High inheritance tax hampering entrepreneurship

In this 2010 file photo, late Samsung Group Chairman Lee Kun-hee, center, is seen with his family members at the Consumer Electronics show held in Las Vegas. Courtesy of Samsung Group

By Yoon Ja-young

Oct. 25 marks the first anniversary of the death of Samsung Group Chairman Lee Kun-hee. During the past year, the bereaved family handled a huge task: paying 12 trillion won ($10.1 billion) in inheritance tax. The family, which obtained loans to pay the tax, recently decided to sell 2 trillion won worth of shares.

The story has turned the spotlight on Korea's high inheritance tax, which the business circle says hampers entrepreneurship, and has prompted the government to consider revising the taxation system

Necessary but too much

Few people would disagree with the view that inheritance tax is necessary for a healthy society by lowering the concentration of wealth and enhancing equity. It is also true that only a handful of the rich are subject to the tax. According to the National Tax Service, only 2.9 percent of the heirs of deceased persons were subject to inheritance taxes last year.

Business people, however, say the tax is too high compared to other countries. Under the current inheritance tax system introduced in 2000, up to a 50-percent tax rate is applied to inherited assets that exceed 3 billion won. That is the second highest among member countries of the Organization for Economic Cooperation and Development (OECD) following Japan at 55 percent, according to the Korea Enterprises Federation. When inheriting stocks from the largest shareholder of a business, another 20 percent tax is levied on the "managerial control premium."

"Korea is among the top in terms of not only the nominal tax rate but also in real taxes paid after deductions. It lacks support for business succession, such as tax cuts for inheritance by children," said Ha Sang-woo, head of economic research at the Korea Enterprises Federation.

The government offers tax exemptions when inheriting businesses, but these only apply to small and mid-tier companies that meet certain criteria, such as annual sales that fall short of 300 billion won. Therefore, it is difficult for the owner's family to keep control over the business for more than two generations, and this is a problem not only for conglomerates such as Samsung.

The family of the owner of Three Seven, which was the top nail clipper manufacturer, had to sell all of their shares in 2008 due to a hefty inheritance tax burden following the sudden death of the founder. The family of the owner of Unidus, which was once the world's top condom manufacturer, also handed over managerial control of the company to a private equity fund in 2017 due to the inheritance tax; and the founder of kitchen utensil manufacturer LocknLock also sold his stake to a private equity fund in 2017 instead of handing over the business to his family, reportedly due to the burden of inheritance tax.

Real estate better than business?

According to an analysis by Lee Young-han, a professor at the Department of Science in Taxation at the University of Seoul, inheriting real estate turned out to be more profitable than inheriting a business after taxation. When considering that real estate prices tend to continue rising, as well as the difficulties involved in managing a company, it means there is less motivation to inherit a business.

"Inheriting and maintaining the philosophy of the founder is essential for the competitiveness of businesses, and family-run businesses often come up with high levels of achievement in the long term. Despite this, the tax burden motivates them to sell and give up the business or attempt to evade taxes," Lee said.

Analysts say the excessively high inheritance tax thus could hamper entrepreneurship.

"The excessive burden of inheritance tax sets barriers to inheriting a business. It not only diminishes assets but also makes the inheritance of managerial control uncertain. As a result, it can weaken entrepreneurship," said Lim Dong-won, a research fellow at the Korea Economic Research Institute.

He said the ownership succession of a business is not just about handing over wealth, but also contributes to a country's economic growth, including job retention, and should not be overlooked.

"When considering the impact it has on the sustainability of the business and the country's economy, the inheritance tax system should be overhauled," he added, suggesting lowering the inheritance tax rate to the OECD average of 25 percent as well as abolishing additional taxes for inheriting shares from the largest shareholder.

According to the National Assembly Research Service's analysis of 38 OECD countries, 24 members levy inheritance taxes. Seven countries levy no inheritance tax at all, while the rest levy taxes on capital gains or extra income.

Some experts suggest that Korea should also levy inheritance acquisition taxes instead of inheritance taxes so that each of the family members can be subject to a lower tax rate.

The Ministry of Strategy and Finance plans to start revising the inheritance tax based on research by the Korea Institute of Public Finance, which is scheduled to be submitted to the ministry around the end of this month.