Related-Party Tunneling Explained — How Internal Deals Fund Succession

A Company That Gets 70% of Its Revenue From Sister Firms — What Does That Actually Mean?

The circular shareholding and treasury stock magic lessons both covered ways to build outsized control with a small amount of capital. This one runs in a different direction. Instead of expanding control directly, a conglomerate routes business — and with it, profit — to a small company the founder's heir already owns a large stake in, inflating that company's value in the process. This pattern shows up disproportionately in systems integration (IT services), logistics, and advertising subsidiaries, and there's a reason for that: group affiliates genuinely need these services, which makes it hard to tell from the outside whether the contracts were actually priced and awarded on competitive, arm's-length terms. Headlines mention that a company gets most of its revenue from affiliates all the time, but rarely explain why that's a problem serious enough that tax law, not just antitrust law, was written specifically to counter it. This lesson walks through how this structure actually creates value, how that value gets converted into succession funding, and how Korea's deemed-gift tax and unfair-support rules try to claw it back.

What Counts as Tunneling — And How Is It Different From Ordinary Internal Trading?

Related-party transactions between affiliates are completely normal in conglomerates worldwide. Having one subsidiary supply materials to sister companies, or run a dedicated logistics or IT operation for the group, can be a perfectly rational efficiency or security decision. The problem arises when two conditions hold at once: the founder's family — typically the heir being groomed for succession — personally owns a substantial stake in the company on the receiving end of the deal, and that company wins a large share of group business without competitive bidding, or on terms more favorable than an outside vendor would get. When both conditions are present, an "ordinary" internal transaction stops being a mere efficiency choice and becomes a channel that moves value out of the group's broader shareholder base — including minority shareholders in the affiliates paying the above-market price — and into a company the family personally controls. Korean competition law addresses this from two angles: unfair support (부당지원행위), which targets a company giving unfairly favorable terms to a related party, and self-dealing (사익편취), which specifically targets whether the controlling family actually profited from that support. The distinction matters — unfair support asks whether the deal itself was unjust, while self-dealing asks whether the family personally benefited from it.

How That Value Turns Into Succession Funding

What makes this structure worth understanding is that it doesn't stop at inflated profits — it feeds directly into the next stage, ownership succession. The setup typically starts with a company mostly owned by the heir. Once group affiliates start directing volume its way, the company posts steady, outsized revenue and profit with almost no independent business risk. That growth pushes up the company's valuation, and from there the inflated value converts into succession funding or control through one of three routes. The heir can sell part of the stake — through an IPO or a private sale — and use the proceeds to buy stakes in other affiliates or fund inheritance and gift taxes owed elsewhere. The heir can receive shares in the company as a gift, taxed at whatever rate applies to that transfer rather than the inflated value the shares eventually reach. Or the company can be merged into the group's de facto holding entity, in which case the inflated valuation translates directly into a larger post-merger ownership stake for the heir. All three routes share the same underlying mechanic: the premium the affiliates paid by directing business on favorable terms ends up funding, or converting into, the family's control of the group — a cost effectively borne by the ordinary shareholders of whichever listed affiliates paid the above-market prices.

The following distinguishes the three legal levers Korea uses against this pattern:

	Legal basis	What it looks at	Sanction
Unfair support	Fair Trade Act	Whether the company gave a related party unjustly favorable terms	Corrective order, fine
Self-dealing	Fair Trade Act	Whether the controlling family actually profited from the support	Corrective order, fine, referral for prosecution
Deemed-gift tax	Inheritance and Gift Tax Act, Art. 45-3	Whether family ownership and affiliate-revenue concentration both exceed set thresholds	Gift tax assessment

Unfair support and self-dealing turn on proving the deal itself was unjust — a slow, evidence-heavy process. The gift-tax rule sidesteps that entirely: cross the ownership and revenue-concentration thresholds and the tax applies mechanically, without anyone having to prove the pricing was unfair. In practice, that numerical trigger is often described as the more immediate deterrent of the two approaches, precisely because it doesn't require winning an unfair-dealing case first.

The Gift Tax, By the Numbers

Korea has applied Article 45-3 of the Inheritance and Gift Tax Act — commonly called the "일감몰아주기 증여세" (business-channeling gift tax) — since 2012, and its logic is unusual. No shares or cash need to actually change hands. If a company earns an abnormally high share of revenue from affiliates of its controlling shareholder, and that controlling family holds a meaningful stake in the company, the tax authority treats the resulting excess profit as a deemed gift to the family and taxes it accordingly. Two ratios decide whether a company is even in scope. The first is the related-party transaction ratio — the share of revenue coming from affiliates of the controlling shareholder. This has to exceed 30% for an ordinary company, 40% for a mid-sized company, or 50% for a small or medium-sized company before the rule applies. The second is the controlling family's ownership stake in the company itself, which needs to exceed roughly 3% for an ordinary company or 10% for a mid-sized or small company. Only when both thresholds are cleared does the calculation kick in, roughly: after-tax operating profit × (actual transaction ratio − the applicable threshold) × (family ownership ratio − the applicable floor). The formula's message is direct — the more revenue is concentrated in affiliates, and the more of the company the family personally owns, the more of that profit gets treated as an artificial transfer rather than a normal commercial return, and taxed as if it had been gifted outright.

