Perspectives from ISB

What to do if you’re a 95-year-old billionaire and you live in a country with inheritance taxes as high as 65 per cent? That’s the challenge facing the family of coffee baron Kim Jae-myeong, honorary chairman of Dongsuh group. It’s a common story in South Korea, which rose to become a global industrial powerhouse dominated by family-run entities known as chaebol. Now those groups are under increasing scrutiny for business practices that have kept the families in power for decades. Failure to plan the transfer of wealth to the next generation risks losing both a big chunk of that fortune and the family’s control of the company that created it.

As a result, the nation’s wealthy dynasties have developed circuitous ways to pass down money, such as directing lucrative deals from family businesses to affiliates controlled by heirs. But with the chaebol deeply unpopular after a series of bribery and corruption scandals, the government is working to close some of the biggest loopholes, potentially encouraging capital flight as families fight to preserve wealth.

The FTC’s regulations for abusing intra-group business deals apply only to companies with more than 5 trillion won in assets and when owner families’ stakes in affiliates exceed 30 per cent. “There are many companies who have gotten away with regulations by adjusting the ownership stake at 29.9 per cent to avoid the threshold of 30 per cent,” FTC Chairman Kim Sang-jo said at a parliamentary hearing in June.

The Kims own 66.1 per cent of Dongsuh Cos. A series of family transfers that began in 2006 left his two sons with 38.3 per cent of the business and his eldest grandson with 11.2 per cent, the third-largest stake. The ownership structure caused controversy when a closely held Dongsuh affiliate came under scrutiny for gaining almost all of its revenue — 93.5 per cent — from other Dongsuh units. The dividend payout ratio reached 88.9 per cent in 2013, when the grandsons owned more than 50 per cent of the business. They have since transferred their stakes to the listed holding company.

The government is clamping down. Even if the commission manages to shut down the inter-group transfer route, families still have other ways to avoid paying inheritance taxes. One is to move money, usually in the form of stakes held by family members in their business empires, to charitable foundations. Another is to combine business units, as Samsung did with its 2015 merger of Samsung C & T and Cheil Industries.

“There are cases in which owner families have no choice but to sell their companies to pay high tax bills,” said Lee Tae-kyu, a research fellow at the Korea Economic Research Institute in Seoul. “We might end up with a lack of companies with a long history and expertise as inheritance tax burdens could force them, especially those small and medium-size companies, to give up on succession planning.”

Source: Lee, Yoojung, January 15, 2018 Gulf News,

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