaty with the US, Australia has since 2006 imposed no capital gains tax on foreign investors in order to better compete with Tokyo, Singapore and Hong Kong.

Australia’s proposal has led to warnings that foreign investment could retreat significantly from the country, while similar impacts could be felt in South Korea even as the country is becoming major source of buyouts in Asia. Morgan Stanley recently predicted an increase in M&A deals in the country in 2010.

In December a Seoul appeals court ruled that Lone Star’s original purchase of KEB was legitimate and cleared two bank officials of charges that they sold it too cheaply. While it is still waiting for a ruling by South Korea’s highest court regarding charges of stock-price manipulation related to the deal, Lone Star founder John Grayken has said he expects to sell the bank sometime this year following two previous failed attempts.