After the death of Hanjin Group chairman Cho Yang-ho, Hanjin Group is caught in the trap of inheritance taxes. This is because Cho Won-tae, his son and president of Korean Air Lines Co., would have to give up his management rights and sell part of the stakes he inherits to pay inheritance taxes, which are estimated at over 170 billion won (US$149.06 million). He may have to sell his stakes in the group’s major subsidiaries and take out loans collateralized by his shares in order to maintain control of Hanjin KAL Corp., the group’s de facto holding company. It means that the inheritance tax whose top rate reaches 65 percent can determine the destiny of Hanjin Group in the end.
Korean businesses are terrified with the punitively high inheritance tax rate, which is among the highest in the world. In many companies where management control has to be transferred from the founders to their children, ruinous inheritance taxes force the latter to give up succession to the family businesses. Some founders who prepare for succession even say that it is better to sell the firms and give cash to their children.
The nominal top rate of the inheritance tax in South Korea is 50 percent, which is twice as high as 26.2 percent of the average inheritance tax rate of OECD member countries. If the successor of a company inherits the largest stock holdings which have the right of management, just like the late Cho’s case, the tax rate can go up to 65 percent as a control premium of 10 to 30 percent is added. The inheritance tax sometimes forces second and third generation successors to give up management rights. The examples include Unidus Corp., the largest condom producer in the world, Three Seven (777) Co., the world’s No.1 nail clipper firm, Lock & Lock Co., the biggest food storage container producer in South Korea, and local furniture brand Casamia Co. The founders’ children sold their management rights due to the hefty burden of inheritance taxes. Lee Woo-Hyun, CEO of OCI Co., had to give up his position as the largest shareholder by selling his stock holdings to pay 200 billion won (US$175.36 million) of inheritance taxes.
Kang Ho-gap, chairman of the Association of High Potential Enterprises of Korea (AHPEK), recently said, “The top rate of inheritance tax is 65 percent. How can there be long-lived companies in the country? Some investment banks even came to me and asked me to introduce firms where founders’ children give up succession.”
Small and medium-sized companies with assets of less than 500 billion won (US$438.40 million) or annual sales of less than 300 billion won (US$263.04 million) can use the deduction system for family business successionbut there are strict requirements. Accordingly, therehavebeencallsto relax various requirements by revising the related law.
The deduction for family business succession is the system that deducts a certain amount of money from inherited property – 20 billion won (US$17.54 million) for companies with more than 10 years of history, 30 billion won (US$26.30 million) for over 30 years and 50 billion won (US$43.84 million) for over 30 years. Those who benefit from the system cannot sell more than 20 percent of assets of family business for 10 years and are required to serve as CEO. They also cannot change main business for 10 years. Moreover, they are now allowed to close the business for over one year or shut down it. They must maintain the 100 percent level of full-time employeesat the time of inheritance, while mid-size firms are required to keep it at the 120 percent level. These are conditions that are hard to hold under the current business environment which is rapidly changing and frequently witnesses the attraction of investment, merger and acquisition (M&A), exchange of stakes and restructuring. If successors fail to hold the post-conditions, they will be charged the deducted amount of inheritance taxes.
This is why some point out that the system is invalid. In fact, the number of cases using thededuction system for family business succession remained at 70 in 2013, 68 in 2014, 67 in 2015 and 76 in 2016. Recently, several cases of “partial amendment to the Inheritance Tax and Gift Tax Act” which is designed to ease requirements for deduction and expand the amount of deduction have broughttomotions, but they have not debated by the National Assembly yet.
Ryu Ki-jung, director of the Korea Employers Federation (KEF), said, “The business succession issue should be viewed in terms of social andeconomic circumstances, such as creation and maintenance of jobs and business know-how succession, instead of the simple negative view of “inheritance of wealth” and “unearnedincome.”
In addition, critics point out that the premium assessment system for the largest stock holdings which is applied to Hanjin Group’s share of inheritance after the death of Cho is also problematic. The system applies 10 to 30 percent of premium inheritance tax rate considering a management right premium when successors inherit the largest stock holdings which have the right of management. This is why 50 percent of the nominal top rate of inheritance tax in South Korea can increase to up to 65 percent in reality. South Korea is the only country among OECD member states that puts a burden on succession of management rights by uniformly assessing the premium of the largest stock holdings. Accordingly, there have been growing calls on the business community to abolish the controlling stock holdings’ premium assessment system.