How to play the incentives game

Fred Burke

Fred Burke, managing partner of Baker & McKenzie, law firm shares his views on how Vietnam should use incentives to attract investment from international investors in the future.

The issue of tax incentives for “quality” investors is obviously complex and each country handles it slightly differently.  If you compare Hong Kong and Singapore, you can see two very different philosophical approaches in our own neighborhood.  Hong Kong takes that potion that a low overall tax rate (about 16 per cent on profits), without special incentives, lets a healthy market place determine who the “winners” will be and provides the best environment for nurturing development.  Singapore, on the other hand, actively targets specific industries it sees as strategic and targets them with fiscal and other incentives. 

Vietnam’s clear choice

In Vietnam’s case, the competitors for investment in the kinds of industries that produce sustainable development, jobs and taxes (directly or indirectly) are countries like Indonesia and Thailand, where fiscal incentives are clear and aggressive.  Given that Vietnam is not in a position to adjust its overall tax structure to adopt the Hong Kong model, it will need to follow the Singapore model and provide for special industries in a position it wants to attract. 

There is a risk of trying to “pick the winners”.  One of the lessons of the Vinashin case is that a business (in that case, shipbuilding) seemed like a good investment before the global financial crisis devastated the global shipping industry is that the state is not always in the best position to decide who the most dynamic industries of the next era will be.  However, based on the country’s sometimes competing realities there are some principles for what kind of investment is clearly desirable and should be given the maximum incentives.

Drawbacks in the “High Tech” approach

Such investments are projects that almost any country in the world would be eager to get.  Using a single standard such as “high tech” status is not sufficient to attract the investment that Vietnam wants.  Next generation electronics manufacturing, which is not necessarily “high tech”, is among them, as are environmental equipment and services projects. A project involving hundreds of millions of dollars in investment to create a manufacturing facility that will not negatively impact the environment or consume unreasonable amounts of subsidised electricity, and which creates direct employment for thousands and indirect employment for many more is obviously something that would be targeted. 

The “high tech” criteria is almost useless in practice, because it is not conferred until after the investment is made, and it must be renewed each year under standards that change from year to year, so the risk of not getting this status is too high for the investor.  That means the government is giving something for nothing, because investors won’t rely on “high tech” status incentives to make their investment decision. 

Effective incentives should be transparent and automatic

 For an investment incentive to work (that is, attract the targeted investment) it must be automatic and completely clear in the law.  That can happen in several ways.  The government can define parameters, such as locations and industries, for special encouragement.  Care must be taken not to run afoul of the Word Trade Organization’s (WTO) restrictions on export subsidies and incentives can no longer be linked to exports alone.  But there are a plethora of other bases, not limited to “high tech” that countries use to attract investment without violating the WTO rules.  The second way is to give the government the legal authority to decide on tax incentives for specific projects that would be included in the investment certificate and guaranteed for the life of the project.  This has the advantage at least of certainty, though it does require investors to spend time negotiating case-by-case treatment.

Affirmative government initiatives are needed

 Vietnam’s last round of tax incentive amendments tried to conform with the WTO rules against export subsidies, but they may have gone too far in tying the government’s hands so that it can not compete for the international investment that, in the wake of the cost increase China is suffering, investors are looking for new homes.  I think this issue was exacerbated following advice from technical advisors who said that “investors don’t base their decisions on tax incentives.”  That is true in one  way, since other factors are more important, but the fact is that investors assume a competitive tax regime or they just cross the country off their list of potential homes.  Without incentives, you won’t even be in the game.

 Don’t miss the opportunity

We have a historical opportunity to make Vietnam a major player in the global sourcing industry in clean manufacturing if only the right incentives can be offered clearly to potential investors.  Until the legislation is overhauled to reflect this, the government must do what it can on a case-by-case basis to attract and keep desirable projects.

Such investments are projects that almost any country in the world would be eager to get.  Using a single standard such as “high tech” status is not sufficient to attract the investment that Vietnam wants.  Next generation electronics manufacturing, which is not necessarily “high tech”, is among them, as are environmental equipment and services projects. A project involving hundreds of millions of dollars in investment to create a manufacturing facility that will not negatively impact the environment or consume unreasonable amounts of subsidised electricity, and which creates direct employment for thousands and indirect employment for many more is obviously something that would be targeted. 

The “high tech” criteria is almost useless in practice, because it is not conferred until after the investment is made, and it must be renewed each year under standards that change from year to year, so the risk of not getting this status is too high for the investor.  That means the government is giving something for nothing, because investors won’t rely on “high tech” status incentives to make their investment decision. 

Effective incentives should be transparent and automatic

 For an investment incentive to work (that is, attract the targeted investment) it must be automatic and completely clear in the law.  That can happen in several ways.  The government can define parameters, such as locations and industries, for special encouragement.  Care must be taken not to run afoul of the Word Trade Organization’s (WTO) restrictions on export subsidies and incentives can no longer be linked to exports alone.  But there are a plethora of other bases, not limited to “high tech” that countries use to attract investment without violating the WTO rules.  The second way is to give the government the legal authority to decide on tax incentives for specific projects that would be included in the investment certificate and guaranteed for the life of the project.  This has the advantage at least of certainty, though it does require investors to spend time negotiating case-by-case treatment.

Affirmative government initiatives are needed

 Vietnam’s last round of tax incentive amendments tried to conform with the WTO rules against export subsidies, but they may have gone too far in tying the government’s hands so that it can not compete for the international investment that, in the wake of the cost increase China is suffering, investors are looking for new homes.  I think this issue was exacerbated following advice from technical advisors who said that “investors don’t base their decisions on tax incentives.”  That is true in one  way, since other factors are more important, but the fact is that investors assume a competitive tax regime or they just cross the country off their list of potential homes.  Without incentives, you won’t even be in the game.

Don’t miss the opportunity

We have a historical opportunity to make Vietnam a major player in the global sourcing industry in clean manufacturing if only the right incentives can be offered clearly to potential investors.  Until the legislation is overhauled to reflect this, the government must do what it can on a case-by-case basis to attract and keep desirable projects.