A Recurring Pattern, Not an Isolated Case

Tunneling controversies tend to follow a recognizable shape rather than being one-off incidents. Companies that have drawn regulatory scrutiny over the years share common traits: a logistics affiliate, an IT/systems-integration affiliate, or an advertising affiliate set up early with a second- or third-generation heir already holding a large personal stake, earning a disproportionate share of its revenue from fellow group companies. What tends to happen next also follows a similar arc — the company goes public to crystallize the value of that stake, the family sells down part of its holding (sometimes following regulatory pressure or public criticism, which also lowers the affiliate-transaction ratio going forward), or the company gets absorbed into the group's holding structure during a broader reorganization, folding the accumulated value into the succession plan. The key thing to notice in this pattern: even when a company is later sanctioned for tunneling, the penalty doesn't unwind the valuation or ownership shifts that already happened. Regulation can deter future behavior, but it rarely reverses a value transfer that has already been completed.

Telling Legitimate Internal Trading From Tunneling

A high internal-transaction ratio alone doesn't prove tunneling — plenty of companies have structurally high related-party revenue for entirely legitimate reasons, like a captive semiconductor-equipment supplier or a group-only data center where security is the whole point. Three things actually separate a normal internal arrangement from tunneling. The first is pricing and contract process: was the work competitively bid, and does the price line up with what an outside vendor in the same industry would charge? The second is independent business capacity: does the company have any customer base outside the group, meaning it could survive if the group volume disappeared tomorrow? The third, and often most decisive, is who actually owns the shares — a group holding company or the affiliates themselves, or the founder's personal heirs. The same transaction ratio reads very differently depending on that answer: concentrated in a holding company, it looks like ordinary group efficiency; concentrated in the heir personally, it starts to look like self-dealing.

What to Check as an Investor

A few disclosures let you check this risk directly. The "related-party transactions" footnote in the annual report breaks down revenue and purchases by counterparty, and it's worth flagging a company where that share is unusually high and isn't trending down over time. Companies belonging to a conglomerate above a certain asset threshold also have to seek board approval and publicly disclose what's classified as a large-scale internal transaction — the disclosure threshold was raised in 2024, a change generally read as shifting regulatory attention away from routine small transactions and toward ones large enough to actually matter. The controlling shareholder and related-party ownership disclosure is worth checking too — specifically, how much of the counterparty company the heir personally owns, and whether that stake has shifted recently through a listing, a share sale, or a merger. None of this means every company with related-party exposure is uninvestable. If you're holding shares in the affiliate paying the above-market price rather than the one receiving the favorable terms, the more relevant question is simply how much that value leakage is actually costing the company's reported earnings.

Takeaways

• Tunneling routes group business to a company the founder's family personally owns a large stake in, inflating that company's revenue, profit, and valuation without corresponding business risk.
• The inflated value gets converted into succession funding or control through a share sale, a low-tax gift of shares, or a merger into the group's holding structure.
• Korea's Fair Trade Act addresses this through unfair-support and self-dealing rules, while Article 45-3 of the gift tax law taxes it mechanically once affiliate-revenue concentration and family ownership both cross set thresholds.
• A high internal-transaction ratio alone isn't proof of tunneling — competitive pricing, an independent customer base, and who actually owns the counterparty's shares are what separate normal group efficiency from self-dealing.
• Checking the related-party transaction footnote, large-scale internal transaction disclosures, and controlling-family ownership stakes gives investors a practical way to screen for this risk.

FAQ

Does crossing the 30% related-party revenue threshold automatically trigger the gift tax?

No. Both the related-party transaction ratio (30% for ordinary companies, 40% for mid-sized, 50% for small and medium-sized) and the controlling family's ownership stake (3% for ordinary companies, 10% for mid-sized and small ones) have to exceed their thresholds before the rule even applies, and the actual taxable amount is calculated separately from after-tax operating profit and the size of each excess. Falling short on either condition means no tax applies.

Should I avoid any company with a high related-party transaction ratio?

Not necessarily. Some businesses — group-dedicated infrastructure or security-sensitive operations, for example — have structurally high internal-transaction ratios for legitimate reasons. What matters more is whether pricing was set competitively, whether the company has any customer base outside the group, and whether the shares of the company receiving favorable terms are concentrated in the founder's family personally.

Where can I find this information?

The related-party transactions footnote and the controlling shareholder ownership disclosure in the annual report cover the basics. For conglomerates above the relevant asset threshold, large-scale internal transactions are also separately disclosed through the Korea Fair Trade Commission.

⚠️ This article is for informational purposes only and is not investment advice. The tax and disclosure thresholds mentioned here reflect the situation as of this writing and may change. You are solely responsible for your own investment decisions and their outcomes.