[Hard for SMEs to Survive] ① Survival Is Key... Must Maintain 100% Industry and Employment for Inheritance Deduction

Inheritance Tax Deduction for Family Business Succession Difficult to Qualify and More Complex Post-Management
Average Annual Usage Only 75 Cases, Virtually a 'Dormant System'
Even Passing to 2nd Generation Makes Management Harder... "No Choice but to Sell the Company," Plea

[Asia Economy Reporters Kim Jong-hwa and Kim Hee-yoon] "A system must be operated to fit the field, but if no one uses it, it is essentially a system that is not needed."

This is a sharp criticism by Kim Hee-seon, a research fellow at the Small and Medium Business Venture Research Institute, regarding the inheritance tax deduction for family businesses, which is close to a dormant system. The inheritance tax deduction for family businesses is a system that allows business owners who have managed small and medium-sized enterprises with an average annual sales of less than 300 billion KRW for more than 10 years to deduct up to 50 billion KRW from the value of inherited property when passing on their business.

To receive the inheritance tax deduction for family businesses, the manager (decedent) must have managed the family business for more than 10 years and hold more than 50% of the shares. Also, to receive the maximum deduction of 50 billion KRW, the manager’s management period must exceed 30 years. Since only 15.8% of small and medium enterprises survive more than 10 years, it is not unreasonable to call it a "dormant system."

The post-management requirements are even more stringent. Companies that receive the inheritance tax deduction for family businesses must comply with two conditions: ‘maintaining the same industry’ and ‘maintaining employment.’ After business succession, the company must maintain the same industry within the medium classification of the standard industrial classification for 7 years and maintain 100% of regular employee employment or 100% of total wages. Failure to maintain these conditions results in a recoupment of 80-100% of the deducted amount depending on the maintenance period.

Inheritance Tax Deduction for Family Businesses, a ‘Dormant System’ Not Suited to Reality

In the era of the 4th Industrial Revolution, where distinctions and boundaries between industries disappear and unmanned services with smart factories and robots replacing humans are the trend, and especially under the impact of COVID-19 where survival itself is a key issue, South Korea is the only country in the world insisting on post-management requirements. As a result, companies receiving the inheritance tax deduction for family businesses account for only about 1% of all inheritance tax taxpayers annually.

According to the National Tax Service’s National Tax Statistics Portal, from 2016 to 2020, the average annual number of cases using the inheritance tax deduction for family businesses in South Korea was only 75.8, with a deduction amount of 264.6 billion KRW. This contrasts sharply with Germany, where the system is most developed, with an average of 13,169 cases annually and a deduction amount of 27.6 billion euros (approximately 37.1 trillion KRW).

Research fellow Kim said, "When meeting business owners for research, they say they do not use the inheritance tax deduction for family businesses because they cannot meet the post-management requirements," adding, "If it is difficult to raise the deduction limit for ‘pre-gift’ given during lifetime, the post-management requirements can be improved." He suggested eliminating the industry maintenance requirement and reducing the employment maintenance requirement from ‘7 years 100%’ to ‘5 years 80%.’

The negative perception that business succession is merely ‘wealth inheritance’ to family members must also change. Research fellow Kim emphasized, "To secure national industrial competitiveness, business succession should be viewed not as passing property to children or relatives, but from the perspective of business continuity," adding, "The system needs improvement so that companies can maintain social value and continue to create economic added value."

The small and medium-sized enterprise sector argues that the inheritance tax deduction for family businesses should be made more practical by allowing industry changes according to industrial trends and expanding the shareholding requirements for business stability. Photo by Getty Images

High Inheritance Tax Discourages Entrepreneurship and Management Will

Kim Jong-hyun, CEO of Saek, emphasized that from the perspective of small and medium enterprises, the gift tax burden on disposing of company stocks and assets before inheritance should be reduced. He said, "If you use the special taxation system for family business gifts, only 10-20% of the tax rate applies, but the problem is that the limit is only 10 billion KRW," adding, "In reality, small and medium enterprises pay an average of 30.5% of inherited property as inheritance tax, and if a manager does not own 100% of the shares, it becomes difficult to conduct smooth management even if the business is passed on to the second generation."

According to a survey by IBK Industrial Bank’s Economic Research Institute, 33% of small and medium enterprise owners are aged 60 or older, meaning more than one-third need generational change within 10 years. Currently, only 3.5% of these companies have completed succession.

Jo Bong-hyun, director of IBK Economic Research Institute, explained, "If the industry is changed or employment maintenance requirements are not met, inherited property must be disposed of within 7 years, and if the heir’s shareholding falls below the standard, taxes can be reclaimed even after inheritance," adding, "To realistically utilize the system, industry change should be allowed according to industrial trends, the shareholding requirement should be lowered from the current 50% to 30%, and the asset disposal requirement should be expanded from the existing 20% to 30%." Jo said, "Most managers want smooth succession while they are alive," adding, "To reduce the gift tax burden from pre-inheritance, raising the special gift tax deduction limit to 50 billion KRW, like the inheritance tax deduction for family businesses, could be a solution."

Hwang Yong-sik, professor of business administration at Sejong University, pointed out, "High inheritance tax acts as a negative factor that can discourage entrepreneurship and business will," adding, "In the rigid domestic labor market environment, if inheritance tax burden is added, managers will accelerate the ‘de-Korea’ phenomenon by relocating factories overseas, and many small and medium enterprises will also push for overseas relocation."