There is now one more factor that must be considered when planning business succession, as the Civil Act amendment under discussion in the National Assembly has passed.
On the 9th, at the office of Barun Law LLC in Daechi-dong, Gangnam-gu, Seoul, Cho Ung-gyu, head of the Asset Succession Division at the Estate Planning (EP) Center, explained the newly changed reserved portion system and said this. Cho said, If a lawsuit over the reserved portion arises in the corporate succession process, it has now become difficult to resolve it simply by transferring some shares.
The core of the Civil Act amendment recently passed by the National Assembly plenary session is the change in the method of returning the reserved portion. If some heirs claim their reserved portion, the amendment requires returning it in cash value, not in kind such as equity in real estate or unlisted shares. It will take effect immediately after presidential approval and promulgation procedures.
Cho, the Deputy Minister, said, Until now, many cases were resolved by a method of transferring some shares when a dispute arose, but going forward, because the payment must be made in cash by selling shares, it may become much harder for the successor to maintain equity.
The problem is especially bigger for unlisted corporations because share transactions are not active. Cho said, Unlisted shares are hard to liquidate immediately in the market, and added, Ultimately, a situation may arise in which the successor, who must maintain control of the company, has to hurriedly dispose of held equity. He continued, There is also a greater chance that a reserved portion suit will soon escalate into a management control dispute.
As a countermeasure, Cho, the Deputy Minister, suggested drafting a will and a will-substitute trust.
He said, A will is basic, but to reduce disputes it must be drafted much more elaborately, and added, You must consider not only asset allocation by heir but also the possibility of a reserved portion dispute.
A will-substitute trust creates an asset management structure in advance. After death, the asset transfer procedures can become much faster and clearer.
In particular, the successor can quickly secure equity when needed, minimizing any management vacuum. The following is a Q&A with Cho, the Deputy Minister.
─What are some cases where business succession became a problem in practice?
There was a case where equity in an unlisted company valued at 100 billion won in corporate value had to be passed to the successor, but there were three children and even a child born out of wedlock. The successor and the other heirs must raise cash at about 50% of the company's value to pay the inheritance tax.
For the successor to continue management, the founder's equity must not be dispersed, but disputes with other children are frequent. In particular, if there is a child born out of wedlock, a lawsuit to return the reserved portion can derail business succession.
The government provides an inheritance tax deduction of up to 60 billion won for succession of small and midsize companies that have been operating for more than 10 years with sales under 500 billion won.
─Can using the business inheritance deduction solve the problem?
Even if the requirements are met, if the previous generation founded the company as partners, disputes are inevitable. In a company where partners A and B each have 50% equity, if A dies first, A's children can get the deduction only with B's consent. In that case, B's children will not be able to receive the deduction later. Smooth agreement is difficult, and legislative supplementation is needed.
─Why is it particularly difficult for unlisted companies?
A listed company is valued based on the average stock price for the four months around the date of death (the start date of inheritance). By contrast, an unlisted company has no market price, so it is valued under the Inheritance Tax and Gift Tax Act by a weighted average of net worth value and net income value at a ratio of 3 to 2. In many cases, however, the valuation comes out higher than the value seen by the market. As a result, the inheritance tax burden is greater for unlisted companies than listed ones. Also, unlisted shares cannot be paid in kind for taxes, and providing collateral is difficult, making installment payments (deferred payment in installments) not easy.
─Is the current system significantly disadvantageous to unlisted corporations?
You could say so. For example, suppose there is a listed company with a stock value of 50 billion won and the founder's equity is 30%. Currently, about 7.5 billion won in inheritance tax is incurred. But if an amendment passes that requires valuing listed shares using the unlisted method, the tax base could rise significantly. In a situation where the manager cannot arbitrarily adjust the stock price, there could be cases where even if the heir sells all inherited shares, they still cannot pay all the tax.
─If smooth succession is not achieved due to inheritance tax, doesn't operating the corporation become difficult?
Yes. A well-run company faces a management crisis just because the CEO suddenly dies, and workers' livelihoods are shaken. If a corporation disappears due to the inheritance tax burden, it negatively affects employment and is a loss to the national economy.
─How should one set up an inheritance plan for smooth succession?
You can use a method of placing shares in trust by will. If a founder with three children dies, equity is generally divided into one-third each, but a will can place the shares in trust and design it so that only dividend income rights are divided one-third each. If the voting rights are exercised by a trustee (such as a financial institution) in accordance with the successor's intent, management control is also stably ensured.
─What is a will-substitute trust?
It is a structure in which the settlor places assets in trust during their lifetime for management, and after death the assets are transferred to the designated person under the contract. If entrusted to a financial company, fees arise, but it is also possible to designate a third-party individual as trustee.
─If there is no child to succeed the business, how can the corporation be maintained?
The Ministry of SMEs and Startups is pushing to enact a special law to support the succession of small and midsize companies through mergers and acquisitions (M&A). For M&A to become active, easing the capital gains tax burden and supporting the costs of post-merger integration procedures are needed. Overseas, there are cases of passing the business to outstanding internal employees, but the current business inheritance deduction does not apply in such cases, so gift tax must be paid.
─Some argue that the wealthy are emigrating overseas due to the inheritance tax burden.
Some consider it, but actually doing so is not easy. To receive foreign tax benefits, one must be a nonresident who stays in Korea for fewer than 183 days, but if they conduct economic activity in Korea, the tax authorities deem them a resident and levy taxes. Also, if they emigrate, they must pay a capital gains tax calculated on the assumption that all held shares are disposed of, as an exit tax. In the United States, citizens and green card holders must report worldwide income wherever they live, so there are cases where people stay long-term while postponing obtaining a green card.
─Barun Law LLC has signed a memorandum of understanding (MOU) with the Korean American Chamber of Commerce in Los Angeles (LA) to help manage the assets of Korean Americans. What is the secret?
A considerable number of compatriots who have moved to the United States experience disputes over assets or inheritance in Korea. For example, a Banpo apartment worth 200 million won that was entrusted to family at the time of emigration rose to several billions of won, and that family claims it is theirs. Many were unable to exercise their rights due to lack of familiarity with Korean law. The Barun EP Center provides information through seminars and takes on cases related to overseas Koreans' assets in Korea to help them properly exercise their legal rights.