Vietnam has a specific foreign contractor tax ("FCT"). The rules describe the tax obligations of foreign entities and individuals who do business in or receive income from Vietnam. The current FCT regime clarifies previous ambiguities. One can now say that the tax regime for foreign contractors is complete. For an entity, the FCT is comprised of two parts: Corporate Income Tax ("CIT") and Value Added Tax ("VAT"). The Law on Corporate Income Tax ("LCIT") and the Law on Value Added Tax ("LVAT") came into effect on January 1, 2009 and both form an intricate part of the foreign contractor tax regime. The government has also issued several circulars to implement and explain these laws. For foreign contractors, the most important is Circular 134/2008/TT-BTC on foreign contractor tax, also with effect from January 1, 2009 ("Circular 134"). It was subsequently amended by Circular 179/2009/TT-BTC dated October 9, 2009 and Circular 64/2010/TT-BTC dated April 22, 20101.
What is a foreign contractor?
Under Circular 134 a foreign contractor is a foreign entity or an individual who does business or receives income in Vietnam. The rules on calculation of taxes for these two groups are quite different. This article largely discusses the rules that apply to entities.
Normally, a foreign contractor generates income in Vietnam as a result of a contract with a Vietnamese counter-party. By a Vietnamese counter-party, we mean any entity whether state, domestic or foreign-owned, that is registered to do business in Vietnam. A foreign sub-contractor is a foreign entity and individual who, in turn, provides services to a foreign contractor or carries out part of the work of a foreign contractor. For ease of reference, in this article, a foreign contractor and sub-contractor are each referred to as a "Foreign Contractor".
For purposes of the FCT, a Foreign Contractor that carries out business or has income in Vietnam in a form that is not recognized under the Law on Investment, the Law on Petroleum or the Law on Credit Institutions, is subject to the FCT. A Foreign Contractor could; for example, be a firm located abroad that provides construction and design services or that is a foreign construction contractor operating in Vietnam. The fact that a Foreign Contractor has a project office in Vietnam does not, by itself, change its status.
The FCT does not apply in the following circumstances:
- A Foreign Contractor that provides goods to a Vietnamese counter-party at Vietnamese or foreign border gates, which goods are not associated with services provided in Vietnam;
- Income of a Foreign Contractor that is derived from services provided and consumed outside of Vietnam; or
- Services of airplane and ship repair, advertising, marketing, investment and trade promotion, brokerage for the sale of goods, training, international post and telecommunications that are provided abroad.
The FCT is a type of withholding tax imposed on Foreign Contractors doing business or having income in Vietnam on the basis of a contract with a Vietnamese counter-party. FCT is comprised of two taxes. VAT and CIT apply to a Foreign Contractor that is an entity. VAT and Personal Income Tax apply to an individual foreign contractor.
Three methods of tax payment
A Foreign Contractor can pay tax in one of three ways. It can apply the Vietnamese Accounting System ("VAS") mechanism, the withholding mechanism, or the "hybrid" mechanism. If a Foreign Contractor meets certain conditions, it can choose between these three mechanisms. Otherwise, it is limited to the withholding mechanism.
The method of FCT calculation which uses the VAS mechanism and the resulting tax are virtually the same as the method of calculation and tax paid by a Vietnamese entity registered to do business in Vietnam. The VAT it pays is the same, and the CIT it pays, and which is calculated on net profit, is the same.
This mechanism is only available to a Foreign Contractor that maintains a Vietnamese permanent establishment, that has a contract for a period of more than six months and that registers with the tax authorities to apply VAS. Once VAS has been adopted, the Foreign Contractor is treated as a Vietnamese entity for Vietnamese tax calculation filing and payment purposes. And where VAS has been adopted, the Foreign Contractor is entitled to pay VAT under the credit method and to pay CIT on its profits/net income. We discuss these two components.
VAT under the VAS mechanism
VAT payable is calculated and deducted under the following formula:
VAT payable = Output VAT – Creditable Input VAT
Output VAT is the total VAT that a Foreign Contractor collects based on the invoices it issues. More specifically, output VAT is the total VAT imposed on the goods or services it sells. It is computed by multiplying the taxable price of the goods sold or services rendered by the Foreign Contractor to a Vietnamese counter-party by the applicable VAT rate.
Creditable Input VAT is the total VAT that a Foreign Contractor pays based on invoices it receives. Creditable Input VAT equals the taxable price of goods sold or services rendered by a selling party to the Foreign Contractor multiplied by the applicable VAT rate.
VAT rates differ depending on the types of goods sold and the services provided by the Foreign Contractor. There are three levels of VAT: 0%, 5% and 10%.
CIT under the VAS mechanism
CIT is payable in addition to VAT and the FCT that applies VAS will pay CIT according to the following methodology.
