A confluence of economic, political, and logistical issues is coming together that is changing the dynamics of doing business internationally for many U.S. companies. The result: China may be falling out of the top spot as a location for American companies looking to establish foreign operations, with several other low-cost countries vying to replace it. But the situation is complicated. American companies that already have operations in China are not leaving, at least not in large numbers.

The complex dynamics that are influencing U.S. companies considering establishing foreign operations include the fact that certain countries are more advantageous than others for certain industries. While the popular perception is that American companies take their manufacturing abroad primarily to save labor costs, in reality, they often establish foreign operations to serve growing foreign markets. If you have a burgeoning customer base in Germany, it may be more cost-effective to manufacture your goods in Poland than in Thailand. And if your company is in the technology space, China still may be a better destination for you than if you manufactured consumer goods.

In other words, there is no one-size-fits-all solution. American companies eyeing foreign operations must do their homework and talk with advisors both at home and abroad to determine the best course. Once they do their homework, most companies will find that four broad trends are driving decisions about establishing foreign operations these days.

Digital Game Essential

First, due to the COVID-19 pandemic, remote work has become a worldwide phenomenon. The more digital and cloud-based your operations are, the more successful you will likely be with your foreign operations. Some general guidance would include:

-Before considering going abroad, evaluate your company’s commitment to technology and determine where upgrades should be made.

-Learn about the technology infrastructure in your target country and make sure it can support your company’s technology profile and needs.

-Don’t forget about workers; you’ll need to ascertain the level of technology skills possessed by your potential new workforce.

Incentives Change with Landscape

Second, every country has a set of incentives in place to attract foreign companies to their shores. Most incentive programs favor certain industries above others.

The Chinese government currently has highly preferential policies to encourage technology businesses to locate in China, especially those related to artificial intelligence and semiconductors. While China is falling out of favor with other manufacturers, if you are operating in one of its favored industries it may still be worth consideration.

While technology companies still find China a viable place to establish or maintain operations, traditional manufacturers in such industries as textiles and apparel are looking elsewhere. Wages in China have doubled in the past 10 years, so labor costs – once the dominant attraction for American companies – no longer provide an advantage.

Consequently, countries like Thailand, Cambodia, Vietnam, India and Mexico are rapidly rising as sites for American companies due to many of the same factors that once made China attractive. Low labor costs, skilled workforces and fewer regulations are attracting American companies.

Moreover, because of the rising costs in China as well as increasing political tensions between China and the U.S., other countries are stepping up their incentives for American companies to locate within their borders.

Each country has unique advantages and disadvantages, and U.S. companies need to weigh the value that these locations would bring depending upon their industries, products and services.

For example, Mexico offers the benefit of being close to American markets, reducing shipping costs and avoiding tariffs. In Southeast Asia, Vietnam makes it easier than China to move goods into and out of the country and offers the most knowledgeable workforce. India is not far behind in terms of workforce. However, India prohibits the export of many goods to protect supplies for its own massive population. Currently, the material used to make surgical masks cannot be exported out of India – a significant disadvantage for American companies with Indian operations that tried to pivot to respond to the worldwide need for protective equipment during the COVID-19 pandemic.

Companies Re-evaluating Supply Chain Strategies

Third, the supply chain and the ease with which goods move in and out of countries must be a part of the evaluation process when establishing operations abroad.

For the most part, U.S. companies moving to the emerging Asian countries and Mexico are those that are establishing foreign operations for the first time. American companies with operations already in China are staying put for now, even though steep tariffs that the U.S. has placed on goods shipped from China are impacting their profitability.

In part, they are staying in China due to supply chain issues. When large companies like Apple went to China, their supply chains went with them. Companies that supply those large manufacturers find it more cost-effective to be where they are. But if a large company decides to pull out of China, its supply chain remains there, and it must deal across borders with suppliers. Hence, companies that are already planted in China – even those much smaller than Apple – can find it very hard to leave.

U.S.-China Trade War

The fourth trend is the ever-increasing tariff war between the U.S. and China, which has significantly impacted American companies looking to establish operations in Asia. Companies already located there are seeing their profitability drop because of the tariffs, and deterioration of the political relationship between the two countries – complicated by COVID-19 – has contributed to China falling out of favor with American companies.

The increasing tensions between the U.S. and China also have started to impact immigration rules, making it difficult for some U.S. companies to get their American employees into China. This is a real-world example of how geopolitical considerations can impact the day-to-day operations of American companies.

Beyond these four trends, U.S. companies considering establishing operations abroad to serve growing global markets should look at several important factors:

Location of customer base

The location of your international customer base is a big driver in determining which country to choose for your foreign operations. You want to minimize transportation and shipping costs, and you also need to consider where your supply chain is concentrated.

Entity structure

Creating a separate entity from your U.S. entity will help keep the domestic and international operations distinct, protecting you from legal and liability issues. A subsidiary structure may be best, depending on the type of operation you are establishing.

Consider the local laws in each country that govern foreign operations, and how they may impact you. For instance, in China and India it’s very difficult for a foreign company to own 100% of a business, depending on the type of company and industry. Those countries, and several others, require foreign businesses to set up entities with at least some minimal local national ownership.

Taxes

Your entity structure will largely determine how tax-efficient your foreign operations are from both the U.S. and local countryside, but it is still advantageous to locate in a country with a low-income tax rate.

Beyond income tax, you need to consider the tax consequences of repatriating cash back to the U.S.

If you select a country with which the U.S. has a tax treaty, you will find a more friendly attitude toward repatriation. When repatriating funds from foreign operations, withholding taxes often can reach 30%, but if there’s a tax treaty in place the repatriation cost can sometimes be reduced to zero.

Taxes can’t always be the driving consideration in deciding where to locate a foreign operation. There are a lot of moving parts, including workforce, overall costs, logistics (can you get a product in and out easily), quality of internet and technology infrastructure, immigration policy for your American workers, and more.

If you are considering establishing a foreign operation for your company, reach out to your Windham Brannon advisor. Even if you expect to wait until after the global COVID-19 pandemic is safely behind us, now is the time to start planning.

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This article was written by International Tax Partner, Nicole Suk