U VIETNAM - TAXATION - PERMANENT ESTABLISHMENT AND RELATED ISSUESU

NEXUS FOR TAXATION IN ASIA: CONTEMPORARY PERMANENT ESTABLISHMENT AND RELATED ISSUES

By Oliver Massmann

1. NEXUS FOR INCOME TAXATION OF FOREIGN (NON-RESIDENT) CORPORATIONS

Pursuant to Amended Enterprise Income Tax Law (“Amended EIT Law”), a non-resident foreign corporation will be subject to Enterprise Income Tax (“EIT”) in the following cases:

- It carries out business in Vietnam not in the forms provided under the Law on Foreign Investment in Vietnam; - Its presence in Vietnam rises to the level of a permanent establishment (“PE”).

1.1 Brief overview of circumstances in which a foreign (non-resident) corporation will be subject to income tax in Vietnam on its business profits in the absence of an applicable double taxation treaty

A foreign company, which does not establish an enterprise in Vietnam in accordance with the Law on Foreign Investment in Vietnam, will be subject to EIT in the following circumstances:

♣ The foreign company receives payments for providing services and goods to companies in Vietnam (except for a pure sale-purchase transaction of goods), including inter-company charges by an offshore head office to the local subsidiary. Even when the foreign company performs services outside Vietnam and does not create a PE under domestic tax law, it is still regarded as a foreign contractor carrying out business in Vietnam and subject to EIT; ♣ A foreign company earns capital gains from sale of shares, assignment of its capital in an investment in Vietnam; ♣ A foreign company receives royalty income from companies in Vietnam including among others, fees for trademark licensing, technology transfer, consultancy fees; ♣ A foreign lender receives interest income from a borrower in Vietnam; ♣ A foreign company has activities that give rise to the level of a PE in Vietnam. A PE under domestic tax law includes:

- A branch, operational office, plant, workshop, warehouse for receipt and delivery of goods, means of transportation, mine, petroleum or gas field, any location where natural resources are exploited, or where there are equipment and facilities serving the exploitation of natural resources; - A construction site; construction works, installation and assembly works; supervisory activities for construction, construction works, or installation or assembly works; - An establishment providing services including consultancy services provided through its employees or another entity; - An agent for a company overseas; - A representative in Vietnam in a case where it has authority to enter into contracts in the name of a company overseas; or a representative which is not authorized to sign contracts in the name of a foreign company but habitually delivers goods or provides services in Vietnam. With this broad definition of a PE, the concept can include a mere distributorship relation between a foreign seller and local distributor, and operation of a representative office in Vietnam. See further details in section 2.1. 1.1.1 Services Income

(i) Taxable income

In case the foreign company does not maintain accounting books in Vietnam and does not adopt the Vietnamese Accounting System, EIT will be calculated at the deemed rate of 5% on the gross contract amount.

(ii) Subject to withholding tax

The tax must be withheld by the local payer.

1.1.2 Sales Income

(i) Taxable income

In case the foreign company does not maintain accounting books in Vietnam and does not adopt the Vietnamese Accounting System, EIT will be calculated at the deemed rate of 1% on the gross contract amount.

(ii) Subject to withholding tax

The tax must be withheld by the local payer.

1.1.3 Income from temporary projects

There is no different tax treatment for temporary projects.

1.1.4 Capital Gains

(i) Taxable gain

A foreign investor, which assigns its capital in a foreign invested enterprise, is subject to enterprise income tax on any gain at a rate of 28%. A fifty per cent tax reduction is available if the capital is assigned to an enterprise established under the laws of Vietnam.

With respect to non-resident foreign companies which buy shares in local companies, there is no specific regulation as to how they declare and pay capital gains tax when they sell shares. However, pursuant to an Official Dispatch of the Ministry of Finance, these foreign corporations are themselves required to register with the tax authority and directly pay EIT on any gain from sale of shares.

(ii) Subject to withholding tax

As mentioned above, tax is paid directly without reliance on the withholding scheme.

