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Adoption as a means of reducing inheritance taxation is said to be common among wealthy people. In overturning a lower court decision that invalidated a late Fukushima Prefecture man’s adoption of his grandson in 2012 on the grounds that the step was a tax-saving measure, the Supreme Court has ruled that the intention to reduce the amount of taxes will not automatically annul the adoption itself. The top court decision may be taken as a sign that the judiciary condones adoption as a tool of reducing inheritance tax. But the National Tax Agency holds that such an adoption, even if it’s confirmed valid, may still not qualify for deduction from taxable assets.

It would be natural for people to want to leave behind as much assets as possible to their family members. Under the inheritance tax system, the basic deduction from the taxable assets rises as the number of heirs increases. It is reportedly not uncommon for the wealthy to adopt their grandchildren or spouses of their children to reduce the tax imposed on the assets inherited by the heirs.

But such tax-saving measures over inheritance could sow the seeds of trouble among the heirs, since some members of the family might sense that they had been unfairly treated compared to others. The case at issue was taken to the court by the man’s daughters, who argued that the deceased’s adoption of the son of their brother, which effectively allowed the brother’s family to inherit more of the father’s assets than each of the daughters, was invalid because it had been intended as a tax-saving measure. Such discord may not be resolved by a court decision. To avoid that, it is advisable that these matters be thoroughly discussed in advance among family members.

The Fukushima man, who died in 2013 at the age of 82, adopted his son’s young child the year before his death. The man, who had earlier lost his wife, had four legal heirs — his son and two daughters plus the adopted son. The heirs’ total inheritance tax payment was reduced through the adoption — since the deduction from taxable assets is calculated by multiplying ¥6 million by the number of legal heirs and adding ¥30 million (¥10 million multiplied by the number of heirs plus ¥50 million before the system was amended in 2015). But the adoption resulted in the son’s family effectively inheriting half the father’s assets, reducing the portion for each of the daughters.

The daughters and their brother contested the validity of the adoption. The Civil Code says an adoption is invalid when the parties concerned have no intention to form a parent-child relationship. The daughters argued that the adoption was invalid because the father, who had been advised by his tax accountant, adopted his son’s son as a tax-saving measure. The Tokyo Family Court upheld the adoption as valid, but the Tokyo High Court reversed the decision and called the adoption invalid because it was nothing but a tax-saving measure by the father, who had no intention of forming a true parental relationship with the son’s child.

In overriding the high court decision, the Supreme Court ruled last Tuesday that an adoption will not be invalidated even if it is primarily meant as a tax-saving measure. Noting that the motivation to reduce taxes and the intention to adopt can coexist, the top court said it saw no circumstances indicating that the father had no such intention.

Adoption has indeed long been used as a measure to cut inheritance taxes. Some wealthy people in the past are said to have had large numbers of adopted children for this purpose — as many as 10 in one reported case. Such a practice led to the 1988 revision to the tax system that limited the number of adopted child who can qualify as legal heir to one (or two when the person in question has no children of his or her own). The inheritance tax law stipulates that an adopted child will not be counted among the heirs if the adoption results in unfairly reducing the tax burden. The tax agency says deduction may be denied for an adopted child even if the adoption itself is valid, depending on the circumstances behind the process and real-life situation of the parties concerned.

The Supreme Court decision may have effectively condoned the status quo. But it should lead people to think about the practice of adoption as a tax-reduction measure.

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