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The Foreign Investment Laws of North Korea

The Democratic People's Republic of Korea ("North Korea") has recognized that foreign capital and technology are essential to help develop its flagging economy. While maintaining its ideological commitment to the autarkic, defiantly self-reliant "juche" philosophy, North Korea has issued extensive laws and regulations that are designed to foster foreign investment, including the Foreign Investment Law ("FIL"), the Free Economic and Trade Zone Law ("FETZL"), the Foreign Enterprises Law ("FEL"), the Equity Joint Venture Law ("EJVL") and the Contractual Joint Venture Law ("CJVL"). This legislative structure constitutes an ambitious attempt to facilitate foreign investment in a flexible manner.

Foreign Investment Law ("FIL")

The FIL, promulgated in 1992, permits foreign investment in "various sectors such as industry, agriculture, construction, transport, telecommunications science and technology, tourism, commerce and financial services," and provides special encouragement and preferential treatment (including tax exemptions and preferential loans) for investment in "sectors that require high and modern technology, sectors that produce internationally competitive goods, the sectors of natural resource development and infrastructure construction, and the sectors of scientific research and technology development." Projects which hinder the development of the national economy and threaten national security or the environment, or which are technically obsolete, are prohibited.

Repatriation of profit and capital is guaranteed, subject to exchange controls. The FIL provides the ambiguously comforting assurance that foreign-invested enterprises are not subject to nationalization of seizure by the State, but that "[s]hould unavoidable circumstances make it necessary to nationalize or seize such enterprises and assets, fair compensation shall be paid."

The FIL provides for protection by law of the "managerial secrets" of foreign-invested enterprises. Since North Korea will be perceived as a country in which there is a substantial risk of misappropriation of intellectual property, investors will be well advised to deal with such issues carefully in any investment contract, with extensive confidentiality provisions and perhaps (as has been the practice in technology transfer contracts in, among other places, South Korea) with liquidated damages provisions to deter violation. Whether such provisions will be acceptable to the reviewing authorities or enforceable in practice remains to be seen.

Under the FIL, foreign investment may take the form of an equity joint venture (habyongsa), a contractual joint venture (hapjasa), or a wholly foreign-owned subsidiary. Wholly foreign-owned subsidiaries (Wegugin kiop)are permitted only in Free Economic and Trade Zones.

The forms used for application to the North Korean authorities for the formation of foreign-invested enterprises are attached for reference. The law provides that applications are to be approved or rejected within 50 days (in the case of equity and contractual joint ventures) or 90 days (in the case of wholly foreign-owned subsidiaries) after submission to the relevant authority.

Free Economic and Trade Zone Law ("FETZL")

One of the new elements of the recent changes in North Korea's foreign investment laws is the FETZL and the creation of Free Economic and Trade Zones ("FTZs") within North Korea's territory. The FTZs are intended to be duty free areas for the importation of capital goods and materials for the production of exports. The other foreign investment laws of North Korea apply in FTZs, including those relating to the establishment of equity and contractual joint ventures and wholly foreign-owned subsidiaries. In many cases preferential treatment is afforded to foreign-invested enterprises with respect to tax rates, rent and financing. [7]

Each FTZ is administered by an FTZ Authority under the supervision of the External Economic Authority. [8]

In 1991 an FTZ was promulgated at Rajin-Sonbong, in the northeast part of Korea on the Tuman River where the boundaries of Korea, China and Russia meet. [9] Other FTZs are in the planning stages.

Visas are not legally required for entry into an FTZ from abroad, but since international connections have not yet been established in Rajin-Sonbong all entry must be through Pyongyang and a DPRK visa is therefore a necessity.

Equity Joint Venture Law ("EJVL")

Equity joint ventures ("EJVs) are the preferred vehicle of the North Korean government for high-tech and infrastructure projects. EJVs are established by means of a joint venture contract between foreign and North Korean parties, which must be submitted to the external economic body of the Administration Council of the DPRK or to the Zone authorities for approval. EJVs are juridical persons under North Korean law, taking the form of limited liability companies with each party's liability limited to the amount of its subscription.

Capital may be contributed to the EJV in the form of cash, property in kind, industrial property rights, technical know-how, land rights or other forms. The contribution of each party other than cash is to be evaluated by mutual agreement on the basis of international market prices prevailing at the time of contribution. This could lead to overvaluation of the local contribution; it remains to be seen whether this matter will be able to be dealt with as a matter of contract between the parties, or whether the reviewing authorities will impose their own views of value.

