Vietnam is responsible for about half of Nike’s footwear production globally, and almost half of the Vietnamese production is shouldered by South Korean equipment manufacturers that have operated there for decades. Nike is just one example of South Korean businesses’ presence in Vietnam in the textile and apparel industry.

But changes proposed to a trade system that would make foreign companies like Korean textile firms in Vietnam no longer eligible for tax exemptions has sent jitters across the textile market, fearing it would drive up costs and force manufacturers to relocate their hubs to elsewhere in Asia, the Korean Federation of Textile Industries said.

At the core of the issue is the impending change to the “on-the-spot exports and import” system that could come as soon as the end of this year. The system has drawn substantial investments from Korean textile firms for the last decades in Vietnam, where nearly 500 Korean companies were operational as of 2019. Korean firms are the biggest investors in this sector, accounting for 25 percent of foreign textile investments, about $4.8 billion over the past 30 years, according to the Vietnam Textile and Apparel Association.

While the change will affect all foreign companies operating in Vietnam, Korean textile firms, having heavily invested in the country based on the tax incentive, could be among those hit the hardest.

The scheme allows foreign manufacturers to enjoy tax exemptions while trading with suppliers and other players in the supply chain within Vietnam, as it recognizes those transactions as export and import deals.

For instance, when a foreign company produces garments in a Vietnam factory and in the process involves using raw materials from a Vietnamese firm and a Vietnamese sewing contractor, the business transaction between the latter two are also recognized as export-import deals.

Korean companies claim that while many of the raw materials used by sewing plants in Vietnam were brought in by China or Korea in the past, more of the materials are supplied within Vietnam now.

The change means, in other words, this chain of supply will no longer be viewed as export-import trade despite a foreign company being the exporter of the products produced in Vietnam. By reclassifying the transactions as local means a value-added tax of 8 percent would be imposed on manufacturers. It will be reverted to 10 percent from next year as the rate has been temporarily reduced as an economic stimulus.

“If Korean textile firms are burdened with VAT, it would spell trouble for their Vietnamese subcontractors. Many of the firms are perplexed,” said Kim Yeon-ho, the leader of a special task force team recently put together to specifically deal with the taxation change by the Korean Chamber of Commerce & Industry in the South & Middle of Vietnam. The team comprises various stakeholders ranging from local Korean textile companies to local Korean agencies and federations related to trade and commerce.

The impact of such a change could be detrimental to foreign exporters as higher tax will be reflected in the cost, which would lead to lower price competitiveness, which had especially been the key benefit of Korean firms operating in Vietnam, said an official of a Korean textile company. The company operates an extensive vertical supply chain, including nine dyeing and knitting subsidies, in Vietnam.

Korean businesses said the change could come into effect as soon as the end of the year, but they are still awaiting confirmation from the Vietnamese customs authorities.

On Thursday, the federation briefed Korean textile companies on how to prepare for the changes at a meeting in Seoul.

Larger firms doing business within tax-free zones may be less affected by the revision. But a direct impact seems unavoidable in most small and medium-sized firms that make up almost 80 percent of all the foreign textile companies in Vietnam, which have been more dependent on the domestic tax exemption scheme than other sectors to maintain price competitiveness.

An expert said the change could be because Vietnam seeks to boost its high-tech industries.

“Vietnam’s motive could be shifting tax benefits from labor-intensive industries to high-tech industries such as electronics and equipment, for goal to become a high-income nation by 2045,” Kwak Seong-il, a researcher at the Korean Institute for International Economic Policy.

Even if the changes prove to benefit Vietnam in the long run, he also raised questions about the immediate impact of the revision not only on Korean textile companies but also on the local economy and labor market.

The textile industry was responsible for 8 percent of Vietnam’s total GDP in 2020 and 25 percent of manufacturing and processing employment in 2021.

Separate data from the Export-Import Bank of Korea showed that Korea’s investments in Vietnam’s textile industry have surged sixfold from the period of 1992-1998 to 2016-2021.

“Among other things, it is skeptical that Vietnam’s workforce is ready for the transition,” Kwak said.

Meanwhile, Korean textile companies in Vietnam are scrambling to deal with the changes as local administrations are pressing forward with the proposal, despite the lack of confirmation from the central customs authorities.

“Vietnam‘s strength lies in the large-scale foreign investment in raw materials, which have facilitated rapid, competitive product manufacture. Now, both raw material producers, including Vietnamese suppliers, and finished goods manufacturers stand to lose competitiveness,” said a senior official at a fabric production plant owned by a Korean firm in Vietnam who wished to be unnamed.

“Moreover, this shift comes at a time when Vietnam’s position in the global textile market is facing challenges, with China remaining dominant and India and Bangladesh expanding aggressively.”

In response, the KoCham Federation of Textile Industries in November last year proposed alternative solutions to the Vietnamese government, including the introduction of grace periods and a quicker tax rebate system that can offset some of the impending VAT load.

However, the uncertainty is already driving some Korean textile companies to relocate some production to countries like Cambodia and Indonesia, according to Kim, the task force team leader.

As the industry stands on pins and needles on the government’s response, he said he is still asking for open dialogue.

“As one of the first and largest foreign investors in Vietnam, we don’t think it’s too much to ask for dialogue,” he added.