[Tax Story] The Value of Operational Experience of Kaesong Industrial Complex from a Tax Perspective

Professor Ahn Chang-nam, Department of Economics and Taxation, Kangnam University

The Kaesong Industrial Complex can be seen as an avant-garde stage where the South and the North fiercely competed to expand their mutual interests. Whether it was a product of the long-standing pressure caused by division and disconnection, many cases ignored conventional common sense and order.

The corporate tax rate (income tax rate) in the North’s Kaesong Industrial Complex was about 10% lower than that of the South. In such cases, it is common for the South’s parent company to transfer more profits to its North-side subsidiary in Kaesong. This reduces the overall tax burden for the entire company (South parent company + North subsidiary). However, many companies operating in the Kaesong Industrial Complex continued to incur losses. This appears to be a financial decision based on the fact that the South’s parent company needs to generate profits to enhance corporate creditworthiness and facilitate bank loans, rather than purely for tax savings. This demonstrated the limitations of tax incentives.

If products made in the Kaesong Industrial Complex are sold at high prices in South Korean department stores beyond the Demilitarized Zone, yet the companies processing these products in Kaesong report losses, no tax official would agree with that. In the early days of the Kaesong Industrial Complex, the North’s tax officials seemed to have low levels of knowledge in accounting, finance, and law, but over time their skills improved. They applied transfer pricing techniques, which had only recently been adopted even in advanced countries, to South Korean companies as well. In the federal United States, when companies operate across multiple states, fierce competition occurs among states to secure tax bases. It is highly likely that a unified Korea will face similar situations someday. Tax authorities from the South and North could compete over a single tax base.

The tax hide-and-seek between taxpayers and tax authorities happens in every country. However, the Kaesong Industrial Complex, where both sides are literally pointing guns at each other, was expected to be better, but it was no less severe than other countries, if anything, it was worse. Vehicles operating within the complex must be registered with the complex office and pay automobile usage tax. One day, a North Korean tax official discovered that the number of vehicles operating in the Kaesong Industrial Complex exceeded the number registered. They found unregistered vehicles. It was also discovered that the companies printed on the safety helmets of South Korean companies working on construction within the complex differed. The primary contractor had registered their business in the Kaesong Industrial Complex, but the subcontractors had not. The South Korean companies’ tax avoidance strategies could potentially trigger a strong response from the North’s tax authorities.

When the South countered the North’s excessive taxation policy by demanding taxation based on grounds, the North quickly revised the Kaesong Industrial Complex tax regulations and enforcement rules. Since the North does not have separation of powers, such changes can be made solely by orders from above. Although the South protested, asking why tax regulations were changed without consultation, they were powerless against the North’s defense that amending tax laws applicable to the Kaesong Industrial Complex was their exclusive authority. Amid escalating conflicts, the Kaesong Industrial Complex was shut down in 2016.

There are opposing views on the Kaesong Industrial Complex as either a “give-away project” or a “bring-in project,” but the fact that many companies that had entered the complex expressed a desire to return suggests that bringing-in was possible.

The experience of operating the Kaesong Industrial Complex so far can be seen as a preventive injection regarding the tax issues that a unified Korea will face in the future. Whether the Kaesong Industrial Complex will reopen depends on denuclearization. However, preparations for reopening should begin now. Useful things should not be damaged by useless ones. There is also a legal maxim that those who benefit must also bear burdens. South Korean companies need to learn accounting transparency and fair taxation. North Korea’s tax regulations need to be revised to meet globalization standards. Only when the predictability of tax burdens increases can a win-win situation be possible.

This content was produced with the assistance of AI translation services.