This article is written by Paul Fairbairn and Victoria Symons, Partners at Cripps Pemberton Greenish
The family of the late Samsung Electronics chairman, Lee Kun-hee, has made headlines recently after his estate was told it will have to pay more than 12trn Won ($10.78bn) in inheritance taxes – a record amount.
South Korea has one of the world’s highest inheritance tax rates, at 50% of the value of the estate (with a potential premium on top of that if the deceased held a controlling interest in a company). The tax bill is reported to be funded through a mixture of donations and the sale of family assets including artworks by Monet, Dali and Picasso (to name but a few), but is also likely to require the sale of some of the Lee family’s stake in Samsung.
While the UK inheritance tax regime is not quite so penal, with a ‘mere’ 40% inheritance tax rate, it’s not hard to imagine how a wealthy family could find itself in a similar position if it has not taken the necessary steps to plan in advance.
Mitigating the Tax
Our inheritance tax rate may be unappealing but the regime can be forgiving.
If the family business is a trading business then Business Property Relief may well apply and reduce the value (for tax purposes) of the business and other assets used in the business by as much as 100%. The rationale being that businesses that put back into the economy should not be sold off or broken up to pay a one off tax bill. The relief is not straightforward and it’s easy to lose fall outside the regime inadvertently. Reviewing the business and the application of this relief before it is tested is therefore essential. Unfortunately for Mr Kun-hee’s family, even if he had been subject to UK inheritance tax, the relief would not have applied as only a controlling interest in a listed business qualifies.
Ensuring the succession of a family business through the generations is about more than just the inheritance tax position. If the business is to survive, it’s essential to engage with the next generation and part of that inevitably involves giving them a stake in the business. It just so happens that giving them a stake is also good tax planning, assuming you survive seven years. You can also tailor the rights attaching to their stake, for example by linking the value of that stake to the future growth of the business, thereby reducing tax and providing an incentive to grow the business in one.
Passing value to the next generation does not automatically mean giving away control, at least not until you are ready. The constitutions of family businesses can, and should, have an inbuilt framework for succession. A crucial part of that is managing the tax, not just by minimising it but also by ensuring that it can be paid when the time comes.
Paying the Tax
Few can rely on donations to fund the tax bills, so it’s essential to ensure there are sufficient assets within the estate, ideally outside the company, that can be liquidated should the need arise. If the owners of the business are not too old then insurance may be the best way to manage this and ensure that the spectre of tax is not distracting everyone from the management of the business and the enjoyment of its rewards.
Relying on the sale of business assets such as shares can be fraught with difficulty – with listed companies, the impact on the market could be volatile resulting in the shareholding’s value decreasing. In contrast, shares in private companies are rarely freely transferable; most are subject to pre-emption rights or an outright prohibition on sale other than at the discretion of the board or other shareholders. Negotiating a way through this process can be costly and time consuming.
For entrepreneurial families, the line between ‘family’ assets and ‘business’ assets can often become blurred; if the family owns all the shares in a company, it’s tempting to view them all as coming from one ‘pot’. The tax man, however, would disagree might your accountant. Extracting assets from a company will nearly always have a tax implication. Dividends are subject to income tax and the availability of distributable profits. If there are insufficient distributable profits, the sale of company assets may result in corporation tax and further dividends as the proceeds are stripped out. And that’s all without considering the solvency or best interests of the company itself.
Again the regime can help as even if Business Relief does not apply, or at least not to the entire value, tax might be paid in instalments to ensure the tax can be paid from dividend profits over ten years.
The fact that Lee Kun-hee was in a coma for the 6 years before his death meant planning ahead was not really an option but it is a tragic reminder that for a business considering this inevitable issue sooner rather than later is always sensible.