The law requires that the "registered capital" (i.e., the subscribed and paid-in capital) of an EJV must be at least 30% to 70% (depending on the size of the enterprise) of the total amount of capital required. It is open to question whether third party debt financing, local or foreign, will be available in any substantial amount, and it can be expected that most projects will proceed on a wholly equity-funded basis.

Contractual Joint Venture Law ("CJVL")

Contractual joint ventures ("CJVs") are the vehicle preferred by the North Korean government for basic manufacturing, tourism and service sectors. As defined by law, a CJV "consists of business activities in which investors from the DPRK and from a foreign country invest jointly, with production and management being assumed by the host partner, and the portion of the investment made by the foreign partner is redeemed or the portion of the profit to which the foreign partner is entitled is allotted in accordance with the provisions of the joint venture contract."

The foreign party to a CJV is permitted to have its own personnel employed by the CJV. In addition, the CJV contract may specify the procedures for governance of the venture, including the establishment of an ad-hoc joint body for making key decisions. As noted above, the law provides for management of the CJV to be assumed by the North Korean party; it is not clear to what extent this could be varied in practice by contract.

A CJV is the functional equivalent of a partnership, with no limitation of liability. It is apparently intended to be a juridical person, although the CJVL is not explicit on this point. Unlike a partnership, however, a CJV is a taxable entity, and is required to pay tax when profit is distributed under the joint venture contract. Given that it has the partnership attributes of limited life, limited transferability of interests and unlimited liability, a CJV would presumably be treated as a partnership under general principles of U.S. tax law.

Foreign Enterprises Law ("FEL")

The FEL provides the basic framework for the creation of wholly foreign-owned entities ("Foreign Subsidiaries"). Foreign Subsidiaries are permitted only in Free Economic and Trade Zones ("FTZs"), and are permitted for projects involving high-tech production of internationally competitive goods in the following sectors:

  • electronics, automation, machine tool and power industries;
  • food processing, garment and everyday consumer goods;
  • building materials, pharmaceuticals and chemicals;
  • construction, transportation and service sectors;
  • other sectors deemed necessary.

Investment will not be permitted in, inter alia, projects whose proposed "equipment and production processes are outdated economically and technologically," or for products for which there is no local or international demand. In addition, projects whose "type of business and mode of management . . . do not conform with or may have a negative impact on the sound ideological emotions of the people and the mode of life" are prohibited. Finally, a number of sensitive sectors, including publishing, press, broadcasting and telecommunications, are off-limits to foreign investors.

Depending on the size of the proposed investment, application to set up a Foreign Subsidiary is made either to the External Economic Commission or to the FTZ Authority. The application must be accompanied by a detailed feasibility study for the proposed investment, including details of the production process and the specific equipment to be used, the amount and timing of capital investment, management and labor requirements, details of the proposed site and utility requirements, proposed articles of incorporation, etc.

The relevant authority will consult with relevant agencies and issue an approval or denial of the proposed application within 80 days of receipt. Upon receipt of approval, the foreign investor must register the enterprise with the FTZ Authority within 30 days and with the local tax authority within 20 days. The specified registered capital must then be invested within six months (or, if approved as a staged investment, within 90 days to two years) from the date of registration with the FTZ Authority. A business license must also be obtained from the FTZ Authority.

Materials may be imported into the FTZ without payment of customs duties, whether as part of the capital contribution to a Foreign Subsidiary or for production, and no duties are imposed on exports. Although the FTZ system is geared to production for export, sales by a Foreign Subsidiary to North Korea are permitted, provided that a North Korean state trading company is utilized for the transaction. A Foreign Subsidiary may export from the FTZ on its own or through a state trading company, but it must acquire any local materials through a state trading company.

Taxation of Foreign Invested Enterprises

Foreign invested enterprises are subject to income tax, property tax, turnover tax and local taxes.

Enterprise income tax is imposed at a rate of 25% of taxable income from business activities (14% for enterprises in an FTZ and 10% for income in priority sectors such as high-tech, natural resources development, infrastructure construction, scientific research and technological development), and 20% of "other income" (10% for enterprises in an FTZ), including interest, dividends, licensing fees and royalties as well as management service income. Taxable income from business activities is reduced by "cost" which is defined by specific illustrations which give rise to some uncertainty. For example, in the case of industrial sectors depreciation is mentioned as a cost, but depreciation is not included for commercial or service sectors; while insurance premiums are included for industrial and commercial sectors but not for the service sector. It is impossible to predict how these issues will be determined in practice.

