The Kaesong Industrial Complex, situated in North Korea just a few kilometers north of the border, was opened in 2004 as part of reconciliation efforts between the two Koreas.
More than 120 South Korean companies have a presence in the complex, which employs tens of thousands of North Koreans and provides an important stream of hard currency to Pyongyang.
North Korea has received roughly 616 billion won ($515 million) from the complex since it opened, according to a South Korean government statement.
South Korean Unification Minister Hong Yong-pyo told CNN that the action was being taken "to stop funds from the complex to be used by North Korea for developing nuclear (weapons) and missiles, and prevent our firms from being sacrificed."
He said authorities in Pyongyang had been informed of the decision, and South Korea had requested their cooperation for the safe return of South Korean nationals working at the site.
Seoul: Kaesong funds used for nuclear weapons
A statement from the South Korean government announcing the move said that despite international efforts to curb Pyongyang's nuclear advancement, it had pursued a further nuclear test and rocket launch, "thereby not even showing the slightest intent to forgo the development of its nuclear and missile capabilities."
Such actions, the statement said, were a "direct challenge to peace and stability on the Korean Peninsula and in the international community."
South Korea had been involved in the joint project at Kaesong "with a view to assisting the lives of the North Korean people, providing impetus to lifting up the North Korean economy, and achieving shared progress for both South and North Korea," the statement said.
But rather than helping to "pave the way to peace," it appeared funds earned by Pyongyang through the site had been used "to upgrade its nuclear weapons and long-range missiles," the statement said.
An estimated 132 billion won ($110 million) had flowed into North Korea through the complex in 2015 alone, it said.
In light of this, the statement continued, "it is clear that the existing approach will not work in discomfiting North Korea's nuclear and missile development plans."
The government had set up a special task force to assist South Korean companies operating at Kaesong to shut down their operations, the statement said.
Japan reveals proposed sanctions
Japan also announced plans to hit North Korea with new sanctions over its rocket launch and nuclear test, following a meeting of its National Security Council Wednesday.
A list of proposed sanctions released by Prime Minister Shinzo Abe's office outlined plans to beef up North Korea-related travel bans, tighten restrictions on money remittances, ban North Korean ships from Japan's ports and expand a freeze on Pyongyang's assets.
The new measures would impose bans on entering Japan for North Korean nationals and officials, foreign residents with links to nuclear technology or missile engineering who had visited North Korea, and crew members of North Korean ships.
It would also impose a ban on remittances to North Korea of more than 100,000 yen ($871), with sums smaller than that permitted only for humanitarian purposes. People traveling to North Korea would have to report to the government sums carried of more than 100,000 yen -- the previous threshold for reporting was 10 times that.
The proposed sanctions still require Cabinet and Parliament approval.
Nuclear enrichment facility 'reactivated': Intelligence chief
The announcements followed news that North Korea has reactivated its Yongbyon enrichment facility and could begin to recover plutonium from the reactor's spent fuel in a "matter of weeks or months," according to James Clapper, the director of National Intelligence for the U.S.
In his annual World Threat Assessment, Clapper said North Korea had threatened to "refurbish and restart" its reactors after the third nuclear test in 2013.
"We assess that North Korea has followed through on its announcement by expanding its Yongbyon enrichment facility and restarting the plutonium production reactor," he said in the report.
Clapper told a Senate committee on world threats Tuesday that North Korea's test activities were "of concern" to the United States.
He said that "Pyongyang continues to produce fissile material and develop a submarine-launched ballistic missile."
"It is also committed to developing a long-range nuclear armed missile that's capable of posing a direct threat to the United States, although the system has not been flight tested," he said.
According to multiple experts, North Korea has at least a dozen and perhaps as many as 100 nuclear weapons, though at present it lacks sophisticated delivery mechanisms.
At the same hearing, Sen. Jack Reed said that North Korea presented "an immediate and present danger to global security," and blamed Pyongyang's largest benefactor and trading partner, China, for failing to bring the regime into line.
"While China could exert pressure on North Korea through economic sanctions to encourage the regime to desist, the Xi administration prefers to remain on good terms with North Korean regime, putting the entire region at risk," he said.
Bomb test, rocket launch
In January, Pyongyang claimed to have successfully tested a hydrogen bomb in its fourth nuclear test.
U.S. officials were initially skeptical of the claim, but later assessed that there may have been a partial, failed test
of some type of components associated with a hydrogen bomb.
Then on February 7, Pyongyang said it had successfully launched an Earth satellite into orbit via the long-range Kwangmyongsong carrier rocket. Both the test and the launch were carried out in defiance of international sanctions.
Two days later, South Korea released the first images of debris retrieved from the sea southwest of Jeju Island shortly after the rocket launch.
An official with South Korea's Defense Ministry said that the booster "separated from (the rocket's) main body and exploded into about 270 pieces."
Officials said that, unlike in previous launches, the rocket booster appeared to have been fitted with a self-destruct device to prevent other parties from studying its capabilities.
A senior U.S. defense official later told CNN that the satellite was "tumbling in orbit"
and incapable of functioning in any useful way.
It stabilized briefly over the weekend, only to resume tumbling in the last day or so, a U.S. defense official told CNN on Wednesday.
Peaceful or military applications?
The technology involved in the launch was "dual-use," and could be used to launch a satellite or deliver a warhead.
Many countries believed the launch was a front for a long-range missile test, while North Korea maintains the launch was for scientific and "peaceful purposes."
An emergency meeting of the United Nations Security Council on Sunday agreed on the need for new sanctions against Pyongyang.
Separately, South Korea and the United States were looking at possible sanctions beyond those imposed by the United Nations, the South Korean government said. It added that Japan was also on board with possible punitive measures, outside any imposed by the security council.