Islamic Finance in Korea: Is The Timing Right for It?

In Korea, it has been a very frustrating and painful experience for a market participant with a keen interest having to wait for any significant developments to introduce Islamic finance (in particular, Sukuk) transactions because there has been no public debate or discussion of the bill to amend the Special Tax Treatment Control Act (STTCA) since 2011. This is so true especially after witnessing each successful issuance of sovereign Sukuk by the UK and Hong Kong governments in 2014. Yong-Jae Chang writes.

In late September 2009, the Korean government (in particular, the Ministry of Strategy and Finance) prepared a draft amendment of the STTCA and tried to submit it to the National Assembly for approval for the first time. Although the effort was not successful, the proposed amendment aimed to recognise the need for ‘off shore’ Sukuk transactions as an alternative method of raising funds and to offset the existing unfavourable (or so-called ‘double’) tax treatment on such transactions.

The major impediment for Korean entities tapping into the Sukuk market has been the various taxes (including an acquisition tax and a registration tax) which could be imposed on a typical Sukuk structure (involving underlying asset transfers) under the current Korean tax laws. For instance, a typical Sukuk Ijarah structure, which will involve the transfer as well as the lease of an underlying asset, will be subject to adverse tax consequences of having to pay various taxes twice (firstly, at the time of an initial transfer to an offshore SPV and, secondly, another transfer back to the seller) making Sukuk an unfeasible form of financing for Korean entities due to unavoidable additional transaction costs.

In February 2011, a bill was reintroduced again to amend the STTCA by the Korean government and it contained provisions which would offset the existing unfavourable tax treatment of Sukuk transactions involving an offshore SPV. Unfortunately, the latest attempt has failed again due to strong opposition from Korean Christian groups who had lobbied vehemently against the bill and had put undue pressure on those politicians on the STTCA review committee of the National Assembly. There has been no further visible effort from the Korean government since then to amend the STTCA because it was actually the third time the bill was submitted without any success in amending the STTCA.

Although it was critical to waive such unfavourable tax treatment in connection with Sukuk transactions in order to level the playing field between Sukuk and other conventional foreign currency-denominated notes or bonds issued by Korean entities to offshore investors (as the latter is given preferential withholding tax exemption on interest payments under the STTCA), it was also quite obvious that no one in the Korean government wished to be held responsible for any similar rejection in the future.

While Sukuk bear certain features of conventional notes or bonds under the Korean Commercial and Civil Codes (KCC) or the Financial Investment Services and Capital Markets Act (FISCMA), Sukuk does not fit neatly into any one of the types of corporate bonds which are defined in the KCC or FISCMA. Thus, a Sukuk is not an instrument which can be issued by a Korean company under the KCC or FISCMA in the past. However, there is a leading legal scholar in the area of finance, Professor Mee-Hyon Lee of Yonsei Law School in Seoul, who recently published an article to argue that it would be permissible for a Korean (not an offshore) SPV to issue Sukuk in the form of beneficial certificates pursuant to the Trust Act (which was revised in 2011).

Professor Mee-Hyon Lee also suggested that it would be prudent for the Korean financial regulatory authorities to: (i) allow such beneficial certificates (as Sukuk) to enjoy withholding tax exemptions on capital gains income by amending the STTCA, and (ii) create a new category of ‘alternative securities’ under the FISCMA to implicitly include Sukuk. This is a (cautiously) positive movement from the legal community but, of course, the ultimate goal of offsetting the adverse tax treatment in respect of asset transfer for Sukuk would still remain unresolved.

Despite initial expectations in the past that Korea would pave the way for the issuance of Sukuk well ahead of Japan, Hong Kong and Singapore, many market participants are now much less optimistic about the introduction of Islamic finance in Korea and it is still unclear as to when the amendment of the STTCA might actually take place. The current political and economic environment in Korea presents a rather ambivalent outlook for such a change since there will be legislative elections in April 2016.

Notwithstanding the above, there was an important initiative in that the Korea Institute for International Economic Policy, a government think tank, has established the Islamic Finance Forum (IFF) in January 2013 and invited representatives from the private sector to continuously learn more about Islamic finance; and a couple of other private institutions in Korea are following suit and trying to broaden knowledge in Islamic finance together. The IFF has been meeting on a bi-monthly basis since its inception to actively discuss various aspects of Islamic finance and relevant developments in the MENA region and Malaysia with great interest and has been publishing research articles and holding annual seminars on Islamic finance for the last two years.

It is expected that there will be more active discussions of Islamic finance within the private sector and the academic community in Korea within the next 18 months and perhaps the timing is right to collaborate with relevant institutions in Malaysia, Hong Kong, the UK and the Middle East to promote Islamic finance and learn from their respective experiences.


Yong-Jae Chang is a partner of Lee & Ko. This article first appeared in Islamic Finance News (1 July 2015, Volume 12, Issue 26, Page 19 - 20). For more information, please visit