[Jeon Daegyu's 7 Trials and 8 Failures] Inheritance Bankruptcy, Cannot Be Free from Taxes

Jeon Dae-gyu, Chief Judge of Seoul Bankruptcy Court

Mr. Kim Ik-su (a pseudonym) applied for limited approval regarding inheritance at the Seoul Family Court on May 6, 2019, after his father passed away. Subsequently, on February 20, 2020, he filed for bankruptcy of the inherited property at the Seoul Rehabilitation Court, and a bankruptcy declaration was made. The Gangnam District Office confirmed on March 10, 2020, that Mr. Kim had an apartment among the inherited properties and imposed an acquisition tax of approximately 50 million KRW. Mr. Kim then filed an objection, claiming that since he had made a limited approval and a bankruptcy of the inherited property was declared, the Gangnam District Office’s imposition of acquisition tax was illegal. The question is whether Mr. Kim must pay the acquisition tax.

The author has been serving as the chairman of the Seoul Metropolitan Local Tax Deliberation Committee since this year. The committee holds bi-monthly reviews of objections filed against local taxes imposed by local governments or reported and paid by taxpayers, as well as pre-assessment reviews. Although taxes are closely related to our daily lives, business owners and individuals generally pay little attention until the tax is actually imposed. Even as chairman, while reviewing objections and pre-assessment reviews, this impression remains. If tax laws are properly utilized, legal tax reduction is possible. Various cases come through objections. Recently, there have been several objections requesting cancellation of acquisition tax or automobile tax on the grounds that bankruptcy of inherited property was declared. For example, a complainant who applied for and received limited approval from the court regarding inheritance after his father’s death and was declared bankrupt for the inherited property filed an objection claiming illegality when the local government imposed acquisition tax on the inherited property.

Limited approval refers to the act of inheriting on the premise that the heir’s responsibility is limited to the extent of the deceased’s property when it is unclear whether the deceased had more assets or debts at the time of death. This system was established to prevent heirs from suffering unfair damage due to excessive debts of the deceased under the principle of automatic inheritance upon death. For instance, if a father dies leaving 1 billion KRW in real estate and 1.5 billion KRW in debt, the heir inherits the debt only up to the 1 billion KRW worth of property. Conversely, if there is 1 billion KRW in real estate and 500 million KRW in debt, the heir inherits the debt up to 500 million KRW. Of course, all property is inherited. Acquisition tax is a tax paid by taxpayers when acquiring real estate or similar assets. Here, acquisition includes purchase, exchange, inheritance, gift, donation, in-kind contribution to a corporation, construction, repair, reclamation of public waters, land formation by reclamation, and other similar acquisitions, including original acquisition, succession acquisition, or all acquisitions whether paid or unpaid. Since limited approval also falls under inheritance, acquisition tax must be paid even if limited approval is made.

What about when bankruptcy of inherited property is declared? Bankruptcy of inherited property refers to a bankruptcy procedure that separates the inherited property from the heir’s personal property and liquidates the inherited property to adjust the interests of the creditors of the inheritance and those who received legacies when the inherited property cannot fully satisfy the debts to the inheritance creditors and legacy recipients. While limited approval limits the responsibility property to the inherited property for the inheritance creditors, the heir manages the inherited property and repays the inherited debts and is not a fair and neutral third party like a bankruptcy trustee.

Moreover, limited approval does not have a creditor investigation procedure, nor does it have a system to deny or restrict set-off, so there is no way to forcibly correct payments that are disconnected from reality, biased satisfaction, or unfair reduction of inherited property. Therefore, the "Debtor Rehabilitation and Bankruptcy Act" establishes a strict bankruptcy procedure for the inherited property itself so that inheritance creditors or legacy recipients can receive fair and equal repayment according to their rights. Bankruptcy of inherited property is a system that separates the inherited property from the heir’s personal property and liquidates it fairly under stricter procedures than limited approval. Does the heir bear tax obligations such as acquisition tax when bankruptcy of inherited property occurs? When bankruptcy of inherited property occurs, the heir is regarded as having made limited approval. Even if a bankruptcy estate is established through bankruptcy of inherited property, the management and disposition rights over the bankruptcy estate belong to the bankruptcy trustee, but the effect of inheritance does not disappear. Even with bankruptcy of inherited property, the heir bears tax obligations related to the inherited property (such as acquisition tax and automobile tax). In conclusion, Mr. Kim must pay acquisition tax whether he made limited approval or was declared bankrupt for the inherited property. If Mr. Kim wants to avoid paying acquisition tax, he must renounce the inheritance.