[Chatham House Roundtable] "Succession of Family Business Means Companies Continue Generations, Creating Jobs and Paying Taxes"

SME Succession Deduction, Criticism of Asset Inheritance Not Appropriate
Business Succession Should Be Smooth to Create Jobs and Contribute to Corporate Tax
Insufficient Government Support in Korea... Effectively the World's Highest Inheritance Tax Rate
System Improvement and Social Awareness Change Needed

Editor's NoteAs Korea's economy experienced rapid growth, the aging of the founding generation of small and medium-sized enterprises (SMEs) that were established and grew during this period has highlighted the need for succession by the next generation. Succession of SMEs, which account for 99% of domestic companies and over 80% of corporate employees, is an essential issue for maintaining the national industrial base and revitalizing the economy. Although the government has significantly reformed systems related to business succession, many SME owners still face difficulties in smooth succession due to burdens such as gift taxes. On the 22nd of last month, Asia Economy held a "Chatham House Roundtable" at its headquarters in Jung-gu, Seoul, to discuss succession plans for SMEs aiming to become century-old companies. The Chatham House is a nickname for the Royal Institute of International Affairs (RIIA) in the UK, recognized as a top research institution in diplomacy and security. The roundtable included Park Hwa-sun, Director of Corporate Growth at the Korea Federation of SMEs; Song Gong-seok, Chairman of Watos; Yeo Sang-hoon, Director of Management Innovation at Big Dream; Cho Woong-gyu, Head of Asset Succession at Barun Law Firm; and Choi Soo-jung, Research Fellow at the Startup Venture Innovation Research Office of the Korea Institute for Startup & Entrepreneurship Development (in alphabetical order). The roundtable followed the Chatham House rule, disclosing the list of participants but keeping individual remarks anonymous.

At the 'Chatham House Roundtable' held on the 22nd at Asia Economy in Jung-gu, Seoul, participants are sharing their opinions on the issues and improvement measures of succession in small and medium-sized enterprises. From the left, Yeosanghoon, Head of Management Innovation at Big Dream; Park Hwasun, Head of Corporate Growth at the Korea Federation of SMEs; Jo Ungkyu, Head of Asset Succession at Barun Law Firm; Song Gongsuk, Chairman of Watos; and Choi Sujeong, Research Fellow at the Korea Institute for Small and Medium Enterprises and Startups. Photo by Yoon Dongju doso7@

▶Moderator = Lee Dong-hyuk, Head of Bio SME & Venture Department

Please diagnose the current situation regarding SME succession.

The business succession system has been improved every year. Significant reforms began in 2008, and under the current administration, the pre-gift limit has been expanded. Also, the installment payment period for gift tax was extended from the previous 5 years to 15 years. Overall, I believe an environment that enables stable business succession has been established.

Although improvements in the business succession system are progressing rapidly, there are still gaps in reality. For example, if a son-in-law succeeds his father-in-law's company, he may not legally receive support under the business succession system because the system requires succession by relatives. We need to consider expanding the scope of business succession.

What difficulties are felt in the field of SMEs regarding succession?

When I was young and focused on growing the company, I never even thought about passing it on to my children. Most SME owners did not realize that succession requires long-term preparation. When the time came to succeed, taxes became a major obstacle. The son who inherits must pay almost 60% gift tax, and after paying taxes, nothing remains.

The Korea Federation of SMEs has worked hard every year to make the business inheritance deduction system nearly perfect. However, the pre- and post-conditions for the deduction system are too strict. When trying to relax the conditions, we are criticized for wealth inheritance. Our public opinion, having witnessed some large corporations' loophole successions, views SME succession similarly. They do not understand the value of SME succession, which maintains businesses, allowing the state to collect taxes and employees to receive salaries.

The criticism of wealth inheritance is not valid. The business inheritance deduction does not exempt taxes completely in the long term. By reducing the tax burden initially to allow succession, the company later pays corporate taxes, contributing to the national economy. Although it is seen as wealth inheritance because it is called a tax deduction, the essence is to enable companies to continue across generations, create jobs, and pay taxes.

How about Japan, which has experienced a similar situation ahead of us?

It is often said that Japan's inheritance tax rate is 55%, the highest in the world, and ours is 50%, the second highest. But this is not true. Currently, Japan also faces a lack of successors, so the government actually supports money to encourage succession. Japan provides various reliefs, including extended tax deferrals until 2027 under special laws, to ease burdens due to changes in the business environment.

Besides the inheritance tax rate, we should look at the scope of inheritance deductions. The UK, the US, and France have no spousal inheritance tax. Japan also does not impose inheritance tax on the spouse's statutory share. Only the children's share is taxed up to 55%. However, in Korea, the spousal deduction is only up to 3 billion KRW, which is insignificant when succeeding companies worth over 10 billion KRW.

Japan enacted the Business Succession and Management Revitalization Act in 2008. Their succession support system comprehensively includes M&A support and financial assistance. However, our succession support focuses only on taxes. We need to benchmark Japanese laws and refine our business succession support system.

The SME sector sees tax support as insufficient. What are the reasons?

