Samsung Headquarters in Seoul's Gangnam district. Photo: AFP

Samsung Electronics is a well-known brand that is familiar to most of us. Its products range from famous mobile phones such as Galaxy and semiconductors that go into laptops. Not surprisingly, its share price has gone up considerably in the past decade, almost tripling from 2010 to 2020.

With the recent global market meltdown caused by the Covid-19 pandemic, however, the share price has plummeted from its recent high. Many think it is an opportune time to buy Samsung Electronics shares during this downturn, especially South Korean individual investors who have been grabbing some of the millions of shares that have been sold by foreign investors in just a month.

But is this really a good time to buy Samsung Electronics? Perhaps not, given one commonly overlooked risk: South Korea’s high inheritance tax, which serves as a potential red flag for investors. And Samsung is not the only corporation affected by this.

South Korea has the second-highest nominal inheritance-tax rate (50%) in the world, only behind Japan (55%). On top of the nominal 50% tax, there can be an extra premium applied if the shares inherited are considered to have control premium, making the total rate go up to as much as 60%.

Although the 60% rate is rarely applied, many managers of Korean companies have expressed concerns that such a high tax rate hinders the continuity of companies, and often they have been forced to sell and liquidate their companies because they could not pay the inheritance tax.

Source: OECD

In light of this, the recent deaths of some chaebol owners show how large the inheritance-tax burden can be. In my Asia Times article titled Koreans’ choice: kind leader vs competent leader published last year, I explained the imbroglio involving Cho Yang-ho and Korean Air. His death left his family liable to inheritance tax equivalent to 270 billion (about US$216 million, using the exchange rate of 1,250 won per dollar).

Although the Cho family can find other means to pay the tax, there would definitely be pressure to sell shares, putting downward pressure on the Korean Air share price. The chart below shows Korean Air’s share price since his death. Although the inheritance tax only contributed a small portion to the downfall of this once-prosperous airline in my opinion, it is undeniable that the tax only complicated matters as Cho Won-tae, the new majority shareholder and CEO of Korean Air, has to divert his energy to focus on defending management rights rather than on running the business.

Other examples of companies negatively affected by Korea’s high inheritance tax include Unidus Corp, the largest condom producer in the world; Three Seven (777) Co, the world’s No 1 nail-clipper firm; Lock & Lock Co, the biggest producer of food storage containers in South Korea; and local furniture brand Casamia Co. The children of the founders of the above firms sold their management rights and discontinued business because of the hefty burden of inheritance taxes. Lee Woo-hyun, chief executive of OCI Co, had to give up his position as the largest shareholder by selling his stock holdings to pay 200 billion won (US$175.36 million) in inheritance tax.

In Samsung’s case, how much exactly will the Lee family of Samsung Group have to pay in total for inheritance tax when Lee Kun-hee, the chairman of Samsung Electronics, aged 78 and who has been hospitalized for quite a long time, passes away? According to the latest corporate filings released for the third quarter of 2019, he currently holds 4.18% (249,273,200) of total Samsung Electronics shares.

Assuming that the share price remains at around 45,000 won per share (though it is likely to fall further), and that Lee does not have any other property (which is not true, but for simplicity of calculation just assume that he only has Samsung Electronics shares), then the Lee family has to pay 60% inheritance tax, which would total 6.7 trillion won, or about $5.4 billion.

Of course, the inheritance tax can be paid via different methods, and there are some ways to reduce the tax burden. Nonetheless, the sheer amount of inheritance tax outstanding that the Lee family will have to pay to inherit the Samsung Electronics shares is just astonishing and unprecedented.

In principle, all inheritance tax has to be paid in cash within six months from the date of the bereavement. In most cases, properties and shares have to be sold to pay the tax in cash. If this happens, the exact amount and impact are difficult to quantify, but it is obvious that such a large block of shares, once sell trades are executed in the market, would result in significant selling pressure.

Is the business of Samsung Electronics solid? Yes, so far it has been, despite the headwinds it is experiencing due to Covid-19 epidemic and challenges from competing companies. There are numerous research reports analyzing how good Samsung Electronics’ business models are and how much profit they earn every year.

However, all companies in South Korea face inheritance risk as they are bound by Korean law. Investors need to be aware of this potential risk, because business performance and the share price can sometimes turn out be different.

Joon Young Kwon holds a master’s degree in international economics and finance from Johns Hopkins University School of Advanced International Studies (SAIS), and currently works as an economics and finance consultant in Singapore. He runs his own blog and language-learning YouTube channel.