Taking care of RO operations

Representative offices are simple to establish, but complex to operate

A representative office (“RO”) is a popular form of business presence of many foreign investors in Vietnam and is commonly used by many foreign investors or traders as the initial vehicle to enter Vietnam’s market.  RO operations have proved to be effective and efficient for the purposes of operation management, facilitating trade and relationships with customers and government. 

By regulations, the activities of an RO is restricted to auxiliary activities in nature such as conducting market surveys, collecting market information relating to the products or services provided in Vietnam by the parent company it represents, acting as a liaison conduit between the parent company and its business partners in the Vietnam. It facilitates business negotiations and contracting for the parent company.  An RO is specifically prohibited from engaging in any direct profit-making activities.  In other words, an RO is a cost centre, not a profit centre, and it must not generate any revenue in its own right.   This prohibition is often stated explicitly in an RO’s licence. 

However, Vietnamese regulations governing the operations of RO are perceived to be ambiguous in many respects. Whilst the regulations restrict the scope of activity of ROs to the above, they do not provide specific definitions of these terms, making it ambiguous on what types of activities that may be regarded as “auxiliary” and what may be regarded as “direct profit-making” activities.  

This ambiguity has, in practice, presented both opportunities and threats for ROs operating in Vietnam.  On the one hand, one may argue that the absence of clear definitions of prohibited activities makes it controversial on what is and what is not permitted for an RO and the absence of clear regulatory guidance has left the authorities with a wide-ranging power to interpret which types of activities are within the licenced scope of an RO and which are beyond.  On the other hand, however, the same absence of clear regulatory guidance can be interpreted to create latitude for some ROs when assessing what activities are permitted.

In practice, some ROs may take an aggressive approach by entering into the “grey area” between what is permitted and what is not, while others choose to stay well on the safe side.  It is not uncommon to see an RO in Vietnam employing hundreds of staff to perform most of the functions which would normally be seen in an incorporated entity.  Some ROs even have a full organisational chart with employees filling full-time positions in sales and marketing.

The strict restrictions on the RO’s activities without clear regulatory guidance coupled with aggressive activities could mean that ROs are exposed to several risks of non-compliance, unless efforts are made to comply with laws and regulations.    

Authorities’ recent activities

The significant growth in size and substance in many RO’s operations have increasingly attracted the attention of the relevant authorities.  Since mid-2010, there has been growing number of regulatory and tax audits and inspections of  ROs by regulatory bodies and tax authorities. These inspections commonly target those ROs which are alleged or suspected of engaging in prohibited activities.  As reported from time to time in the local media, licencing and tax authorities have raised concerns about ROs’ violation of regulatory requirements.  Some ROs have been even named in the press outlining their alleged violations. 

The authorities have been continually reminding ROs to comply with the regulations in two main areas (i) staying within “liaison” activities and (ii) fulfilling their personal income tax obligations for their employees and contractors (such as freelance consultants etc.).  Recently, in efforts to promote (or enforce otherwise) RO’s compliance with the regulations, the authorities have been conducting extensive joint regulatory and tax audits at several selected ROs.  These increasing regulatory and tax audit activities indicate that the authorities are taking enforcement measures more seriously than just warnings.  These have been seen in recent audit and inspection cases, which were carried out in a more coordinated and sophisticated manner, as reflected in the size and composition of audit and inspection teams, the length and depth of their analysis, the extensive scope of their examination, and the disciplinary actions they have taken against violations.

What is in their sights and the consequences?

As the authorities’ audit and inspection activities have recently increased in both scope and scale, more ROs may be subject to audit or inspection, and more areas of compliance may be examined by the authorities during an audit or inspection, the risk of exposure to non-compliance will be therefore higher.  Typically, the targets of an audit or inspection may include ROs employing a relatively large or considered excessive number of employees and/or engaging excessive sale or marketing activities in “sensitive” business sectors such as pharmaceuticals, trading, and certain service sectors.  The areas of focus may include the RO’s significant expenditures, maintenance of accounting books and records (including financial statements), compliance of employees’ personal income tax obligations, excessive employment of sales or marketing personnel, management control arrangement over the commercial activities of distributors, business partners, importers and affiliated entities or sales outlets and potential permanent establishment issues.  Examination of these areas could lead to findings of violations of the prohibited activities of the RO, omissions or under-declaration of personal income tax for employees, failure to meet minimum bookkeeping requirements for ROs or permanent establishment issues.  The scope of an audit or inspection may not necessarily be limited to the activities of the RO alone but it may be extended to the entire supply chain and hence the impacts of non-compliance (if any) could be more far reaching than what might have been contemplated.  The consequences may include one or a combination of financial impacts such as administrative penalties, assessment of tax liabilities, tax penalties, or non-financial impacts such as reprimands, withdrawal of the RO licence and exposure to negative publicity.

Best practices for ROs

With increasing enforcement activities by the authorities, it is important that ROs prepare themselves for full compliance with the Vietnamese laws and regulations.  To make sure their operations stay within the laws, it is advisable that RO management reviews their current practices and constantly monitors the day-to-day activities of their personnel to ensure that they do not cross the line of permitted activities.  A thorough review  of the RO’s regulatory and tax compliance affairs would be a good exercise.  The review may cover areas including commercial activities, status of personal income tax filings, book-keeping records, financial statements and permanent establishment risk.  Such a review would help management to identify the risk areas and make prompt remedies or improvements to mitigate those risks before they become issues in an audit or inspection.  Additionally, on a longer term basis, given the continuing regulatory restrictions on scope of activities of ROs and the removal of most trade restrictions against foreign investors in 2009 (as a result of Vietnam’s accession to World Trade Organization in 2007), many business sectors are now open to wholly foreign ownership.  It may be worthwhile for foreign investors who currently have only RO presence in Vietnam to revisit their business model and consider alternative forms of their market presence in Vietnam, as most of the current restrictions on ROs would automatically disappear  (or the risks substantially mitigated) when their business are carried on under an incorporated entity.

The views of the authors do not necessarily reflect those of KPMG. The authors can be contacted by email at namnguyen@kpmg.com.vn  or thoang@kpmg.com.vn