Unlisted SME stocks are only for maintaining management rights and are practically worthless as assets. However, when inherited, separate cash is needed to pay taxes. Some may give up inheriting these worthless shares and close the business, causing employment issues. This requires social consideration.

There are also problems when succeeding listed stocks. Stock succession tax is calculated based on the average price over four months. In my case, sales and operating profits declined, but the stock price rose due to news of succession. The succession date was already set, but the stock price increased just a week before succession due to the issue, resulting in huge taxes. This conflicts with the government's 'Value Up' policy to enhance corporate value.

Abroad, many succeed businesses through foundations or trusts, allowing various solutions related to inheritance tax. Korea lacks such options.

Setting tax deduction limits by amount causes ongoing problems. Korea is the only country that sets limits by amount. Japan and Germany base it on the proportion of total assets.

What other problems are encountered regarding business succession?

If the business inheritor changes the industry within the major category of the standard industrial classification, they can receive gift tax special treatment for business succession. However, during recent preparations, I found that the company's major category changed, so I could not receive inheritance tax deductions. My father founded a stationery distribution company, classified under distribution. But I saw distribution alone was not competitive, so I started producing and selling our own brand of scientific educational tools. As a result, the major category changed from distribution to manufacturing, and I lost the tax benefits. Isn't it contradictory that developing the inherited business into a related field disqualifies succession support?

Looking at the scientific educational tools case, the business can evolve from distribution to manufacturing and further to education. When there is business relevance, the major category should not apply, and succession support should be available.

Business succession should shift to a negative regulation system. Next-generation managers want to grow and develop the company, but regulations and systems should not block such attempts.

If the business changes to an industry outside the major category within five years after receiving tax support for succession, inheritance and gift taxes are fully reclaimed. This standard has recently been relaxed considerably. Although many legal improvements have been made, the field still feels inconvenienced. In today's rapidly changing business environment, companies must invest not only in existing industries but also in new businesses and R&D.

Legal issues are not the only challenges in business succession.

While preparing for succession, many regulations cause difficulties, but society also tends to underestimate SME succession. When I complained to a friend about difficulties in succeeding the company, the response was, "What kind of business succession is a stationery store?" If friends think this way, how do ordinary people view SME succession? My father started a small distribution business, but I am proud to have successfully inherited and developed it. Despite creating jobs and paying significant taxes, public perception is discouraging.

Korea lacks legislative support awareness for SME succession. This leads to criticism of wealth inheritance. For example, the business inheritance deduction allows business owners who have managed SMEs or mid-sized companies for over 10 years to deduct up to 60 billion KRW from taxable inheritance assets when passing the business to children. In Germany, a similar system has over 10,000 cases, but Korea has only 200-300. Despite the system, other regulations hinder its use. Legislative efforts to solve this face criticism of wealth inheritance and stall, preventing smooth improvements.

Even when laws are established, lack of detailed application often prevents proper use. Whether support or regulation, clear application standards should be established to avoid arbitrary interpretation, but in reality, it depends on officials' discretionary interpretations. Even if SME owners believe they can receive support, if officials say no, that's the end. For listed companies, there are issues in determining tax amounts based on stock prices. Currently, the company's BPS (book value per share) is about 11,000 KRW, but the tax is expected to be calculated at about 6,000 KRW. What about the remaining 5,000 KRW? There is no codification on this. Lack of detail causes many difficulties.

Please summarize how to improve the business succession system.

It is necessary to distinguish between personal asset succession and business succession. Using public interest corporations to succeed businesses should be considered. Succession through public foundations can reduce gift taxes to ensure business continuity. The business inheritance deduction is similar to capital gains tax, levied when capital is realized and gains occur, not immediately at inheritance. It is necessary to relax regulations and expand the scope of those eligible for the deduction.

Comparing budgets allocated to newly founded startups and existing SME succession support, startup support is overwhelmingly larger. While startups are important, sustaining existing companies through succession is also crucial. R&D support for succession companies is needed. The most important is non-institutional support. Small companies have created many jobs and paid significant taxes, but the public does not recognize this and questions why "silver spoons" should be supported. Policies and systems that gain public consensus are necessary.

Institutional support should enable young successors to invest and innovate in the business. For example, if funds prepared for investment are kept in deposits for over three months, tax benefits related to investment assets are not provided. Regulating reserve funds saved for investment needs to be addressed.

A method to fix asset value at the time of succession is needed. Also, issues with statutory reserved portions exist. If asset size increases after death, taxes are imposed based on the increased assets regardless of the heir's contribution. Although some unconstitutional rulings exist, legislation is needed instead of relying on precedents. Consider changing inheritance tax to inheritance acquisition tax. Inheritance tax applies rates based on the total estate of the deceased, while inheritance acquisition tax applies rates based on the property each heir acquires. Applying inheritance acquisition tax when multiple children inherit SME shares can significantly reduce tax burdens.

Besides tax benefits, pre-succession education is important. Japan has centers where those wanting to succeed businesses can receive counseling, including succession consulting and legal support, all funded by the government. We need such comprehensive support systems.

▶Summary by Lee Seung-jin