This is the seventh part in a series of contributions focused on analyzing Vietnam’s current key transfer pricing regulation Decree 132[1] from the perspective of the 2022 Transfer Pricing Guidelines (“TPG”) of the Organization for Economic Cooperation and Development (“OECD”).

Special rules for the deduction of costs and expenses

Decree 132 provides in some specific rules with respect to the deductibility of costs and expenses.

Firstly, a general rule sets out a number of rules prohibiting the deductibility of costs and expenses. Decree 132 states in this regard that costs of related party transactions which do not have a normal substance or which do not contribute to the sales or income of a taxpayer, are not deductible. This includes, Decree 132 continues, (i) payments to related parties which have no business or production activities or none that is relevant to the taxpayer’s business, (ii) payments to related parties that have a business activity but its assets, employees and functions is not commensurate with the value of the transaction and (iii) payments to an entity in a country or territory that does not levy corporate income tax and there is insufficient value contributed to the business of the taxpayer[2].

Vietnam’s Corporate Income Tax Law also has several rules on the deductibility of expenses. In general, enterprises can deduct all expenses (except for negative list of non-deductible expenses) if they are incurred for the production and business of the taxpayer, if they are evidenced properly and, except for small amounts, were paid through the banking system[3] .

The TPG do not provide an exact equivalent to this portion of Decree 132 on general deductibility of costs and expenses, but the same ideas are certainly found in the OECD universe. With respect to payments to related parties without any (relevant) business activity, an unrelated party is unlikely to pay a service provider that does not maintain a business, so the OECD’s general arm’s length principle applies.    

Special rules for services

Specifically for services charged by related parties, Decree 132 provides a number of conditions for the deductibility of service fees[4]:

• The services have a commercial, financial or economical value and are directly used for the business or production of the taxpayer;
• Unrelated parties would also be charged for such services;
• The transfer pricing method for determining the price of this type of services must be applied uniformly throughout the group, as evidenced by contracts, invoices and documentation on the calculation, factor of allocation and pricing policy. 

In case the group uses internal service centers, Decree 132 provides that the taxpayer must determine the total value of this function and calculate the allocation in proportion to each participant.

The TPG dedicate a chapter to intra-group services outlining which services should be disregarded, and how to calculate an arm’s length compensation. The structure and degree of detail in the TPG’s section on services is larger than the few provisions included in Decree 132. The key condition that there must be a benefit for the taxpayer from the service, and that the fee is in accordance with what an unrelated party would have paid, underlies both Decree 132 and the TPG. Furthermore, many of the key references in Decree 132 with respect to services are also found in the TPG. For example, Decree 132 and the TPG both refer to services which benefit other entities such as shareholders[5], which have duplicate charges[6], services without clear beneficial value to the taxpayer[7] and services which are in reality just benefits from being part of a corporate group[8], and a marked-up on a service that is run through a related party conduit without added value[9].

Special rules for interest on loans

Decree 132, in following of earlier regulations[10],  provides in a maximum limit for the deductibility of interest on related party loans within the same tax year. The deduction for interest (except on loans within the year) may not exceed 30% of the net profit generated from business activities within the taxable period plus loan interest costs arising after deducting deposit interests and lending interests arising within the taxable period plus depreciation expenses arising within that period of a taxpayer. Specifically:

• Calculation of Loan Interest Cost (A) in period: (A) = Actual loan interest payment (-) deducting interest income (from deposit or lending)
• EBITDA (B)= Net profit from business activities + A + depreciation
• Deductible Loan Interest Expense in period = A or 30%*B whichever is lower.

Any excess interest which is not deductible in that tax year may be carried forward for up to 5 years. This limitation does not apply to loans from banks and financial institutions and loans for certain state projects.

The operation of the threshold calculation means that in case a borrower has no profit of the year, no interest can be deducted from related party loans at all, at least not in that year, regardless whether the loan has an arm’s length character[11].

Note that Vietnam corporate tax law provides in other restrictions for the deductibility of interest. The interest deduction is capped or non-deductible in case the interest rate exceeds 150% of basic rate announced by the State Bank of Vietnam for loan with non-economic enterprise/non-credit institutions, the excess amount is not deductible (i.e. note the Civil Code limits the rate at 10% p a for VND). Furthermore, interest is not tax deductible in case the shareholders have yet to pay up their committed capital in full to the company.

In effect, with the cap on deductible interest, Decree 132 goes outside of the scope of the arm’s length principle. Even if the related party lender has provided a loan to the borrower at arm’s length conditions, the interest deduction remains capped for each tax year. Indeed, Decree 132’s interest deductibility cap traces back to an earlier Decree[12], where the same cap applied regardless whether the loan is provided by a related or an unrelated party.

The TPG has no similar provision.  From the OECD’s perspective, just because a lender is a related party does not ipso facto mean that the interest paid should not be taken into account for the tax calculation of the borrower if it exceeds a threshold which is not based on the transaction itself, but entirely on the taxable income of the borrower.

But, disregarding the tax consequences of a loan, in whole or in part, are definitely within the OECD mindset. In the Commentary on the OECD Model Tax Convention Art 9, the OECD clarifies that this provision of the Model DTA is not meant as an impediment to domestic tax rules aimed at curbing tax avoidance through use of related party loans[13]. The OECD underlines this idea in 2020 in the context of the BEPS Actions:

“This guidance is not intended to prevent countries from implementing approaches to address the balance of debt and equity funding of an entity and interest deductibility under domestic legislation”.[14]

[1] Decree 132/2020/ND-CP Prescribing Tax Administration for Enterprises with Related Part Transactions dated 5 November 2020.

[2] Decree 132, art. 16 (1). 

[3] Art 9 (1) of the Law on Corporate Income Tax No. 01/VBHN-VPQH dated 30 Jan 2023

[4] Decree 132, art. 16 (2) (a)

[5] Compare with OECD TPG 2022, 7.9: “shareholder activities”

[6] Compare with OECD TPG 2022, 7.11: “duplication”

[7] Compare with OECD TPG 2022, 7.6: “benefits test”

[8] Compare with OECD TPG 2022, 7.12: “incidental benefits”

[9] Compare with OECD TPG 2022, 7.34: “an associated enterprise acting as an agent”

[10] Decree No. 68/2020/NĐ-CP amending Clause 3, Article 8 of Decree No. 20/2017/ND-CP

[11] Official Dispatch No. 9662/ CTBDU-TTHT dated 5 June 2023

[12] Decree No. 20/2017/ND-CP

[13] See also the OECD Report on “Thin Capitalisation” adopted by the Council of the OECD on 26 November 1986 and reproduced in Volume II of the full version of the OECD MTC at page R (4)-1. 

[14] OECD Transfer Pricing Guidance on Financial Transactions, 2020.