The Implementation of the Interest Deduction Rule and Its Implementing Obstacles in Vietnam
Vietnam initially introduced its Interest Deduction Rule under Decree 20/2017/ND-CP ("Decree 20") in 2017, right after Vietnam became the 100th member of the Inclusive Framework on BEPS on June 21, 2017. At the outset, the Interest Deduction Rule of Vietnam appeared rudimentary and simplistic. Accordingly, Article 8.3 of Decree 20 provides that:
“The total interest expense incurred during the tax period by the taxpayer is deductible when determining the corporate income tax payable, provided that it does not exceed 20% of the total net operating income plus interest expense and depreciation expense incurred during the tax period by the taxpayer.”
This provision applies to enterprises engaging in related-party transactions. To specify, if an enterprise conducts specific transactions with its related party, it will be considered engaging in related-party transactions and subject to the Interest Deduction Rule.[1]
Pursuant to this regulation, there are two notable points for taxpayers when determining the deductible interest expense.
Firstly, the deductible interest expense is capped at 20% of the total net operating income plus interest expense and depreciation expense, so-called Earnings Before Interest, Tax, Depreciation, and Amortization, or EBITDA. Vietnam followed the guidance of the OECD/G20 BEPS project in Action 4: 2015 Final Report. Accordingly, as the OECD/G20 BEPS commented, countries were recommended to 'set their benchmark fixed ratio within a corridor of 10% to 30%'.[2] Vietnam opted for a fixed ratio of 20%, an average rate between 10% and 30%, which was reported by the OECD that 'At a benchmark fixed ratio of 20%, 78% of these groups would in principle be able to deduct all of their net third-party interest expense'.[3]
Secondly, this provision does not take into account the interest income generated within the same tax period as the interest expense. Stated differently, Vietnam has adopted the concept of gross interest expense when calculating the interest limitation rule. This deviates from the guidance and concept of the OECD/G20 BEPS in Action 4: 2015 Final Report.[4] Furthermore, considering the gross interest expense within the Interest Deduction Rule might result in a situation of double taxation where the interest income is fully taxable while a portion of the interest expense is excluded due to this limitation rule.[5]
Acknowledging two obstacles raised by business communities during the implementation of Article 8.3 of Decree 20, specifically that the fixed ratio of 20% of EBITDA was deemed too low for deducting interest expense and that interest income was not considered in the computation, the Vietnamese Government has replaced Article 8.3 of Decree 20 by a new regulation in Decree 132/2020/N?-CP issued in the late of 2020 ("Decree 132"). Decree 132 remains in effect to the present day.
Under Article 16.3 of Decree 132, there are three new significant changes to consider when calculating the interest limitation rule. The first notable point is the increase in the fixed ratio of the interest limitation cap from 20% to 30% of EBITDA. Secondly, the interest expense subject to the interest limitation rule is the net interest expense resulting from offsetting interest expense against interest income. Lastly, the non-deductible interest expense resulting from this interest limitation rule can be carried forward for up to the following five years and deducted if the net interest expense/EBITDA ratio is below 30% in those years. These changes have relaxed the interest limitation rule and received widespread support from the business communities.
However, after three years of the implementation, in late 2023, the Ministry of Finance of Vietnam received numerous requests from taxpayers, specifically real estate corporations and Build-Operate-Transfer (BOT) businesses, proposing the amendment of the Interest Deduction Rule under Decree 132.
According to these requests, generally speaking, there are two main difficulties for taxpayers when complying with this rule. After the COVID-19 pandemic, businesses demanded substantial loan capital to revive business and production activities. Nonetheless, limiting interest expenses to 30% of EBITDA leads to non-deductible interest expenses being rejected for CIT calculation, thus elevating the tax liability. While the Interest Deduction Rule aims to mitigate base erosion and profit-shifting risks [6], these businesses have argued that their interest expenditures are geared toward fostering business activities rather than facilitating profit-shifting maneuvers.
