This article was written by Lawyer Nguyen Nhat Duong and Cao Nguyen Bao Lien, published in the Legal Electronic Magazine on December 21, 2023. Below is the English version:
Decree 132/2020/ND-CP ("Decree 132") was issued on November 5, 2020 and took effect on December 20, 2020 and was originally intended to prevent transfer pricing for foreign invested enterprises ("FDI enterprises") with related party transactions.
However, most FDI enterprises in Vietnam are subsidiaries of multinational corporations with parent companies in developed countries. These countries have relatively low interest rates, so the interest rates that FDI enterprises borrow from their foreign parent companies are also much lower than the interest rates in the Vietnamese market.
Therefore, the provisions of Decree 132 on interest expense control and other provisions on related party transactions are not very meaningful for FDI enterprises. On the other hand, for domestic enterprises (non-FDI enterprises), these regulations create many barriers that hinder business activities and enterprise development.
In this article, we will highlight some limitations and inconsistencies in the provisions of Decree 132 on interest expenses that need to be amended by the relevant authorities in the near future.
1. Companies face difficulties due to the ease of classification as a related party
Article 5 of the Decree 132 stipulates the cases in which the parties are considered related parties under one of the cases where one company lends to another company on the condition that (i) the amount of the loan is at least 25% of the equity of the borrowing company and (ii) it accounts for more than 50% of the total value of the medium and long-term debt of the borrowing company1.
This provision poses many challenges for companies that require large amounts of capital from banks. For example, for companies in the real estate sector, it is inevitable to rely on banks to provide a large amount of capital to maintain their business activities. However, under this provision, in the case of a real estate company with low equity capital, and at the same time it is heavily dependent on the bank loan without any other sources, the company is very likely to be classified as having a related party relationship with the bank. In this case, the loan transaction between the company and the bank will be considered a related party transaction and the company will be required to report these transactions to the tax authorities.
The identification of the related party relationship between the company and the bank in this case will have a significant impact on the calculation of the deductible interest expense, which will be further analyzed in the following section. In our opinion, this provision needs to be amended in a more flexible manner in the context of bank borrowing, which is still very urgent at this time to help companies overcome the difficult period. In the long term, a more thorough assessment of the relationship between the bank and the borrowing company is required in the case where the loan amount is at least 25% of the borrowing company's equity and accounts for more than 50% of the total value of the borrowing company's medium and long-term debt. At the same time, it is necessary to focus on the common criteria for determining the related party relationship between the parties, including one party's direct or indirect participation in the management, control, capital contribution or investment in the other party.
2. The need for flexibility in the rules on the maximum amount of deductible interest expenses
One of the current challenges faced by many domestic companies in Vietnam is the cap on total deductible interest expense when calculating corporate income tax.
Specifically, according to Point a Clause 3 Article 16 of Decree 132, the total deductible interest expense after deducting interest on deposits and loans incurred in the period of the company is deductible in determining the taxable income of the company for corporate income tax purposes, which shall not exceed 30% of the total net profit from business activities in the period, plus the total deductible interest expense after deducting interest on deposits and loans incurred in the period, plus the depreciation expense incurred in the period (EBITDA - Earnings Before Interest, Taxes, Depreciation and Amortization) of the company.
As mentioned in Section 1, with the current rising borrowing rates, it is quite possible that the interest expense will exceed 30% of the Company's EBITDA. Therefore, it can be seen that by combining the provisions of Letter d, Paragraph 2, Article 5 and Letter a, Paragraph 3, Article 16 of Decree 132, domestic companies are unintentionally facing legal difficulties in addition to existing market difficulties.
In our view, in addition to the changes mentioned in section 1, the competent authority should consider allowing borrowing companies to prove that the transaction is at arm's length by comparing it with transactions at market prices (in this case, interest rates) in order to deduct all reasonable interest expenses. This is a necessary change because borrowing enterprises with market interest rates are almost not at risk of transfer pricing or other purposes to evade tax obligations.
3. The unreasonableness of the provision on the deadline for the transfer of excess interest expenses
As mentioned above, Point a Clause 3 Article 16 of the Decree 132 limits the deductible amount of interest expense to 30% of the EBITDA of the borrowing company. For these excess interest expenses, the Decree 132 allows the borrowing company to carry forward to the next tax period when determining the total deductible interest expenses, if the total deductible interest expenses incurred in the next tax period are lower than the above 30% limit. At the same time, the time limit for the transfer of interest expense is continuously not more than 05 years from the year following the year in which the non-deductible interest expense is incurred in the period2. This provision seems to assist the borrowing company in allocating interest expenses to subsequent tax periods, thereby increasing the deductible amount of the lending company. However, this provision does not reflect the current situation.
With high interest rates and no signs of a slowdown, it is quite possible that a company will continue to incur excess interest expense, in which case this provision will be almost ineffective.
Another approach, according to the Ministry of Finance's clarification on whether excess interest expense can be carried forward to the next tax period if the company has no related party transactions in that period, the answer is that interest expense can only be carried forward to the next tax period with related party transactions3. Therefore, this provision is not yet fully satisfactory with the actual situation for enterprises. Specifically:
First, it is not every tax period that a company has related party transactions. A company may have a bank loan, but then complete the repayment of the loan. If the company has no further related party transactions after that, the company is not allowed to carry forward the interest expense to the next tax period.
Second, the 5-year period should also be considered to be flexible, because if there are no related party transactions within 05 years, the company may no longer be able to deduct interest expenses, and in case the rights of the company are restricted by the laws.
In conclusion, the current limit on the amount of interest expense for related parties has many unreasonable points, on the one hand, it is not effective for enterprises to overcome difficulties, on the other hand, it also restricts the development of enterprises. According to the content of Resolution 105/NQ-CP dated July 15, 2023, the government has assigned the Ministry of Finance to preside over and coordinate with ministries and authorities to study and propose amendments to Decree 132 to remove obstacles for manufacturing companies regarding tax management provisions for related-party transactions, and report to the Prime Minister in the fourth quarter of 2023. However, according to the progress in the Ministry of Finance's Official Letter No. 12094/BTC-TCT dated November 23, 2023 on the collection of opinions on the need to amend and supplement Decree 132, the revised draft will be collected for public opinions in the first quarter of 2024 and summarized and reported to the government for promulgation in the third quarter of 2024. With the above progress, companies will still have to wait for further amendments from the relevant authorities for a relatively long period of time.
Read the article at: Quy định về giao dịch liên kết của doanh nghiệp – đã đến lúc cần sửa đổi, bổ sung
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Footnotes
1.Point d Clause 2 Article 5 of the Decree 132.
2.Point b Clause 3 Article 16 of the Decree 132.
3.https://mof.gov.vn/hoidapcstc/home/cthoidap/134605, accessed on 18/12/2023.
Originally Published 20 December 2023
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
