Family Business Inheritance Deduction Reform Imminent: What Executives Preparing for Succession Easily Overlook

Daeryun LLC Attorney Cho Kyung-hee

The government is reviewing a plan to define core requirements of the family business inheritance deduction, such as eligible industries and deduction limits, directly in statute rather than in the enforcement decree. This follows criticism that the standards should be aligned with the purpose of the system after cases came to light in which some large bakery cafes and parking lot businesses took advantage of the family business inheritance deduction.

The family business inheritance deduction is a system designed to support the management succession of small and medium-sized enterprises, currently allowing a deduction of up to 60 billion won. However, since this discussion has not yet reached the stage of a confirmed legal amendment, some argue that, from the perspective of executives preparing for succession, checking whether the deduction is applicable under current standards and reviewing the tax risks that may arise in the future should take priority over the institutional change itself.

Daeryun LLC Attorney Cho Kyung-hee said, "The family business inheritance deduction is not simply a system to reduce inheritance tax, but a system to support the continuous management succession of a company," adding, "It is necessary to first examine whether the requirements are met and the post-management obligations, rather than the deduction limit."

The following is a Q&A with Attorney Cho Kyung-hee.

Q. What changes will result from this family business inheritance deduction reform, and what should executives preparing for succession check first?

A. Looking at the direction currently under discussion, there is a possibility of changes to eligible industries, the scope of recognized business assets, and post-management requirements. For example, a plan is being considered to exclude from the deduction those restaurant businesses that have no actual manufacturing activity, and to prevent excessive deductions using land, a plan is being discussed to narrow the scope of eligible land and set a deduction limit per unit area. In addition, where a secondary business is a non-deductible industry, a plan is being considered to apply the deduction only to assets belonging to the main business. Therefore, executives who are establishing succession plans on the premise of the current family business inheritance deduction need to check not only the deduction limit but also whether their industry will remain eligible in the future and whether there are any problems with their business asset composition. In addition, requirements under current law, such as industry requirements, the largest shareholder's equity ratio, the management period, and the heir's succession requirements, should also be reviewed together. In particular, where there have been past gifts, share transfers, or reorganizations of shareholdings among family members, it may be difficult to judge based on the current shareholding structure alone, so advance review is important.

Q. What disputes most frequently arise in relation to the family business inheritance deduction?

A. The representative issues are whether post-management requirements have been violated and the determination of non-business assets. Article 18-2 of the Inheritance Tax and Gift Tax Act imposes certain post-management obligations, such as maintaining the industry, maintaining shareholdings, and maintaining employment, even after receiving the family business inheritance deduction. Violating these can result in the recapture of taxes already deducted. Disagreements also frequently arise with the tax authorities over whether real estate or financial assets held by a company are assets directly related to the business. There are also not a few cases in which it becomes an issue whether a change of industry or reduction in employment, unavoidable due to changes in the management environment after inheritance, constitutes a violation of post-management obligations. In practice, disputes arise more often in the management process after receiving the deduction than at the stage of applying the deduction.

Q. What is the biggest tax risk in the family business succession process?

A. The valuation of non-listed shares can be seen as the biggest variable. Many executives focus on the requirements of the family business inheritance deduction, but the actual inheritance tax burden varies greatly depending on the corporate valuation result. Article 63 of the Inheritance Tax and Gift Tax Act and Article 54 of the same Act's Enforcement Decree stipulate that non-listed shares be calculated using a supplementary valuation method. Because of this, there are not a few cases where the appraised value is calculated higher than the actual corporate value. In particular, companies with a high proportion of real estate or cash assets may face a higher-than-expected appraised value and thus a greater inheritance tax burden. In addition, whether non-business assets are held and transactions with related parties can also become major tax issues. Regardless of whether the family business inheritance deduction applies, it is important to review the financial and tax structure at the stage before succession and to examine in advance the factors that affect corporate valuation.

Q. What do CEOs tend to overlook during the succession process?

A. In practice, there are not a few cases in which management control disputes arise among family members after succession, or unexpected shareholding structure problems come to light. If succession proceeds without a sufficient plan for the successor's management participation or with an unstable shareholding structure, the operation of the company itself can be shaken. Family business succession is closer to a long-term project to pass on the sustainability of the company to the next generation than to an inheritance procedure at a specific point in time. Therefore, if you are approaching succession, you must prepare not only tax and legal review but also successor development, reorganization of the shareholding structure, and the establishment of a decision-making system among family members. Rather than focusing solely on tax savings, it is most important to create a structure in which the company can be operated stably after succession.

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