The Effects of Fund Taxation on Rate of Return of Mutual Funds

This study investigates whether tax factors affect the rate of return on a fund by performingempirical analysis. With regards the traditional financial instruments, such as stocks and bonds,previous studies empirically demonstrated that the rate of return on assets affected by changes intaxation also experience changes. On June 1, 2007, the Korean government implemented a temporary tax act previously proposed onJanuary 16, 2007 for overseas investment funds with the aim of vitalizing foreign investments andstabilizing the foreign currency market. The main provision of the act is tax exemption on gains fromthe disposal or evaluation of foreign listed stocks invested through the overseas investment funds underthe Indirect Investment Asset Management Business Act. This study investigates whether the tax exemption rule for the overseas investment funds affects pre－tax returns on the funds by considering the announcement or enforcement of the exemption asevents. This study finds that both a tax capitalization effect and a lock－in effect exist on returns forfunds when a tax exemption is introduced. In particular, after the announcement of the tax exemptionintroduced, the rate of returns for overseas investment funds significantly increased (tax capitalizationeffect), whereas upon the enforcement of the tax exemption, the rate of returns for overseas investmentfunds significantly decreased (lock－in effect). Given that a fund is less dealt with in a tax empirical study area compared with traditional financialinstruments such as stocks and bonds, this study contributes to the tax study area by performing theempirical tests comprehensively with the aim of identifying whether tax factors affect rate of returnearned by funds.