New tax developments in Vietnam

Vietnam has seen a series of major tax reforms over the past decade.  2009 marked several major tax reforms and was the second step of the unification process of two separate tax regimes, which commenced in 2006, and included a single standard corporate income tax (“CIT”) rate of 25% for both foreign invested and domestic enterprises.  More recently, the Vietnam Government has sought to alleviate the impact of the economic downturn by introducing a range of incentives, principally to qualified small and medium enterprises (“SMEs”), certain hard hit sectors and to large employers.  The incentives have ranged from deferral of tax payments and a 30% reduction of CIT.  The Government continues its efforts to tackle existing issues within the tax regulations and has proposed further changes to be implemented in 2012.  This article highlights some recent developments and proposed changes in the Vietnam CIT environment.

CIT in Vietnam

The standard CIT rate is 25%, but with enterprises operating in extractive industries generally subject to higher rates of up to 50%.  Tax incentives in the form of preferential tax rates, tax holidays and tax reduction are available and granted based on regulated encouraged sectors and projects located in difficult socio-economic locations.

While the standard CIT rate is regionally competitive, some tough CIT deductibility provisions have meant that effective tax rates can be significantly higher.  There has been reform in this area with the introduction of general deductibility provision and items like staff bonuses now deductible if necessary criteria and documentation requirements are satisfied.  However, the most significant area of continuing concern is the limit on the deductibility of advertising and promotion (“A&P”) expenses.  Vietnam allows a deduction of A&P expenses of up to 10% (15% for the first three years of operation) of all other deductible expenses.  For a taxpayer trading in goods, cost of goods sold is not included in the base for undertaking this calculation.  For taxpayers in certain industries (e.g. FMCG), the A&P cap presents a significant tax burden and, despite significantly lobbying, there are no clear indications that abolishment of the A&P cap will occur any time soon.

Foreign enterprises having a permanent establishment (“PE”) in Vietnam shall pay CIT on the taxable income earned in Vietnam (irrespective of whether it relates to the PE) and on the taxable income generated out of Vietnam and related to the operations of the PEs.  These domestic PE provisions are very broad.  However, in practice, there has been only limited application of the PE provisions and the tax authorities have preferred to tax foreign enterprises operating in Vietnam via the foreign contractor withholding tax regime, which is a relatively easily applied collection mechanism for payments made by Vietnamese companies to foreign service providers.

Proposed tax reforms 2012

New guidelines on CIT, VAT and Special Sales Tax are in the drafting process and expected to be issued by the end of 2011 and effective from 1 January 2012.  The changes are aimed at rectifying certain limitations of existing legislation, address issues that various industry sectors have lobbied for reform and cater to tax policy changes to be introduced by the Government.

The proposed changes include favourable amendments to the CIT deductibility provisions including a full deduction for life insurance premiums for employees (subject to documentation requirements) and for commissions paid for multi-level marketing (which had previously been subject to the A&P cap).

For taxpayers enjoying tax incentives, the changes seek to rectify a currently problematic provision of the legislation that results in certain business related income being considered “other income” and subject to the standard, rather than the incentivized, CIT rate.  Income from the reversal of provisions for inventory devaluation, financial investment loss, bad debts, warranty and salary will no longer be treated as other income.  In addition, income from asset sales, selling of scraps, import/export duty refund and realized foreign exchange gains/losses will not be considered “other income” to the extent the income can be shown to directly relate to the incentivized business activities.

Less favourable changes include the need to include payables that have remained unpaid for more than three years as income.  This change may have implications for intercompany payables that have accumulated over a long period of time and which, for tax purposes, will now be effectively treated as written off/forgiven.  For the real estate industry, for assets that are contributed as capital (such as land use rights) and revalued, the revalued amount will be taxable over a maximum of 10 years, which differs from the currently more generous ability to tax this revaluation over the life of the asset.

The proposed changes include the introduction of a limitation on the tax deductibility of interest (akin to a thin capitalization rule).  In the past, Vietnam had a legislated debt to equity limit in its investment laws, but this was removed a number of years ago and investors have increasingly sought to more lightly capitalise their Vietnam subsidiaries.  While the proposed tax changes provided for a relatively generous limit of deductible interest on debt 5 times the charter capital, the introduction of a thin capitalisation rule could lead to more stringent limitations in the future.  The draft changes are yet to detail how to determine debt for the purpose of assessing the limitation.

