Korean EVs left behind as tax credit excludes cars

Excluding electric vehicles from South Korea's domestic production tax credit has significantly undermined the competitiveness of local automakers like Hyundai and Kia, who are already grappling with shrinking operating margins—Hyundai’s Q2 operating profit dropped 20.8% year-on-year to 2.85 trillion won, while Kia’s declined 4.9%. This policy gap leaves domestic EVs at a disadvantage against cheaper Chinese imports, which benefit from lower production costs and government support, intensifying fears that South Korean manufacturers will lose market share without similar incentives.

Chinese EVs, notably BYD’s Dolphin, are aggressively capturing South Korean market share by undercutting prices—Dolphin’s base model sells for about 24.5 million won, significantly cheaper than Hyundai’s Casper Electric at 28.47 million won and Kia’s EV3 at nearly 40 million won. This price disparity, combined with South Korea’s relatively low 8% import tariff on Chinese EVs compared to the US and EU’s tariffs exceeding 40%, creates an uneven playing field that domestic producers struggle to navigate amid rising costs and limited government support.

The surge of Chinese EV imports equipped with domestic Chinese batteries threatens not only automakers but also South Korea’s battery industry, as models like Tesla’s Model Y and BYD’s vehicles rely on Chinese LFP batteries, reducing demand for South Korean suppliers. Industry voices lament that excluding EVs from the tax credit removes a crucial lever to lower unit costs and enhance price competitiveness, with experts like Lee Hang-gu warning that without direct policy support and investment incentives, South Korea risks falling behind in emerging technologies such as software-defined and autonomous vehicles.

While six major business groups have welcomed South Korea's domestic production tax credit as a positive step, they are pressing the government to issue swift and detailed guidelines to ensure the policy’s effective implementation and clarity for industry stakeholders. This call for clearer rules underscores the urgency felt by automakers and battery manufacturers who need a stable framework to plan investments and compete against Chinese imports. Simultaneously, the battery industry is advocating for a direct refund system and third-party transfer mechanisms akin to the U.S. Inflation Reduction Act’s direct pay system, which would provide much-needed liquidity rather than just deferred tax benefits.

Despite broad industry support, the current tax credit system falls short for loss-making firms, particularly battery manufacturers operating without corporate tax liabilities, rendering the credits effectively useless during critical investment phases. This paradox means companies can be allocated tax credit limits worth hundreds of billions of won but cannot convert them into immediate cash flow, hampering their ability to scale production and innovate. Lawmakers like Democratic Party’s Lee Yeon-hee emphasize the government’s responsibility to support strategic sectors through these early loss-making periods, citing SK Hynix’s successful recovery as a model for proactive intervention.

However, the government remains divided on adopting direct refund mechanisms, with the Ministry of Economy and Finance resisting changes due to concerns over fairness across industries and potential WTO trade disputes. This internal discord contrasts with the Ministry of Trade, Industry and Energy’s push for more flexible support measures, highlighting a policy impasse that risks undermining South Korea’s competitiveness in the global EV and battery markets. Without resolving these tensions and introducing practical liquidity solutions, the tax credit risks remaining a theoretical benefit rather than a catalyst for industrial growth.

Facing a sharp 20.5% decline in North American EV sales in the first half of 2026 and a strategic pivot by automakers toward hybrids, South Korea’s leading battery makers—LG Energy Solution, Samsung SDI, and SK On—are decisively shifting away from EV battery production. They are exiting joint ventures with Detroit automakers and repurposing their EV battery plants into standalone operations focused on energy storage systems (ESS), reflecting a strategic response to structural market changes and reduced EV demand.

Leveraging existing EV battery manufacturing infrastructure to produce lithium iron phosphate (LFP) batteries for ESS applications allows South Korean firms to minimize capital expenditures and accelerate entry into the rapidly expanding ESS market. LG Energy Solution’s mass production of ESS-specific LFP batteries at its former Ontario joint venture plant and plans for ESS lines in Tennessee exemplify this efficient transition, which also absorbs underutilized capacity and shortens new plant construction timelines.

The pivot to ESS is not only a market adaptation but also a financial lifeline, with all three major South Korean battery makers returning to operating profitability in Q2 2024 after seven quarters of losses. This turnaround is driven by cost reductions, production flexibility gained from standalone operations, and the surging demand for ESS solutions, particularly in North America where shipments grew 83% year-on-year to 75.9 GWh in H1 2024, and LG Energy Solution’s ESS revenue soared 4.6 times year-on-year in Q2.

South Korean battery manufacturers are aggressively targeting the U.S. ESS market, which is projected to nearly sixfold grow to 320 GWh by 2035, fueled by rising demand for uninterruptible power supplies in AI data centers and supportive trade policies. Favorable conditions include a 25% tariff on Chinese ESS batteries starting in 2026 and up to $45 per kilowatt-hour in Advanced Manufacturing Production Credits for domestic production. However, to fully capitalize on these incentives, companies must reduce reliance on Chinese raw materials and comply with stringent U.S. supply chain rules, underscoring the critical need for enhanced local manufacturing capabilities and expanded R&D in system integration.