Major South Korean companies are increasingly turning to a tax-free dividend strategy, distributing payouts by reducing capital reserves rather than using operating profits. This approach, which gained traction after Meritz Financial Group’s high-profile adoption last year, is particularly favored by firms where controlling shareholders hold large stakes.
As the March annual general meeting (AGM) season begins, several major companies—including OCI, Daishin Securities, Woori Financial Group, L&F, Yulchon, and Ildong Pharmaceutical—are putting forward proposals to reduce reserves, approve capital reserve reductions, or transfer capital reserves to retained earnings. Companies of all sizes and industries are embracing this method, known as capital reserve-funded dividends.
Despite the term, these dividends do not involve reducing payouts. Instead, they allow companies to convert part of their capital reserves into retained earnings, which are then distributed to shareholders. Investors are welcoming the move, calling these dividends effectively tax-free.
Typically, dividends are paid from a company’s retained earnings accumulated through business operations and are subject to a 15.4% dividend tax. However, dividends funded by reducing capital reserves are classified as capital transactions rather than income, making them tax-exempt. This is because they are considered a return of capital originally contributed by shareholders. The legal basis for this practice was introduced following amendments to S. Korea’s Commercial Act in 2011.
Since the 15.4% dividend tax is not applied, shareholders effectively receive 18.2% more in net income. High-net-worth individuals benefit even more, as those whose combined dividend and interest income exceeds 20 million won (about $13,790) per year face a comprehensive financial income tax of up to 49.5%. By receiving capital reserve-funded dividends instead of traditional dividends, they can avoid this additional taxation.
For example, if a company distributes $10 billion as regular dividends and the highest tax rate applies, the net payout would be around $5.13 billion. In contrast, through capital reserve-funded dividends, shareholders would receive the full $10 billion tax-free. This tax advantage is why some investors see these stocks as the ultimate dividend plays.
The growing adoption of capital reserve-funded dividends can be traced back to Meritz Financial Group, which first implemented the strategy.
In 2023, the company converted about $1.4 billion of capital reserves into retained earnings, securing a massive pool for tax-free dividends. The move stemmed from its acquisition of Meritz Fire & Marine Insurance and Meritz Securities as subsidiaries, which created capital reserves that were later reallocated for dividends.
One investor, who bought Meritz Financial Group shares after the announcement, said, “During dividend season, I usually have to sell some shares to avoid comprehensive financial income taxation, which is a hassle. But with stocks offering capital reserve-funded dividends, there’s no need for that.”
The biggest beneficiary of this strategy was Chairman Cho Jung-ho, the company’s largest shareholder, who at the time held a 48% stake. He received about roughly $158.93 million in dividends without paying any taxes.
By comparison, Samsung Electronics Chairman Lee Jae-yong was expected to receive over $206.67 million in dividends the same year, but his net amount after taxes was less than about $124 million. The contrast underscores the massive tax benefit of capital reserve-funded dividends. Chairman Cho is expected to receive another about $89.5 million tax-free this year, based on 2024 fiscal results.
Market analysts point out that companies with high ownership stakes held by controlling shareholders, or those requiring substantial funds for inheritance or asset restructuring, are at the forefront of this trend.
Among them, Celltrion is seeking approval to reallocate reserves, with a 28.4% largest shareholder stake. KCC Glass has proposed a reserve reduction, with a 43.7% largest shareholder stake. HS Hyosung is looking to adjust its reserves, with a 57.7% largest shareholder stake.
Yonsei University professor Lee Nam-woo said “The rise in tax-free dividends comes as the interests of controlling shareholders and general investors are increasingly aligned.” He added that it is ultimately up to the board of directors to decide how much equity the company should retain to ensure financial stability.
