Transfer of Control and Tax Implications

In a meaningful move for one of South Korea’s largest conglomerates,Hanwha Group Chairman Kim Seung-yeon is initiating the transfer of control to his three sons. While the elder Kim will remain chairman, providing “strategic advice and support for global business,” as stated in a Hanwha Group statement, the transfer is not without its complexities. The immediate hurdle is a ample gift tax, estimated at 221.8 billion won (approximately $150.7 million USD).The group has emphasized its commitment to “pay transparently and in good faith.” however, questions linger about the financial strategies employed to manage this considerable tax burden.

This transition mirrors similar shifts within other family-controlled business empires, known as “chaebols,” in South Korea. These transitions frequently enough involve intricate intra-group transactions and are subject to intense public and regulatory scrutiny, akin to the estate tax debates surrounding wealthy families in the United States, like the Walton family (Walmart) or the Koch brothers.

Concerns surrounding Hanwha Aerospace and Internal Transactions

Despite Hanwha Group’s assurances of clarity, concerns have surfaced regarding the role of hanwha Aerospace in facilitating the inheritance process. Allegations suggest that Hanwha Aerospace may have been leveraged to generate resources for inheritance tax payments.

Specifically, the acquisition by hanwha Aerospace of a 7.3% stake in hanwha Ocean last month for 1.3 trillion won, funded by Hanwha Energy and Hanwha Impact Partners, both closely linked to the Kim family, raised eyebrows. Soon after this acquisition, Hanwha Aerospace announced a 3.6 trillion won capital increase. This led to shareholder complaints that the company was essentially cashing out Hanwha Energy, owned by the owner’s family, and then asking shareholders to foot the bill for future business investments thru a paid-in capital increase.

This kind of maneuver raises concerns reminiscent of corporate governance issues seen in U.S. markets, such as potential conflicts of interest and the prioritization of family interests over those of minority shareholders. Imagine, for instance, a scenario where a U.S.-based company’s subsidiary is used to finance the controlling family’s personal expenses – it would likely trigger SEC investigations and shareholder lawsuits.

Dividends, Donations, and the Taxman

The timing of Kim Seung-yeon’s equity donation and the dividend payments received by Kim Dong-kwan, the likely successor, are under scrutiny. One major question is how Kim Dong-Kwan will address the taxes generated by his father’s equity donation.

Last year, Kim Dong-kwan received a total of 9.199 billion won from Hanwha, Hanwha Aerospace and Hanwha Solution. In February, Hanwha Co., Ltd. decided to pay cash dividends of 800 won and preferred stocks of 850 won in 2024. Kim received a total of 3.6 billion won as a preferred stock and a common stock dividend.

Hanwha Energy, which owned 22.16% of Hanwha Co., Ltd., received KRW 13.3 billion in dividends last year.Kim is holding half of Hanwha Energy’s stake in Hanwha Energy, so it’s estimated that he received 50% of the dividend of 13.3 billion won, about 19.5 billion won last year in total.

Even with these substantial dividends,questions remain whether existing dividends and remuneration alone will be enough to cover the gift taxes. This leads to suspicion that higher-dominant affiliates may be asked to help fund the gift taxes.

The donation tax,estimated at 221.8 billion won, is based on the average closing price from March 4 to 31.However, this is not a confirmed tax amount. The final donation tax is determined by applying the average of the stock price for two months before and after April 30, so fluctuations in the stock price could increase the donation tax.

Minority Shareholder Discontent

Kim also faced complaints from minority shareholders who were overwhelmed by the declaration of the capital increase of 3.6 trillion won. Kim has started a stake in Hanwha aerospace, which is directly 3 billion won. Consequently, there is an observation that the business community has limited resources for paying gift taxes with existing dividends and remuneration alone.

Hanwha Energy’s Role.

Hanwha Aerospace decided to acquire 7.3% of Hanwha Ocean’s stake in Hanwha Ocean, which was owned by Hanwha Impact Partners (5.0%) and Hanwha Energy (2.3%) last month. Hanwha Impact Partners is 100% subsidiary of Hanwha Impact, and Hanwha Impact’s largest shareholder is Hanwha energy (52.07%). Hanwha Energy has stopped dividends after the dividend dividend of 50.1 billion won in 2021.

An official of the industry said, “hanwha Impact would have taken KRW 90 billion, Hanwha Energy and Hanwha Energy’s U.S. subsidiary, which would have taken KRW 400 billion.” “Hanwha Impact will raise about 450 billion won to Hanwha Energy through special dividends, and Hanwha energy will reduce the burden of donation tax.”

An official of Hanwha Group said,”The gift tax is planned to be paid through loans with personal assets or stocks.”

Potential Counterarguments and hanwha’s Defense

Hanwha Group likely anticipates these criticisms and emphasizes its commitment to transparency. The group maintains that all transactions are conducted in compliance with regulations and that the primary goal is long-term growth and stability. The company points to its investments in key sectors like aerospace and renewable energy as evidence of its commitment to innovation and economic growth. However,the inherent complexities of chaebol structures leave room for skepticism.

One potential counterargument is that intra-group transactions, while raising concerns about fairness, can also be efficient mechanisms for resource allocation and strategic alignment within a large organization. Though, this argument depends heavily on robust corporate governance and autonomous oversight, which are areas where Korean chaebols have historically faced challenges.

Implications for U.S. Investors and Businesses

While this situation unfolds within a Korean context, it offers valuable lessons for U.S. investors and businesses operating internationally. Understanding the nuances of corporate governance in different cultures is crucial. The Hanwha case highlights the potential risks and rewards of investing in family-controlled businesses, where personal and corporate interests can be intertwined. It also underscores the importance of regulatory oversight and shareholder activism in ensuring fair and transparent business practices.

For U.S. companies considering partnerships or acquisitions involving Korean chaebols,thorough due diligence is essential. This includes not only financial and operational reviews but also a careful assessment

How are U.S. investors able to protect their interests when investing in family-controlled businesses, particularly in regions like South korea where chaebols are prevalent?