For taxpayers enjoying tax incentives that were previously awarded due to export criteria, these will be removed from the end of 2011.  This change was a condition of Vietnam’s World trade organization accession.  The Government has previously announced that affected taxpayers are entitled to determine whether they are entitled to alternative incentives based on the regulations effective at the time they were originally licensed or those effective at the end of 2011.  Contained within the proposed changes is a requirement for the tax authorities to be notified of the option selected by a taxpayer.  Failure to do so will presumably result in the taxpayer having no tax incentive entitlements.

Proposed foreign contractor withholding tax changes

Vietnam’s foreign contractor withholding tax (“FCWT”) regime is a collection mechanism for CIT and VAT on payments to foreign companies e.g., interest, royalties, licence fees, management fees and head office charges.  As part of the proposed tax reforms, the Government is looking to amend certain provisions relating to the CIT element of FCWT.

The proposed changes to CIT rates to be applied under the FCWT regime are as follows:

 

 

Current

Proposed

Services

5%

10%

Interest

10%

5%
Reduced to 2% for incentivized projects approved by the Prime Minister

Re-insurance

2%

0.1%

Drilling rig rental

5%

5%*

Financial derivatives

2%

2%*

* No change.  Previous official letter position elevated to Decree status.

 

The reduction of the interest withholding tax rate from 10% to 5% is an appreciated change since it will lower the finance costs for Vietnamese enterprises which are already troubled with the high lending rates in Vietnam and are keen to obtain financing from overseas.  The reduction of the withholding tax rate for re-insurance is also a positive step, even though most of the foreign re-insurers are able to claim a CIT exemption under a treaty.

In contrast, the proposed CIT rate increase for services from 5% to 10% will have a significant impact and will require taxpayers to review their existing agreements and whether any CIT exemption under a treaty is available in order to lower the tax burden.

The current draft version of the changes do not include transitional or grandfathering provisions, but past FCWT reforms suggest that these may be forthcoming when more detailed guidance is issued.

Recent developments

New rules on profit repatriation

Changes regarding profit repatriation for foreign investors became effective from January 2011, which bring positive and negative changes.  A step backwards is that foreign investors shall be permitted to remit their profits only annually at the end of the financial year or upon termination of the investment in Vietnam.  Provisional profit distributions, as allowed under the old regulations, are no longer an option.

The previously required tax clearance has been replaced with a notification process.  Taxpayers must notify the tax authority of the proposed profit remittance within 7 working days before payment.  Approval from the tax authority is no longer required.

Increased focus on compliance with Vietnam accounting system

All entities operating in Vietnam must prepare their financial records in compliance with the Vietnam accounting system, which includes the use of local currency and language, and a prescribed chart of accounts.  However, such requirements may not always be fully compatible with foreign-sourced accounting systems and accordingly compliance with these requirements by foreign investors has in the past often been lax.  In addition, there had been limited enforcement by the authorities.  However, in recent tax audits this has become an area of specific focus.  The tax authority has used VAS non compliance as a basis to make significant tax adjustments including the denial of tax incentives, the reclaiming of VAT refunds and the disallowance of CIT deductions.  Taxpayers need to be increasingly aware of the VAS requirements and ensure compliance.

Fiscal stimulus measures 2011

In order to bolster the Vietnam economy in the current global climate, the following CIT measures have been announced.

Eligible SMEs are entitled to a one year deferral of their 2011 CIT payment.  The 2010 deferred CIT amounts that are due in 2011 are also eligible for an additional nine month deferral in 2011.

There is a draft decree providing for a 30% reduction in 2011 CIT for SMEs and labour intensive enterprises engaged in manufacturing, processing, processing of farm produce, forestry products, aquatic products, garments and textiles, footwear, electronic components and construction of certain infrastructure.  This will not be applicable in respect of certain activities (e.g. profits from lotteries, property trading, finance, banking, insurance or those subject to special sales tax), or to SMEs which are majority owned by a holding company which is not a SME.

Transfer pricing developments

Since the introduction of detailed transfer pricing regulations in 2006, there has been increased focus on this area by the tax authority and significant coverage of transfer pricing issues in the media.

A new transfer pricing Circular was issued in April 2010 and since this time the tax authorities have been more active in information gathering, requesting retrospective disclosure of related party transactions and reviewing transfer pricing documentation.  More recently, the tax authorities have sent questionnaires to taxpayers aiming to gather industry related information which may be used for the development of transfer pricing legislation, to develop an information database and to target particular areas that the tax authority consider to be of concern.

So far, only a limited number of detailed transfer pricing audits have been carried out.  However, it is expected that a lot more transfer pricing audits will be carried out by the tax authorities over the next years.  Training of tax officials is carried out to prepare them for this task.  The tax authorities have indicated that the focus of such transfer pricing audits will not only be large, loss making multinational companies, but also on domestically owned companies and or profit making companies with fluctuating margins.