The government is seeking to ease the tax burden associated with generational business succession at small and medium-sized family enterprises. Baek Yong-ho, policy planning chief at Cheong Wa Dae, told a meeting of SME executives on Thursday that the government has set out to introduce the German model that offers generous tax relief to those inheriting family businesses if they maintain employment levels after the transition.
Baek’s remark raised expectations among owners of family-run SMEs, which constitute the backbone of the nation’s economy. Yet it is uncertain when the government would be able to implement the new tax scheme. Baek did not disclose a legislative schedule.
Korea’s present tax rules on business succession are much stricter than those in other countries. For instance, the nation’s top estate tax rate is set at 50 percent, one of the highest in the world and well above 30 percent in Germany, 35 percent in the United States, 40 percent in Great Britain and 10 percent in Taiwan.
Korea’s tax system is also much more rigid in offering tax relief on business assets. Under the current law, a person who inherits a family company can have a maximum 40 percent of the firm’s business assets exempted from the tax base ― if he holds on to more than 80 percent of its assets and 100 percent of his shareholdings for 10 years after succession.
In contrast, a German successor to a family business is entitled to tax relief on 85 percent of the firm’s business assets if the company pays at least 80 percent of the original wages to the employees for five years following the succession. He can claim 100 percent tax exemption if the company maintains the original wage levels for seven years following the transition.
If the German system is implemented in Korea, it would undoubtedly facilitate business succession at small family-owned companies by significantly alleviating the liquidity burden imposed by inheritance tax. In many cases, successors to family businesses lack the cash to pay estate taxes. Thus they are forced to sell off part of the business they inherit.
Asset disposals, however, are bound to impair a firm’s productive capacity. In some cases they even imperil the very viability of the company. To avoid such a situation, some Korean businessmen employ expediencies, including tax dogding.
Surveys show that the higher the liquidity burden, the larger the volume of the assets sold off and, consequently, the worse the subsequent performance of the companies. The odds are high that these companies will ultimately fold, and their employees will lose their jobs.
It is in this context that many advanced countries have in recent years abolished inheritance tax altogether (New Zealand, Hong Kong and Singapore), replaced it with capital gains tax (Canada, Australia, Sweden and Portugal), or lowered its rates sharply (Great Britain, the Unites States, Japan and Taiwan). The main reason for these moves was a desire to safeguard jobs.
Yet in Korea, calls for preferential tax treatment for business successions are still ignored at best and condemned at worst. Family business succession is generally seen as an unwholesome father-to-son wealth transfer that needs to be curbed.
This explains the inability of the government to pass its bill to lower inheritance tax rates through the National Assembly. The bill, submitted in 2008, has been regarded by lawmakers as an attempt to provide tax breaks to the rich.
The government has a stronger case for its proposal to introduce the German tax relief scheme as it will serve two important purposes ― protecting jobs at SMEs and helping them evolve into long-lived companies.
In Germany, the number of companies that belong to the global top three in their business fields in terms of market share amounts to 1,200. Among them, 840 are more than 200 years old. These long-lived family enterprises owe their global competitiveness to their expertise handed down from generation to generation.
These German firms offer an important lesson as to how we should foster SMEs. The government needs to facilitate business successions at family-run companies to help them develop their unique managerial and technological expertise over generations. A small but globally competitive company is not created overnight.
