How to keep a billion dollar fortune in the family, South Korea style

South Korea has some of the world's highest death duties

What to do if you’re a 95-year-old billionaire and you live in a country with inheritance taxes as high as 65 per cent?

That’s the challenge facing the family of coffee baron Kim Jae-myeong, honorary chairman of Dongsuh group, who built a fortune valued at $2 billion by the Bloomberg Billionaires Index. Kim, who’s never appeared on an international wealth ranking, stepped down from management more than two decades ago, but the group remains firmly in family control, with each generation having to find a way to pass down the wealth without running afoul of the taxman.

It’s a common story in South Korea, which rose to become a global industrial powerhouse dominated by family-run entities known as chaebol. Now those groups, from global behemoths such as Samsung Electronics Co. to Korean household names like Dongsuh, are under increasing scrutiny for business practices that have kept the families in power for decades.

High tax

South Korea’s inheritance tax of as much as 50 per cent is the second-highest among members of the Organisation for Economic Co-operation and Development, after Japan, and the rate can hit 65 per cent in the case of the largest shareholder. That means failure to plan the transfer of wealth to the next generation risks losing both a big chunk of that fortune and the family’s control of the company that created it. As a result, the nation’s wealthy dynasties have developed circuitous ways to pass down money, such as directing lucrative deals from family businesses to affiliates controlled by heirs. The government is working to close some of the biggest loopholes, potentially encouraging capital flight as families fight to preserve wealth.

Of 27 conglomerates with assets exceeding 10 trillion won ($9.4 billion), contracts between companies in that group reached 152.5 trillion won in 2016, according to South Korea’s Fair Trade Commission, the nation’s top antitrust watchdog. That represents 12 per cent of their deals that year. The chaebols of fellow billionaires Chung Mong-koo of Hyundai Motor Co., Chey Tae-won of SK Corp., and Lee Kun-hee of Samsung Electronics Co. are the top three in terms of inter-company transactions: Hyundai reported 30.3 trillion won, followed by SK with 29.4 billion won and Samsung with 21.1 trillion won.

Mounting pressure

The FTC’s regulations for abusing intra-group business deals apply only to companies with more than 5 trillion won in assets and when owner families’ stakes in affiliates exceed 30 percent. Hyundai in particular has faced mounting pressure to address intra-group transactions.

Coffee cache

At Dongsuh, Kim’s two sons have taken turns to lead the business, which they control through family stakes in publicly listed Dongsuh Cos., and the process of handing leadership to his grandchildren is underway. A Dongsuh spokesman confirmed the family’s holdings, while declining to comment on Kim’s net worth or the transfer of wealth.

Dividend controversy

The ownership structure caused controversy when a closely held Dongsuh affiliate came under scrutiny for gaining almost all of its revenue — 93.5 percent — from other Dongsuh units. The dividend payout ratio reached 88.9 percent in 2013, when the grandsons owned more than 50 percent of the business. They have since transferred their stakes to the listed holding company. The watchdog hasn’t taken action against Dongsuh, which has about 2 trillion won in assets.

Charity stakes

Even if the commission manages to shut down the inter-group transfer route, families still have other ways to avoid paying inheritance taxes. One is to move money, usually in the form of stakes held by family members in their business empires, to charitable foundations. Another is to combine business units. How companies manage to transfer wealth through generations is key to Korea’s longstanding business model. But it requires a close-knit family and the trust of the patriarch in handing over both power and money, something that doesn’t always run smoothly as the current feud between two sons at the giant Lotte retail group shows.