Vietnam: Onshore Or Offshore: Which Cross - Border Services Are (Not) Subject To The Foreign Contractor Tax?

Last Updated: 12 December 2008
Article by Edwin Vanderbruggen

A particularly troublesome controversy in Vietnam international income taxation relates to the application of the Foreign Contractor Tax ("FCT") to cross border services. Foreign enterprises (i.e. non - residents without a legal presence in Vietnam) may be a supplier of almost any type of service that is useful in Vietnam's emerging and dynamic economy. Enterprises in Vietnam may appeal to foreign suppliers for information technology services, engineering and construction services, management services and consulting, marketing or financial services, professional and legal advice, and so on.

The tax treatment of service income derived from Vietnam is not always clear when one reviews the applicable regulation and rulings ("Official Letters" or "OL") to the different fact patterns that may occur in practice.

By and large, a distinction has been created by the tax authorities between "services inside Vietnam" and "services outside Vietnam". In both cases, the service fee is paid by a resident enterprise in Vietnam, such as a project owner or the customer of a consulting service. So, "onshore" services would be subject to FCT, often at a total rate of 10% (includes both income tax and VAT) while "offshore" services would not be subject to the FCT.

The distinction between these two categories of "onshore" and "offshore" services is exactly the problem. The interpretation and application of this issue has evolved over time, going from the "old" regulation of Circular 169 -1998 ("Circular 169") to the currently applicable Circular 5-2005 ("Circular 5"), OL 1108 of 29 March 2006 and rulings based on that interpretation.

In this Tax Pointer, we summarize the main tax issues and points of exposure related to distinguishing between taxable onshore services and exempt offshore services.

Offshore services under Circular 169

Circular 169 is the predecessor of the currently applicable Circular on FCT Circular 5. Circular 169 provides clearly less detailed regulations related to the Vietnam income of entities that are not legal persons established in Vietnam.

For one, Circular 169 does not provide for a detailed definition of source income, i.e. the definition of income that must be subject to FCT in terms of its "link" to Vietnam ("nexus").

Circular 169 states merely that: "Tax obligations stated in this circular are applicable to foreign organizations and individuals doing business in Vietnam, which are not subject to investment forms regulated in the Law on Foreign Investment in Vietnam".

Another provision in the same Circular defines a "Contractor" as "a foreign organization or individual operating a business in Vietnam, which is not subject to investment forms regulated in the Law on Foreign Investment in Vietnam. Business operations of a contractor can be carried out through contracts signed between them and a Vietnamese organization or individual, hereinafter referred to as the Vietnamese contract signing party ".

As can be noted, this regulation referred to "business operations in Vietnam" or "doing business in Vietnam". There is no clear rule providing that any payment made from a source in Vietnam, is ipso facto subject to FCT, although reference is made to a "contract concluded with a [Vietnam party]".

Circular 5-2005: another definition

Circular 5 offers a more detailed regulation of the taxation of foreign entities deriving income.

One remarkable addition is the definition of "income derived in Vietnam" which is defined as "income in any form of a foreign contractor or foreign sub-contractor paid by a Vietnamese party under the signed agreement between the foreign contractor and the Vietnamese party (except for cases of supply of goods stipulated in Section II.2 of Part A of this Circular), irrespective of the location of the business establishment through which the foreign contractor or foreign sub-contractor conducts its business activities"

The difference is telling. Indeed, the definition of a "foreign contractor" under Circular 5 is enlarged as well: "foreign contractors mean foreign organizations without Vietnamese legal person status, foreign individuals providing independent professional services, doing business or earning incomes in Vietnam under written contracts or agreements between them and Vietnamese organizations or individuals (the Vietnamese parties)."

Source of payment only?

Does this mean that the FCT applies to income paid from Vietnam merely because the source of payment was in Vietnam? No, it seems not. There is a difference between earning income "in Vietnam" and earning income "from Vietnam". Other provisions of Circular 5 make it clear that an element of territoriality is still required. Art. A I 1 and 2, for example, define the scope of persons subject to the FCT as those who "do business or earn income in Vietnam".

OL 1108-2006: a new concept?

The Ministry of Finance ("MOF") General Department of Taxation ("GDT") has issued an interpretative OL for general application on 29 March 2006, addressing several interpretation issues of Circular 5. One of the issues, in fact the first one mentioned, is the question of tax liability for services performed outside Vietnam.

OL 1108 refers to the general rule of tax liability of foreign contractors, and states that "foreign organizations and individuals that do business in Vietnam but are not present in Vietnam, and earn income in Vietnam shall be subject to tax in Vietnam. Services provided by foreign organizations or individuals that are not present in Vietnam are subject to tax in Vietnam. Certain Vietnam DTA's adopt a rule from the UN Model DTA which extends the meaning of permanent establishment with regard to furnishing of services ("furnishing of service-PE"):

"The furnishing of services, including consultancy services, by a resident of one of the Contracting States through employees or other personnel, provided activities of that nature continue (for the same or a connected project) within the other Contracting State for a period or periods aggregating more than six months within any twelve-month period".

Therefore, even if the non -resident enterprise which furnishes the services does not have a fixed place of business in the source country, the mere fact that the service or the consultancy is supplied, is deemed to be a permanent establishment, and may consequently be taxed on the income by the source country. However, there are more conditions. (1) the service was performed in the source country, (2) for a period exceeding 6 months, and (3) by employees or other personnel.

Note that both the "construction site-PE" and the "furnishing of service-PE" require that the activity takes place within the source country .

Technical Fee provision in DTA?

Some DTA's concluded by Vietnam do not provide for this rule (for example France, Japan, Korea and Singapore). This means that the non-resident enterprise is less likely to have a PE in Vietnam when the service supplier is a resident of those countries.

Certain Vietnam DTA's do provide for a separate provision for technical service fees (e.g. Canada, Malaysia, India, Italy). Such a provision allows Vietnam to levy a withholding tax on all technical service fees, even if no PE exists or when performed abroad. All that is required for Vietnam to have taxing rights under the DTA in this case, is for the payer of the technical fee to be a resident of Vietnam.

Effect of the DTA on offshore services

In short, different DTA's affect the question of the FCT in different ways, depend ing on the exact rule included in the DTA. By and large, treaties with a special provision on "technical fees" will not present an impediment to any taxation imposed under the FCT. Vietnam has under this provision the right to tax the income if it was paid by a Vietnam resident (with a maximum withholding) even if service is performed or provided outside of Vietnam.

For treaties that do not have a technical fee provision, Vietnam will only have taxing right if the service income can be attributed to a Vietnam PE of the service provider. For services that are performed or provided inside Vietnam, this can very well be the case. Construction or installation work exceeding 6 months, for example, would be subject to tax in Vietnam since it can be attributed to a Vietnam PE.

However, services that are performed or provided outside Vietnam can not in and of itself lead to the existence of a PE in Vietnam. The service provider can of course have a PE for another reason, such as having an office or a dependent ag ent. But only in exceptional cases would the income of a service which is genuinely performed outside of the source country be attributable to a PE in that source country.

How to be sure in your case?

As can be seen, there are many uncertainties associated with the taxation of cross-border technical fees. When is a service used abroad, and when is it used in Vietnam? Will the GDT confirm a possible exemption under the DTA under Circular 133 -2004, which is a condition for treaty application? An in -depth analysis or revaluation may be called for in many cases.

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.

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