Avoid this founder’s $10 billion mistake, incorporate in Singapore

cs-editor Business News, Corporate Compliance, Startup News, Taxation

After the death of Samsung Electronics chairman Lee Kun-hee, his family faced a giant tax bill on their inheritance. Mr. Lee’s family expects to pay more than USD$10.8 billion in taxes, which is more than half of the value of the total estate and more than three times the total inheritance taxes the South Korea government collected last year. South Korea has one of the highest inheritance tax rates in the world (it is 50%). This would be the largest ever tax payment in the country’s history.  For the Samsung founder’s family, this inheritance tax may directly influence the family’s control over the tech conglomerate as it is likely to dilute their stake. The family plans to pay the bill over the next five years. However, it is unclear how these tax payments will be structured and whether the family will start selling Samsung holdings or not. Analysts say it is likely that the family will use loans and dividends from their own shares to pay the tax bill. 

US families could face even higher tax rates on inherited wealth (often in the form of company stock).  Under the proposed tax plan released by President Joe Biden earlier this year, which is likely to be watered down, taxes levied on inheritances, including unrealized capital gains, would be taxed at normal income rates, in addition to inheritance tax. This could result in net tax rates as high as 85%, the highest in the US in nearly a century. It is a similar situation in Europe, where most countries impose taxes on wealth upon the death of a person. In fact, in certain cases, some European countries’ inheritance tax rates may be as much as 80% if the estate is above a certain threshold amount.

The situation in Singapore is dramatically different since it imposes no tax on inheritance. Furthermore, Singapore imposes no tax on dividends and capital gains. These factors can dramatically impact the take-home wealth a founder and her family can build.

Usually, when starting a company, most founders do not think about long-term tax implications. They are naive and young, and focused on building up their company than caring about the future tax consequences. Often, they are inexperienced in tax issues and do not consider an appropriate corporate structure, tax planning, or exit strategy. While Samsung is an old company, nevertheless it is a cautionary tale for founders. Its example offers a warning and an opportunity for young entrepreneurs to set up the right structure from the beginning. Incorporating your company in Singapore may be the first step in this regard, as explained below.

Taxes that erode wealth

An important objective of every entrepreneur is wealth-building. Here are the key taxes that can reduce your net take-home wealth from a new venture:

  • Capital gains tax. The capital gains tax is a levy on the profit from an investment that is realized when the assets are sold. When you sell any capital asset, the difference between the adjusted basis of the asset and the amount you realized from the sale is a capital gain (or a capital loss). In some countries this tax can be quite high, e.g.: 33% in Ireland, 30% in France, 20% in the UK, and rates ranging from 10% to 37% in the US. But Singapore has no tax at all on capital gains. 
  • Tax on dividends. This tax is imposed on the distribution of a company’s profits to its shareholders. In most countries, when shareholders receive dividends from a business, they have to pay a tax on them. For instance, Canada imposes taxes on dividends at rates that can go up to 48%. But in Singapore there is no tax on the dividends received by a shareholder from a Singapore company. Furthermore, there is no tax on foreign dividends received by residents of Singapore either. 
  • Inheritance tax. As discussed above, most countries impose an inheritance tax that is paid when inheritors receive assets from a deceased person. Usually, this tax is paid in the state in which the decedent lived or owned property, but the rules vary from country to country. The amount of tax to be paid depends on the size of the inheritance and the recipient’s relationship with the deceased person. Singapore has no inheritance tax, so by creating your assets (such as shares in a company) in Singapore, you can dramatically maximize the wealth that your next generation will receive.
  • Income tax. Income tax is a levy that governments impose on income generated by businesses and individuals within their jurisdiction. Most countries use a progressive income tax system in which the rate of income tax imposed depends on the tax bracket. In this system, taxation progressively increases as income grows. In most western economies, for high income taxpayers, this rate is around 40-45%. But Singapore has very low income tax, ranging from 0% to 22% at most.