1.1.5 Other Income

(i) Taxable income

Payments of royalty income, and interest on loans are subject to 10% EIT.

(ii) Subject to withholding tax

The tax must be withheld by the local payer.

1.2 Points to note/ potential surprises/ traps for the unwary

A PE under the new definition in domestic tax law can be broadly interpreted. The tax authorities have taken an aggressive position in respect to distributorships, for example, stating that a distributorship relation between an offshore seller and a local distributor constitutes a PE where the distributor is exclusive, the conditions of sale are decided by the offshore seller, the distributor provides the offshore seller with lists of customers, and the distributor is not allowed to sell other competitive products. As such, trading relations between an offshore seller and local distributors can give rise to a PE for the offshore seller subject to EIT in Vietnam in the event

that the provisions of the distribution agreement give the offshore seller certain degree of control over local distributors.

Another operation potentially exposed to constitution of a PE is the operation of representative offices (RO) in Vietnam of foreign companies. ROs are not allowed to carry out business activities in Vietnam. However, the operations of ROs can give rise to PE exposure when the personnel of ROs sign contracts in the name of the foreign companies, or when the ROs serve as a local vehicle for delivering goods or providing services in Vietnam.

Since the taxation of PEs through operations of ROs has attracted the attention of the tax authorities only recently, few precedents have been set though the tax authorities have begun some investigations on ROs. It is uncertain as to how far the tax authorities will interpret PE exposures, particularly with the distributorship relations and operations of ROs.

1.3 Relevant provisions of/ protection pursuant to Vietnam’s double taxation treaties

Foreign companies, which carry out business in Vietnam not in the forms provided under the Law on Foreign Investment in Vietnam and generate income, are subject to tax in Vietnam even if the business activities do not constitute PEs.

Vietnam has 38 double taxation treaties in force to date. In general, the treaty provides that the profits of an enterprise of a Contracting State will be taxable only in that State unless the enterprise carries on business in the other Contracting State through a PE situated therein. Thus, foreign companies without PEs can apply for tax exemption under the relevant treaties. Moreover, the definition of PE in a treaty is normally narrower than that provided for in domestic law (i.e., the amended EIT Law). Furthermore, when the treaty tax rates are lower than ones under domestic tax law, foreign companies can apply the lower rates subject to approval of the tax authorities.

The application to the tax authority for treaty protection, however, is a cumbersome and lengthy process. Some of the application documents include a resident certificate and a tax registration issued by the tax authority of the foreign country, copy of contracts.

2. NEXUS FOR TAXATION OF THE COMPENSATION OF NONRESIDENT INDIVIDUALS

2.1 Brief overview of taxation of the compensation income of a nonresident individual in the absence of an applicable double taxation agreement

Under domestic tax law, non-resident foreign individuals are those who stay in Vietnam less than 183 days in 12 consecutive months or those who do not stay in Vietnam. They are subject to tax at a flat rate of 25% on Vietnam-sourced income.

2.2 Points to note/ potential surprises/ traps for the unwary

It should be noted that Vietnam-sourced income is income arising in Vietnam regardless of where the income is paid, even when a non-resident foreign individual does not stay in Vietnam.

2.3 Relevant provisions of/ protection pursuant to Vietnam’s double taxation treaties

Article 15 of most of the treaties provide that remuneration derived by a resident of a Contracting State in respect of an employment exercised in the other Contracting State shall be taxable only in the first-mentioned State if:

- The recipient is present in the other State for a period or periods not exceeding in the aggregate 183 days in a year concerned; and - The remuneration is paid by, or on behalf of, an employer who is not a resident of the other State; and - The remuneration is not borne by a permanent establishment or a fixed base which the employer has in the other State.

Thus, non-resident foreign individuals who meet the above treaty conditions can apply for tax exemption in Vietnam subject to approval of the tax authorities. As mentioned above, this process is cumbersome and lengthy.

Please do not hesitate to contact Oliver Massmann if you have questions on the above under Uomassmann@duanemorris.comU