CIT payable = Assessable Income x CIT rate
Assessable Income = Taxable Income – [Tax Exempt Income + Losses Carried Forward]
Tax Exempt Income is income that is exempt from tax and that is listed as 'tax exempt income' in the LCIT. Tax Exempt Income is usually income from business sectors or investment activities that are encouraged, for example, income from cultivation, husbandry or income from performance of contracts for scientific research and technological development, or income from investment in favored geographical areas.
Loss Carried Forward is the loss an enterprise suffers after it has completed its tax finalization for any fiscal year. The losses may be carried forward to the next fiscal year and set off against taxable income in that year. Losses cannot be carried forward for more than five years.
Taxable Income means income earned from production or business activities and from other income such as income from capital transfer, or income from real property transfer.
Taxable Income is calculated under the following formula:
Taxable Income = [Turnover – Deductible Expenses] + other income
Turnover is total revenue, excluding value added tax.
Deductible Expenses are actual expenses related to production or business except for 'non-deductible expenses' as defined in the LCIT. To qualify, deductible expenses must conform with LCIT rules, and supporting documents are required.
As from January 1, 2009 the standard CIT rate is 25%. The rate that applies to encouraged sectors or locations is lower. For example, companies operating in education and training, health, and environment enjoy a CIT rate of only 10%.
The FCT paid under the withholding mechanism is a hybrid. It has elements of the VAT which combine with elements of the CIT in a way that is unique to the FCT. Unlike the VAS mechanism, FCT for the withholding mechanism is calculated on the basis of turnover.
A Foreign Contractor that does not use VAS pays FCT by way of a withholding mechanism. That is, before making a payment to a Foreign Contractor, the Vietnamese counter-party deducts the taxes from the payment, which it then pays to the tax authorities on behalf of the Foreign Contractor.
We discuss both elements of the FCT as calculated in the withholding method.
VAT under the withholding mechanism
VAT payable = Added Value x VAT rate
VAT rate is 0%, 5% and 10% depending on the goods sold and the services provided by the Foreign Contractor.
Added Value = VAT Turnover x Value Added Ratio of Turnover
VAT Turnover is the total turnover without deducting any payable taxes. VAT Turnover includes all expenses paid by the Vietnamese counter-party on behalf of the Foreign Contractor.
Value Added Ratio of Turnover is the regulatory rate provided in Circular 134. The rate differs depending on the type of goods or services, eg: trade 30%, services and construction 50%, transportation or manufacturing 30%.
CIT under the withholding mechanism
CIT payable = CIT Turnover x CIT rate as a percentage of taxable turnover
CIT Turnover is the total turnover, excluding VAT, without deducting any payable taxes. It includes all expenses paid by the Vietnamese counter-party on behalf of the Foreign Contractor.
CIT rate as a percentage of taxable turnover is stipulated in Circular 134. A rate of 1% applies to trading, 2% to construction, 5% to services, 10% to loan interest, etc.
In the withholding mechanism the two components--VAT and CIT-- are combined and are applied together. Let us take an example which will illustrate how the withholding mechanism works.
Example: A foreign contractor has a contract with a Vietnamese counter-party to supervise the construction of a Cement Plant. The contract price, including tax, is US$100,000,000. In addition, the Vietnamese counter-party arranges travel, accommodations and working space for the management of the foreign contractor, and that is valued at US$300,000. Under the contract, the Vietnamese counter-party is responsible to withhold VAT and CIT on behalf of the foreign contractor.
The combined VAT and CIT payable are calculated as follows:
VAT payable = VAT Turnover x Value Added Ratio of Turnover x VAT rate = [100,000,000 + 300,000] x 50% x 10%2 = US$5,015,000
CIT payable = CIT Turnover x CIT rate as a percentage of taxable turnover = [100,300,000 – 5,015,000] x 5%3 = US$ 4,764,250
Total FCT payable = 5,015,000 + 4,764,250 = US$ 9,779,250
A Foreign Contractor has another option--the hybrid mechanism--in addition to the VAS and withholding mechanisms. By the hybrid mechanism, a Foreign Contractor would pay VAT under the VAS mechanism and CIT under the withholding mechanism.
Three mechanisms, one choice
Each mechanism--VAS, withholding, or hybrid--has its own advantages and disadvantages. The options are not open to all Foreign Contractors. Each Foreign Contractor that has a choice will have to decide which mechanism to adopt. As discussed above, only Foreign Contractors that satisfy all conditions to adopt the VAS mechanism are entitled to choose any of the mechanisms. Other contractors must adopt the withholding mechanism.
A Foreign Contractor that chooses to employ the VAS mechanism must register with and pay taxes directly to the designated tax authority and must comply with rules applicable to entities using VAS including rules on supporting documents and deductible expenses. If the Foreign Contractor chooses the withholding mechanism, the Vietnamese counter-party must register with the appropriate tax authority and withhold and pay tax on behalf of the Foreign Contractor. Under this option, and as the tax is levied generally on turnover, the Foreign Contractor pays tax regardless of its profit or loss and regardless of how much input VAT it may set off against output VAT. A Foreign Contractor which selects the hybrid mechanism can recover its VAT, and it can avoid having to implement the full VAS.
