The Case for Vietnam as the Heir to China’s Manufacturing Crown

Our clients in Vietnam, when asked to justify shifting operations from China, typically say that it makes good economic sense to relocate if they can get Vietnamese production up to 70% of that achievable in China.

Vietnam is wooing China’s manufacturing base by reducing its corporate income tax rate to 22%, with a further reduction to 20% expected in 2016 – a full five percentage points lower than China

Located right on the border of China’s Guangxi and Yunnan Provinces, and with easy access to the manufacturing hubs of Guangdong Province and wealthy consumer markets in cities such as Hong Kong, Guangzhou and Shenzhen, Vietnam will prove to be highly influential in determining how much of China’s traditional light manufacturing base remains in the south of that country.

With a population of some 90 million and GDP of US$171 billion, Vietnam has been pushing itself forward as a China alternative for some time now. That has been matched with assertive investment policies designed to attract foreign investors and a huge improvement in infrastructure.

In truth, China does not seem to mind that much. It is also keen to dissuade low-cost manufacturers from continuing their life span in China. This is one reason why, a decade ago, then Premier Zhu Rongzhi stated that Shenzhen’s role was to move away from making Christmas trees and become an IT hub.

China’s Heir

It is Vietnam that is set to inherit the lower end of light- and medium- manufacturing from China.

To make sure that happens, and to set it on the road route to becoming one of the manufacturing powerhouses of the world, Vietnam has taken an impressive stance to attracting foreign investors.

It is about to come into compliance with the tariff requirements of the ASEAN Economic Community program, which will be established by end 2015. This means that Vietnam will come into line with reducing all tariffs on goods imported from other ASEAN nations, and will also come into line with the ASEAN-China Free Trade Agreement.

That FTA reduces tariffs on 97% of all ASEAN exported products entering China and should result in a huge increase in Vietnam-China trade in 2016. It also means that Vietnam could step into the breach as China becomes an expensive place to manufacture.

Manufacturing products in Vietnam destined for the China market is already becoming a trend. From January 2016 it will become a flood.

Vietnam also has its eyes on China’s manufacturing industry, and is looking to woo it from its traditional base in Guangdong. To do that, it has reduced its corporate income tax rate to 22%, with a further reduction to 20% expected in 2016 – a full five percentage points lower than China.

Bilateral trade with China has boomed. China is already Vietnam’s largest trade partner. Bilateral trade is expected to reach US$60 billion in 2015, although the process has not always been smooth. Vietnam occasionally sends back large quantities of foodstuff and sometimes imposes bans on Chinese products entering the market due to health concerns.

Politically also, the two nations have not always seen eye to eye. A brief maritime skirmish in the late 1980s over disputed islands resulted in Vietnamese deaths. Tensions over such issues retain the potential for violence. Chinese owned factories were ransacked after one such incident in 2014.

Vietnam may have its neighbor as its largest trade partner, but it does look to balance that with attracting a healthy amount of non-Chinese investment and trade as well, including from former enemy United States and the European Union.

We can compare Vietnam and China in terms of average operational costs as follows:

Trade and Taxes

Vietnam’s top five exports are:

  • broadcasting equipment (10%)
  • crude petroleum (7.4%)
  • leather footwear (4.0%)
  • computers (3.4%)
  • coffee (3.1%)

The top five imports are:

  • refined petroleum (8.8%)
  • telephones (3.8%)
  • integrated circuits (3.3%)
  • hot-rolled iron (2.0%)
  • light rubberized knitted fabric (1.7%)

In agriculture, Vietnam is a major exporter of coconuts, Brazil nuts, cashews, and pepper. In terms of exports, Vietnam has already poached a lot of what was a Guangdong-based, Taiwanese series of investments in the shoe making industry, and this shows now in its footwear exports.

An emerging IT sector finishes off computer parts and accessories, as can be noted by the importation of integrated circuits and exports of broadcasting equipment and computers. The country also has a developing petrochemical industry – the offshore source of some of the maritime disputes with China, which also wants them.

Vietnam has been active in signing bilateral Double Tax Agreements with several important countries, including China, India, and many other Asian nations, in addition to several within Europe and elsewhere. These can be immensely useful when looking to increase profitability in trade and investment.

Investment Structures

Foreign investors can choose from an array of allowed vehicles in restructuring their investments in Vietnam. They include:

  • Limited liability company
  • Joint-stock company
  • Partnership company
  • Representative company
  • Branch office

Limited Liability Companies. 100% foreign-owned enterprises and joint-venture enterprises can be established as a limited liability company (LLC). In an LLC, members are only liable for the debts of the partnership to the extent of the capital contribution they have poured into the company.

There is usually no minimum capital requirement for foreign investors that intend to establish an LLC in Vietnam, although authorities will expect the investor to commit a reasonable amount of charter capital according to the scale and business scope of the project.

