A management crisis that begins after death... Small business inheritance and taxes, you need to prepare in advance [Contribution]

When a small business owner dies, the remaining family has no choice but to consider selling if it is difficult to run the business.
Most of them have problems with off-balance-sheet debt and advance payments, such as policy funds loans.
Advance preparation required for inheritance

Mid-sized companies such as Hanssem and Lock & Lock were sold to private equity funds. The excessive burden of inheritance tax is often cited as the main cause behind this. Coincidentally, both companies switched to a professional management system after the sale, but the management situation actually worsened. This clearly shows how difficult it is to manage small and medium-sized businesses.

When a small business owner dies, there has been an increasing number of cases where the spouse or children consult about inheritance tax issues and whether to sell the company. Here is one example: There was a representative of a company who earned a stable income through salary and dividends during his lifetime. The representative was directly responsible for everything from sales to operations. My spouse didn't know anything about business. The children were young. After the sudden death of the CEO, there was no manpower to replace him, and it became unclear whether the business would continue, leading to inquiries as to whether the inheritance should be given up if a suitable buyer does not appear.

The family remembered that the deceased had said during his lifetime, “I created off-balance-sheet debt while trying to make my financial situation look good for policy fund loans, etc.” In the actual sale due diligence process, problems such as off-balance-sheet liabilities as well as advance payments were identified, and in the process of selling the company, the representative's personal guarantee related to the bank loan had to be sorted out as well.

When reporting inheritance tax, if there is no market value for unlisted stocks, the ‘supplementary valuation method’ is applied. In this case, retroactively based on the valuation base date, the three-year net profit/loss value per share and the net asset value per share at the valuation base date are evaluated by weighting the average at a ratio of 3:2, respectively.

However, if real estate accounts for more than 50% of a company's assets, a ratio of 2:3 is applied. Additionally, if the amount calculated in this way is less than 80% of the net asset value per share, the final valuation is adjusted to 80% of the net asset value per share.

However, if profits were overstated in consideration of loans, etc. during the tax reporting process for the past three years, the net profit and loss value and net asset value were overestimated, and the value of inherited unlisted stocks was also overestimated.

At this time, in order to correct this to reduce inheritance tax, it is necessary to prove that the off-balance-sheet debt actually existed. In addition, if the representative's advance payment is confirmed, the amount may be considered as the deceased's income and may be subject to comprehensive income tax separately from inheritance tax.

During the sale due diligence process, it was confirmed that business performance deteriorated sharply in a short period of time after the death of the CEO. As issues such as off-balance sheet liabilities overlapped, the acquisition amount had no choice but to be set lower than the supplementary valuation amount under the Inheritance Tax and Gift Tax Act. In this process, the heirs even experienced emotional conflict with the buyer who was an acquaintance of the representative.

In the end, after many twists and turns, the matter was resolved when the heirs found a third party buyer and sold the company for a slightly lower amount than was initially discussed. If it is not sold at such a low amount, there may be a situation where the tax authorities impose overestimated inheritance tax based on the supplementary assessment amount under the Inheritance Tax and Gift Tax Act.

Looking at these cases, it may have been a wise decision for the founders of Hanssem and Lock&Lock to sell the companies to a private equity fund when the business environment was good rather than handing them over to their children. Owners of small and medium-sized businesses have to navigate uncertain management situations every day, and at the same time, they have the difficult task of preparing in advance what kind of situation their families will face in the event of an unexpected accident.

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