Payment net of FCT
Foreign Contractors that pay by the withholding mechanism often request the Vietnamese counter-party to pay any amounts due "net of all taxes". In such circumstances the contract price is grossed up and the amount withheld actually becomes an expense of the Vietnamese counter-party.
This mechanism involves a larger total payment of contract price and FCT. However, there is a benefit to the Vietnamese counter-party if payment is made by the withholding method and the FCT obligation is passed to the Vietnamese counter-party. That is, the VAT portion that the Vietnamese counter-party pays on behalf of the Foreign Contractor is the Vietnamese counter-party's Input VAT. It may set its Input VAT off against its own Output VAT, thus, effectively, offsetting the VAT portion of the FCT. This effectively lowers the overall net effect of the FCT. However, by paying the net amount to the Foreign Contractor the total gross amount paid by the Vietnamese counter-party will probably be more. The relative advantages and disadvantages of making a payment to the Foreign Contractor net of taxes should be assessed and may be apportioned.
The impact of Double Taxation Agreements on the FCT
The Double Taxation Agreements ("DTA") which Vietnam has entered into with other countries can have a significant impact on the FCT. Generally, a Foreign Contractor may avoid FCT if it is from a country that has a DTA with Vietnam and if it does not have a permanent establishment ("PE") in Vietnam. This is because a rule that is provided in most DTAs is that a non-resident company may only be taxed on its business income in the source country (Vietnam) if it has a PE in the source country to which the income is attributed.
What constitutes a PE may vary in each DTA. Most if not all of Vietnam's DTA follow the OECD Model or UN Model DTA which defines a PE as a fixed place of business through which the business of an enterprise is wholly or partially carried out. A place of business must be "fixed". That means, a particular building or a physical location that is used to conduct the enterprise's business must be more than temporary.
Although Vietnam's DTAs employ the same definition of PE, the specific list of what constitutes a PE in each DTA may differ. For example, the DTA between Vietnam and the Seychelles or the DTA with Sweden extend the meaning of a PE to furnishing a service. In this connection, even if the non-resident enterprise that provides services does not have a "fixed" place in Vietnam, the service supplied is deemed to create a PE and consequently the income from that service is taxed in Vietnam. Of course, some other conditions may apply, such as: the service was performed in the source country for a period exceeding six months and by an employee or other personnel.
Some of Vietnam's other DTAs do not enlarge the definition of PE, for example, Malaysia, Singapore and France. This means that a Foreign Contractor from those countries that provides services in Vietnam is less likely to have a PE in Vietnam when the service provider is a resident of those other countries and consequently is not taxed in Vietnam.
Under the LCIT, the term PE means a production or business establishment through which a foreign enterprise conducts all or a part of its production and business activities. This concept does not use the term "fixed place" as used in most DTAs. It would suggest that the place of business need not be established with any decree of permanence. Activities that are not conducted from a fixed location and that may consequently escape the concept of PE under the DTAs may nevertheless be reached under the domestic rules of Vietnam. That is why reference to DTAs is important.
The rules on PE under Vietnamese law and those under the DTAs may be inconsistent. Because the rules that regulate PEs between a DTA and Vietnam differ, Foreign Contractors should look carefully at the relevant DTAs between their country and Vietnam to verify the concept of PE in order to be able to implement their FCT obligation.
In addition to the avoidance of FCT by way of a PE, generally, a Foreign Contractor may claim a tax credit in its home country for the FCT it pays in Vietnam owing to the principle of elimination of double taxation which principle is the underlying objective of the DTAs. Of course, a Foreign Contractor that seeks the benefits of a DTA must prove that it is covered by the DTA and must comply with other conditions and procedures in the DTA and with the tax regulations of Vietnam and of its home country.
Some Foreign Contractors will have choices on which form of FCT they can choose. They will also have options depending on the interaction of the FCT and DTAs. All of this is to say that Foreign Contractors that are subject to the FCT must choose among the options available to them.
* This article was written by Dong Hoang Nam of Russin & Vecchi, and was published in the Journal of International Taxation in August 2009. It was later submitted to Mondaq. This version has been updated by Pham Thi Phuong Anh of Russin & Vecchi.
1. Circular 05/2005/TT-BTC dated January 11, 2005 still governs FCTs which arose from contractor or subcontractor agreements and which were concluded before the effective date of Circular 134.
2. This is the VAT rate for goods or services provided in Article 8.3 of the Law on VAT.
3. This is the CIT rate as a percentage of taxable turnover from the provision of services in accordance with Circular No. 130 /2008/TT-BTC dated December 26, 2008.
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.