Understanding Vietnam’s Sourcing Models
HANOI – Regardless of whether a foreign company is involved in manufacturing, assembling, purchasing, or designing products in Vietnam, each business will have to develop its own individual model for sourcing the necessary goods, component parts and raw materials that will determine their short or long-term success. Making the right decision is crucial since any misstep could be very costly.
Ultimately, businesses sourcing products from Vietnam successfully will reach a trigger point where they will need to establish a permanent entity or base full time employees in Vietnam to carry on work such as supplier searches, price negotiations, export formalities, quality control supervision, and so on. To do this, there are essentially three types of entities that foreign investors can utilize to create a sourcing platform in Vietnam:
- Representative Office
- Limited Liability Company
- Service Company
- Trading Company
Each of these sourcing platforms feature several defining characteristics that differentiate them from each other – the most suitable and cost efficient sourcing platform for an individual business will depend on its goals and scope of operations. We cover the defining characteristics of each of these sourcing platforms in the ensuing sections.
Representative offices (ROs) are the most inexpensive and easiest type of model to establish. Typical uses for ROs include:
- Maintaining relations with existing suppliers;
- Coordinating sourcing activities;
- Helping with quality control at the suppliers’ factories; and
- Searching for new suppliers.
ROs act as an arm of their overseas parent company, and as such have no legal status within Vietnam. Importantly, an RO is forbidden from conducting any revenue-generating activities in the country. Therefore, ROs can only indirectly interact with Vietnamese businesses.
On the plus side, ROs do not require any capital injections, and are funded according to their needs, acting as cost centers. ROs that are involved in supporting sourcing activities are not liable for corporate income tax but are still subject to a value added tax (VAT) of 10 percent on input goods and services. Companies that intend to register an RO must have been in operation for at least one year.
Foreign staff working for ROs can have a direct employment relationship with ROs instead of the parent company abroad. Unlike in many other countries in the region, ROs can directly hire Vietnamese staff and/or foreign staff.
While an RO is relatively easy to establish and maintain, they are fairly limited in terms of operational scope since they cannot actually issue invoices or sign contracts. However, this can be an advantage because it reduces the accounting and tax compliance burden for an RO, thus helping to keep costs low. More importantly, operating an RO can often become very costly because of the need to have business done with the parent company overseas.
Despite their drawbacks, foreign companies often choose ROs as their first step in entering the Vietnamese market. An RO can allow a company to get a feel for the lay of the land while still keeping a light footprint since they only require a limited number of staff in the country to search for suppliers and conduct quality control assignments. As long as costs are kept low and the activities of the RO are within the scope of the parent company, there are probably no better alternatives to this type of entity, and many foreign businesses are using ROs to rent offices, hire local staff, and obtain working visas for their foreign employees.
Limited Liability Company
Unlike an RO, a foreign-invested limited liability company (LLC) can make profits and issue local invoices in VND to its customers. Furthermore, the liabilities of the shareholders are limited by the assets they bring to the business. LLCs can also employ local staff directly.
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. However, certain industries (such as banking, real estate, and auditing services) may require a specific amount of charter capital. 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.
For sourcing purposes, two types of LLCs are available in Vietnam:
- Service Company; and
- Trading Company.
A service company is an LLC that has as its core activity the provision of services to third parties. Foreign investors involved in sourcing activities use this type of company for activities such as providing market and supplier research, quality control, product development, design, and logistical support services. A service company is the easiest type of LLC to establish, as it requires a shorter time frame and a lower capital requirement compared to a trading or manufacturing company.
Service companies have proven to be great alternatives to ROs, especially when an RO’s operations start to grow and its costs begin to rise. A basic review of expenses and available business model alternatives will highlight how this type of structural change may help reduce tax burdens, while also increasing the flexibility of its operations.
If a business wishes to engage in import and export activities as well as domestic distribution (i.e., retail, wholesale and franchising trade activities) in Vietnam, the most common method chosen is establishing a trading company. Generally, a trading company is inexpensive to establish and can be of great assistance to foreign investors by combining both sourcing and quality control activities with purchasing and export facilities, thus providing more control and quicker reaction times compared to sourcing purely while based overseas.
Trading companies are also the ideal choice for foreign companies that need to source in Vietnam in order to resell in Vietnam. Without a Vietnamese trading company, the alternative would be to buy from overseas, and have the goods shipped out of Vietnam before then reselling back into Vietnam via local distributors (which would mean additional logistical costs, customs duties and VAT).
Trading and distribution is still a sensitive sector for foreign investors. Therefore, the licensing process can vary 4-6 months from the date of submitting the application dossier to the licensing authority, until the business license can be issued.
This article is an excerpt from the May 2014 edition of Vietnam Briefing Magazine, titled “Developing your Sourcing Strategy for Vietnam.” In this issue, we outline the various sourcing models available for foreign investors – representative offices, service companies and trading companies – and discuss how to decide which structure best suits the sourcing needs of your business. Perhaps the most important factors to consider when choosing a sourcing structure are your staffing requirements, your need for operational flexibility, and which option offers the greatest cost efficiencies. In this issue, we compare how each of these factors match up with the available sourcing platforms in order to help foreign businesses find the best option for their specific sourcing needs.
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