Property tax is payable on all buildings (at a rate of 1% of registered value) and on vessels and airplanes which are owned by an enterprise and located within North Korea as of January 1 of each year (at a rate of 1.4%).

Turnover tax is imposed on the proceeds of sale of products into North Korea rates ranging from 1.5% to 20% (with higher rates for restricted items such as alcohol and tobacco products). Turnover tax is also imposed at a rate of 2% on the proceeds of the sale of commodities, and at a rate of 2% to 4% on service income of all kinds.

Local taxes include a city management tax equal to 1% of the monthly payroll of the enterprise, as well as other miscellaneous registration and license fees.

Enterprises in an FTZ and in priority areas may be entitled to an exemption of income tax for the first three profitable years as well as a reduction of up to 50% of such tax during the subsequent two years. Each of these benefits can be extended for an additional year for large investments in priority infrastructure sectors. Other reductions and exemptions are available for FTZ enterprises for property tax and turnover tax.

Foreigners in North Korea for more than 180 days are subject to income tax at progressive rates of up to 25%, as well as to a local tax of 1%.

If a foreign investor reinvests business profits in North Korea, a tax refund of 50% (up to 100% in high priority areas) is available for the income tax paid on the reinvested amount.

Other Relevant Laws Labor Laws

Except to the extent that the consent of the External Economic Commission has been obtained in the approval process to employ foreign managers, technicians and other skilled workers, a foreign-invested enterprise is required to use local labor for its business activities in North Korea. The foreign-invested enterprise may determine in its own discretion the number of employees needed for its operations, but local labor is required to be hired through the local labor exchange, which will recruit from other areas if certain skills are not readily available. The foreign-invested enterprise may refuse to hire the specific workers recommended by the labor exchange, "if found inconsistent with the terms of the contract of employment."

A contract must be concluded with the trade union that represents employees to determine and define the duties of the employees, production quotas, all aspects of remuneration, and other working conditions. The foreign-invested enterprise may dismiss employees only for specified reasons, and only after consultation with the trade union and the labor exchange; the grounds for dismissal include:

  • the case of an employee who is not capable of continuing his work or other employment due to a non-job related injury;
  • redundancy due to changes in production management or technical considerations;
  • bankruptcy or winding-up of the enterprise;
  • the case of an employee who has inflicted great loss to the enterprise or has seriously violated labor discipline.

These limitations will give foreign investors reason for concern about their ability to manage their personnel effectively.

Other provisions of the labor regulations set out a general framework of worker protection, including hour and wage provisions, social insurance and social security, and workplace safety requirements. In addition, the Foreign Enterprises Law, which applies only to Foreign Subsidiaries, requires contributions to the relevant trade union of 1% to 2% of the payroll.

Leasing Land The FIL provides for leases from the State of land required by foreign-invested enterprises for a maximum period of 50 years. The Law on the Leasing of Land ("Leasing Law") provides that leases are to be administered by the local land administration office (in an FTZ, the FTZ Authority) which is deemed to be the lessor. Leases may be entered into by negotiation (either as part of the approval process of a foreign investment or thereafter) or, in an FTZ, through tenders and auctions.

A lease may be assigned or subleased, and provision is also made for mortgages which pertain both to the lease rights and to the structures on the land.

Rent is in principle payable in advance, although arrangements can be made for payment in installments (with interest) in priority sectors or for high-rent developments. In addition to rent, "land use charges" are also payable on an annual basis, subject to reduction or elimination for up to 10 years in FTZs.

Dispute Resolution

The FIL provides that all disputes relating to foreign investment are to be settled by a court of law or an arbitration body of North Korea, or may be taken to arbitration in a third country. Similar provisions are contained in the FETZL, the EJVL, and the Leasing Law.

However, the FEL, the FEL Implementation Regulations, the CJVL, and the Labor Regulations provide for dispute resolution by a North Korean court or arbitration agency, and make no reference to third-country arbitration. It is not clear whether the different treatment in the other laws is intended to override the FIL, or whether the provisions of the FIL (which purports to be the framework for foreign investment in North Korea) would supersede the contrary provisions.

Furthermore, North Korea not yet a signatory to any international convention on the recognition and enforcement of arbitral awards, so the enforceability of a third country award is subject to question in any event.

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