Vietnam to rewrite tax rules that limit related-party interest deductions

By Duy Cao, Rajah & Tann LCT Lawyers

Facing criticism from both foreign multinationals and domestic companies, Vietnam’s Ministry of Finance has proposed changes to controversial tax rules enacted last year that limit interest deductions for loans among related parties. The government is also reviewing a draft law on tax and transfer pricing administration.

Vietnam interest deduction limits

Decree No. 20/2017/ND-CP, enacted 24 February 2017 (Decree 20), limits deductions for related party total loan interest to 20% of total net profit generated from business activities plus loan interest and amortization costs arising in that period.

Save for credit institutions and insurance companies, this regulation applies to all taxpayers, local and foreign-invested, effective 1 May 2017.

It could be said that lawmakers are attempting to prevent the high interest rates that parent companies intentionally charge their subsidiaries to reduce profits and, accordingly, Vietnam taxes.

However, it cannot be said that the government is succeeding. The new regulation has caused confusion and created debate as to whether it should also apply to local enterprises.

In early 2018, enterprises such as EVN, Vinacomin, Vicem, and Lilama challenged the Ministry of Finance on the implementation of this regulation.

These taxpayers argue that limiting loan interest costs between related companies would harm enterprises and damage investment and business development because borrowing and re-lending activities between parent companies and their subsidiaries are common, legitimate, and a beneficial means of capital mobilization. As a result of these limits, legitimate profits of a company are reduced and additional capital expenses would be incurred.

Moreover, the companies have argued that there are circumstances in which there are specialized projects in which only the subsidiaries of a parent company with access to the necessary technology and knowledge can effectively execute. 

To bypass the cap on loan interest costs, parent companies may need to assign projects to a third party, rendering the subsidiary redundant and significantly decreasing efficiency, productivity and profit, these companies argue.

Further, the major local enterprises argue that Decree 20 has only “scratched the surface” of foreign enterprise tax avoidance while domestic enterprises have been caught in the crosshairs of these new transfer pricing regulations.

Course for correction?

In light of the recent challenges, the Ministry of Finance has proposed changes to Decree 20. The decree was discussed by the National Assembly on November 8, 2018, and amendments are expected to me issued in 2019.

Although there are not yet any official proposed changes publicized, it is expected that the interest deduction limits would only apply to taxpayers that are foreign-invested companies in Vietnam.

Transfer pricing administration

Notably, a draft law on tax and transfer pricing administration is also now being consulted and is expected to be submitted for National Assembly approval with a tentative effective date from 2020.

This draft intends to regulate taxation of related party transactions. Numerous issues in Decree 20 are also elaborated upon in the draft law.

The amendments include clearer guidance addressing the tax declaration requirement, related party pricing, and related party transactions. The reporting obligations of the parent company are also addressed. The general principles of the Decree 20 are also reaffirmed.

Notably, the new draft provides the tax authorities with authority to review the compliance of taxpayers in declaring and determining the prices of related transactions on the principle of “substance-over-form” with the purpose of preventing transfer of profits through transfer pricing, tax avoidance, and tax evasion.