Study on the Effect of Taxation on Investment in Funds with Indirect Investment Structure : Evidence from Korean Market

This study investigates whether the temporary tax exemption for overseas equity funds with indirect investment structure under the Korean tax law affects fund investors’ investment decision-making. We analyzes changes in cash flow to overseas equity funds with indirect structure at the time of enforcement and expiration of RSTA 2016 by comparing them with cash flow to domestic equity funds and cash flow to overseas equity funds with direct structure, respectively. The empirical analyses confirm that net cash flows to overseas equity funds with indirect structure are higher than domestic equity funds with the enforcement of the tax exemption rule. The fund investors attempted to reduce their tax burden by investing the tax-favored funds compared with the tax-unfavored funds after the enforcement of the rule. With respect to the test of comparison of cash flows to funds with direct and indirect structures with the enforcement, additional cash flows have been determined to come to overseas equity funds with direct than indirect structure. The fund investors probably preferred the funds with direct than indirect structure as tax uncertainties exist in the calculation of non-taxable income to be distributed to fund with indirect structure. We have limited test results around the sunset of the tax exemption. We attribute the limited results to the investment capping rule and the seasonal effect. This study contributes to the extremely limited literature that explores the fund structure affecting the fund investors’ decision-making from a tax perspective.