Business | YEN FOR LIVING

Resorting to adoption to avoid inheritance tax

by Masako Tsubuku and Philip Brasor

Special To The Japan Times

Revisions to the inheritance tax went into effect in 2015, and related statistics for that year were recently made public by the National Tax Agency.

The main change had to do with the basic deduction. Before 2015 the deduction equaled ¥50 million plus ¥10 million for each heir. That formulation has now changed to ¥30 million plus ¥6 million for each heir. This means, for example, that the estate of a person with three heirs is subject to inheritance tax if it is greater than ¥48 million, whereas before 2015 it was exempt until it reached ¥80 million. Consequently, the estates of a wider group of people now have to pay inheritance taxes when those people die, so what used to be a tax that affected mainly rich people is now a concern for more of the middle class.

As a result, the portion of deceased who were taxed rose from 4.4 percent in 2014 to 8 percent in 2015, an increase of 80 percent. According to an article in the Tokyo Shimbun on Jan. 26, this is a bigger increase than the National Tax Agency expected. As predicted, the greatest increase was in Tokyo, where the portion of deceased people subject to taxation rose from 7.5 percent to 12.7 percent. Nagoya’s figure rose from 6.1 percent to 11 percent.

Before the revision, most of the assessment was on property — land and buildings — but now a good portion is on cash and savings. With the inheritance tax now covering a wider range of incomes, the average cost of the tax per person in 2015 has dropped. Technically, the tax is imposed on people who die and, in 2014, the average amount of tax “paid” by each deceased person who paid it was ¥24.17 million. In 2015, the average amount dropped to ¥17.16 million.

In any case, it is the heirs who eventually have to pay this tax, and all of them have to file tax reports regardless of whether or not they are subject to taxes. There are still a variety of ways to avoid the tax or lower it, but all such measures require that a report be filed in the first place, which means heirs have to learn about a law they probably didn’t think carefully about before the revision went into effect.

In this regard, the revisions will likely prove to be a windfall for financial advisers, since it will pay for people to move money from savings accounts to investments such as stocks and mutual funds. Tax accountants will also benefit, and a few news items seem to indicate that such professionals are working overtime to help families keep as much of their assets as possible.

One adviser who specializes in inheritance taxes told the Tokyo Shimbun that 10 percent of the inquiries he receives are about how to lower an individual’s tax burden through adoption, a fairly common practice and, apparently, one that even the authorities have come to accept as being legal.

Last week, the Supreme Court rejected a suit by the daughters of a man who had adopted the son of his eldest son — in other words, the man’s grandson — as a fourth heir. The daughters claimed that the adoption should be voided because the purpose was to lower their father’s inheritance tax bill.

In effect, the court said that the man’s action was not illegal. The man adopted the grandson, who is in his 20s, just before he died in 2013 at the age of 82, but even though his motives were not completely spelled out, the court didn’t expressly see any problem if they had to do with lowering his tax burden.

Adoption for the sake of financial adjustment has always been a common practice in Japan among the well-to-do. In fact, such adoptions, usually of adults who only need to be at least one day younger than the adopting “parent,” constitute the overwhelming majority of adoptions in Japan.

So-called special adoptions, meaning taking on an infant or child for the purposes of raising that child as a full-fledged member of one’s family, are much rarer. In many cases, adults are adopted when a family does not have someone to take over a family business or a male heir who can carry on the family name. However, the practice is obviously also used to cut taxes.

About 40 percent of estates valued at more than ¥500 million after the deductions involve adoptions. The practice used to be so widespread that the applicable law was changed in 1988, limiting adoptions to two if the adopting party had no natural children and to one if the adopting party had any natural children. Prior to 1988 there were no limits to how many children someone could adopt.

In the recent Supreme Court decision, the deceased had adopted his son’s son, thus giving him four heirs instead of three — his son, his grandson-cum-son and two daughters. Consequently, each heir would receive a smaller share of the inheritance than they would if there were only three heirs, and that may have been the point.

In many such instances, the legator may want to confer a larger piece of the pie on one particular heir — in this case his eldest son, who, along with his own son’s share, would receive half rather than a third. Or, he may simply have wanted his grandson to receive part of his legacy directly. Minus a will stating so explicitly, Japanese law doesn’t take grandchildren into consideration for inheritances.

However, whether or not this idea was the real motivation behind the adoption, it would be difficult to make it the basis for a suit since such adoptions are permitted under the Civil Code, so the daughters, who obviously felt cheated, argued that their father was trying to avoid paying taxes.

In accordance with tax rules, the greater the number of heirs, the higher the basic deduction and the lighter the eventual tax burden, even when a special regulation regarding adopted heirs is factored in.

Adopted heirs contribute a larger portion — 20 percent more — to the inheritance tax on an estate than do “natural” heirs, meaning the sisters would legally contribute less. However, apparently those savings were not enough to offset what they would lose in their share of the estate.

After the trial, the lawyer for the estate said the verdict, in fact, can be interpreted as saying that the deceased man’s intention was to give money directly to his grandson, but in any case, the court didn’t feel there was anything wrong if it was about reducing taxes, either.

The National Tax Agency is probably not happy with this kind of ruling, but there seems to be little it can do, and now that the revisions have made a larger population subject to inheritance tax, it’s likely more people will resort to adoptions in order to pass on as much of their estate as possible to their heirs.

Yen for Living covers issues related to making, spending and saving money in Japan on the second and fourth Sundays of the month.

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