Secondly, and more importantly, the interest limitation rule of Vietnam applies not only to loans from related parties but also to loans from third parties. Supposing that a party engages in related-party transactions, in that case, any interest expense, regardless of interest expense originating from bank loans, third-party debts, or related-party debts, is subject to the 30% EBITDA limitation. Consequently, the Vietnamese Government has assigned the Ministry of Finance to study and propose amendments to the Interest Deduction Rule within 2024 to support business communities.
The Vietnam Chamber of Commerce and Industry (VCCI), an agency dedicated to advocating for the business community, has put forth recommendations aimed at amending the Interest Deduction Rule to support taxpayers in the aftermath of the pandemic.[7] According to VCCI's recommendations, the Interest Deduction Rule of Vietnam needs to allow the full deduction of interest expense from third-party loans, provided taxpayers can demonstrate that the interest rates on these loans adhere to the arm's length principle. This suggestion is reasonable and might resolve business concerns in relation to the loans from third parties. In practice, several countries, such as Japan, Korea, and India, do not apply the interest limitation rule to third-party loans.[8]
However, a second recommendation from VCCI might lead to a potential discriminatory risk. Accordingly, VCCI suggests that the interest expense arising from loans between two domestic companies should be exempt from the interest limitation rule if they are subject to the same CIT rate while retaining the applicability of this rule to interest paid to foreign entities. This idea is worth pondering to the extent that two enterprises subject to the same CIT rate would have little incentive to shift profits through interest expenses. However, this recommendation contradicts the non-discrimination clause, commonly stated in Article 24 or 25, in the double tax treaties of Vietnam and other jurisdictions. The non-discrimination clause precludes Vietnam from applying different CIT treatments between interest paid to residents of other contracting parties and interest paid to Vietnamese companies for interest expenses.
Other taxpayers have advocated for the increase of the fixed rate of 30% EBITDA to a higher fixed rate. This increase may not be impossible; however, it depends on various factors. In Action 4: 2015 Final Report, the OECD has affirmed that 'a country may apply a higher benchmark fixed ratio' outside a corridor of 10% to 30%. Nevertheless, that country may need to consider other factors before increasing the fixed rate, for instance, whether that country permits the carry-forward of unused interest capacity or the carry-back of disallowed interest expense and whether that country has high interest rates compared with those of other countries.[9] Furthermore, an increase in the benchmark fixed ratio could impact Vietnam's budget revenue by allowing for more deductible interest expenses, potentially resulting in a reduction in tax collection. On the other hand, the guidance of the OECD in the Action 4 Report is not binding to Vietnam and is not a BEPS minimum standard. Therefore, Vietnam retains its tax sovereignty, enabling it to determine whether to increase or decrease the interest limitation cap.
In conclusion, the application of Vietnam's Interest Deduction Rule brings many benefits, such as ensuring the prevention of profit shifting among related parties, enhancing integration with international tax standards, and increasing revenue for the state budget. Regarding the potential amendment of this rule, proposing changes to limit the scope of this rule only to loans from related parties is reasonable. If relevant parties can prove compliance with the arm's length principle of loans from third parties, the interest expense resulting from these loans should be exempt from this rule.
[1] Decree 20/2017/ND-CP, Article 8
[2] OECD/G20 BEPS, Limiting Base Erosion Involving Interest Deductions and Other Financial Payments: Action 4: 2015 Final Report, para 97
[3] Ibid., para 96
[4] Ibid., para 62
[5] Ibid., para 62
[6] OECD/G20 BEPS, Limiting Base Erosion Involving Interest Deductions and Other Financial Payments: Action 4: 2015 Final Report, p. 11
[8] See the summaries of Interest Deductions for Japan, Korea, and India at https://taxsummaries.pwc.com/
[9] OECD/G20 BEPS, Limiting Base Erosion Involving Interest Deductions and Other Financial Payments: Action 4: 2015 Final Report, para 99
2023 AmCham Scholar | Fresh graduate at Hanoi Law University - Economics Law
1 年Thanks anh for a very insightful article ?!