Case study

Consider the example of an entrepreneur who successfully launches a new venture. Let us assume that as a result of the entrepreneurs efforts, the business starts to generate US$1 million in annual profits after paying corporate taxes. The entrepreneur can take this amount as dividends. After 5 years of successfully running a company, the entrepreneur receives an offer to buy the business at a valuation of US$50 million. Let’s calculate her take-home wealth in two scenarios: a) she is based in the US and b) she is based in Singapore.

If the entrepreneur incorporated the company in the US, she would pay approximately $450k each year in taxes on dividends. Furthermore, she would pay long-term capital gains tax on the sale. When combined with the 3.8 percent net investment income tax (NIIT) and average top state capital gains tax rates, this rate in US is around 29% (the Biden proposal would raise the combined rate to 48.4 percent). Using a 30% rate, the total tax at sale would amount to US$15 million. So the approximate take-home amount would be US$2.75m during the first five years and US$35 million at sale (we are ignoring some US state taxes that could erode this amount further). Thus, the net take home amount for the entrepreneur will be $37.75m. On the other hand, if the entrepreneur were based in Singapore, this amount would be $55m. 

Now consider the situation that the entrepreneur wishes to give the wealth she has built to her children as inheritance. In Singapore, the children would receive the full $55m since there is no inheritance tax. But in the US, the children will receive approximately $22.65m after inheritance tax. The advantages of incorporating the company in Singapore are obvious. Thus, the taxes in US eroded the wealth by more than 60%. But no erosion occurred in Singapore.

If the entrepreneur had established the company in a developed European country, the situation could be even worse. European countries generally levy even higher (compared to US) inheritance taxes on wealth. For instance, Germany imposes 50% tax on inheritances, while France has the highest inheritance tax rate in Europe at 60%.

More tax hikes are coming 

With the pandemic, the developed-world economies suffered dramatic slowdowns. To support the economy during the pandemic, many governments borrowed substantial amounts at a pace never seen before. This deficit spending has raised the debt owed by the countries to very high levels. To repay this borrowing, the countries will have to impose tax increases in future. As of the writing of this post, in the US, the Biden administration is actively working with congress to impose tax increases to repay the pandemic bill; it is expected that many countries will follow suit. The UK government has already said it would probably increase corporate taxes by 6%.

On the other hand, Singapore has made no efforts to change its tax structure; its well-managed reserves and economy have enabled it to make the necessary pandemic investments without resorting to higher taxes.

Plan ahead

When you are setting up a new business, proactive tax planning will help you build and preserve wealth so that you and your family can reap its maximum rewards in the long run. With the rising strain on global economies due to COVID spending debts, taxes are likely to rise. Smart planning can help minimize their impact on your assets and maximize your net take-home wealth. Regardless of whether you wish to keep the business within your family or sell it, careful planning will ensure that you and your family do not lose the fruits your hard work through excessive taxation. By incorporating in Singapore, you can avoid most of the taxes that erode wealth. Furthermore, it offers relatively low corporate taxes, many incentive and tax relief programs and low personal tax brackets. 

Many ultra-high net worth individuals have already made a move to Singapore for these reasons. Recent examples include Eduardo Saverin (a Facebook founder), and Sergey Brin (a Google founder). Our team is here to help you develop a business structure that is appropriate for your situation and future plans. Through upfront planning, you too can harness the business-friendly advantages Singapore offers. Contact us if you need our assistance or advice.

About CorporateServices.com

Headquartered in Singapore, CorporateServices.com, empowers global entrepreneurs with information and tools necessary to discover Singapore as a destination for launching or relocating their startup venture and offers a complete range of company incorporation, immigration, accounting, tax filing, and compliance services in Singapore. The company combines a cutting-edge online platform with an experienced team of industry veterans to offer high-quality and affordable services to its customers. Contact Us if you need assistance with setting up a new Singapore company or if you would like to transfer the administration of your existing company to us.

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