An LLC can consist of a single member or multiple members, but the total number of members cannot exceed 50. Investors can be corporations or individuals. An LLC cannot issue shares.

Joint-Stock Companies. Foreign-owned enterprises and joint ventures can also be established as a joint-stock company (JSC), which can issue securities and bonds. Investors often choose to create a JSC if they plan to go public in the future.

The JSC’s charter capital is composed of shares belonging to the founding shareholders in proportion to the capital they have contributed. There is no minimum requirement for the capital contributions of foreign investors.

A JSC is required to have at least three shareholders. There is no limitation on the maximum number of shareholders, nor on their nature – they can be individuals or institutions, Vietnamese or foreigners.

Partnership Companies. A partnership company is a legal entity established by at least two individuals who are members of the partnership and co-owners of the enterprise. They are the General Partners and are liable for all obligations of the partnership without limit.

In addition, a partnership company can consist of limited liability members (individuals or organizations) who contribute only part of the capital and have limited liability and rights in the operation of the company.

Representative Offices. A representative office (RO) is not a legal entity and is forbidden from conducting any revenue-generating activities. Rather, ROs are permitted to conduct market research, serve as a liaison with an overseas parent company and/or serve other supporting roles such as ensuring quality control, acting as a product showroom and helping to facilitate the execution of the contracts of the parent company.

ROs are not subject to tax in Vietnam. Unlike in certain other Asian countries, ROs are permitted to hire staff directly.

Branch Offices. A branch office is a subsidiary of a parent company. Under Vietnamese law, it does not constitute a separate legal entity. Unlike the representative office, a branch office is entitled to conduct business activities in Vietnam within the parent company’s business scope.

To set up a branch in Vietnam, a parent company must have conducted business in its home country for at least five years.

Other Investment Options. A business cooperation contract (BCC) is typically signed between a foreign investor and a local company or the government of Vietnam, with the objective of jointly conducting business operations in Vietnam. BCCs are based on sharing allocation of responsibilities, as well as sharing profits or losses, without creating or forming a legal entity in Vietnam.

Build-operate-transfer contracts (BOT), build-transfer-operate contracts (BTO) and build-transfer contracts (BT) are specific projects carried out by foreign investors and an authorized government agency. These additional investment vehicles have been introduced in Vietnam to entice international capital into the infrastructure sector.

Business scopes can range from traffic, electricity, production and business, water supply or drainage, waste treatment and other conditional or restricted sectors as stipulated by the Prime Minister.

The difference between these contract types is at what point the title of the project is transferred to the government, namely after the investor operates the project, before the investor operates the project or immediately following completion (in which case the investor does not operate the project and is compensated for capital investment in other ways).

Vietnam employs its own language and script in official documents and the majority of documentation must be in Vietnamese and translated into the pertinent language.

Professional Resources

The Vietnamese government has built numerous development zones across the country, mainly along its long eastern coast, in addition to developing processing zones at the border with China and Cambodia.

The largest of these are currently centered around Ho Chi Minh City in the south, which is near well-established sea port facilities.

Zones close to the border with China repackage Southeast Asian goods for the Chinese market. These new industrial zones are meant to prepare the country for the ASEAN Economic Community and increase the trade flows via existing rail links from ASEAN nations as far away as Indonesia. Singapore, Thailand, and Laos are all viable routes en route to China.

In banking and finance, Vietnam is well served in Hanoi, Ho Chi Minh City and the main tourist resorts. However, it can get very local  very fast when one steps out of these areas, something that can cause problems getting investment financing into the right places.

There are numerous Asian and international banks operating representative offices and some limited activity branches in the country. 

Summary

Vietnam is fast becoming a significant player when it comes to an ASEAN strategy for foreign investors. Part of this is the nation’s demographic dividend, which sees Vietnam today with a large, business-friendly and young workforce.

Vietnam has also taken a leaf directly out of China’s book in terms of its FDI strategy. It has been canny in providing attractive tax breaks and incentives for foreign investors, much as China did 25 years ago.

Infrastructure, especially rail links through to China and down through ASEAN, is being upgraded. When completed, this will ensure that Vietnam is strategically placed as a repacking and consolidation hub for China-ASEAN two- way trade.

Vietnam represents a good study as a potential investment destination for investors looking to reach out to both China and ASEAN, as well as an ability to offer China-based businesses a culturally similar and less expensive manufacturing solution.

About the Author

Dezan Shira & Associates is a specialist foreign direct investment practice that provides advisory services to multinationals investing in emerging Asia. This article was first published in Vietnam Briefing and was reedited for clarity and conciseness. For further details or to contact the firm, please visit www.dezshira.com.

Photo credit: Shutterstock

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