Vietnam Corporate tax: Transfer pricing adjustments in tax holiday years can result in Vietnamese corporate tax liability

Recent official letters (OLs) issued by Vietnam's Ministry of Finance have illustrated the ability of the Vietnamese General Department of Taxation (GDT) to levy corporate income tax on tax adjustments resulting from tax audits of tax holiday and tax incentive years. Although the tax adjustments described in the OLs are not clearly labeled as transfer pricing tax audit adjustments, the principles used to levy tax in such years apply equally to TP adjustments. TP adjustments arising in a tax audit of an incentive tax year will more likely result in tax payable than other typical audit tax adjustments (for instance, denial of deductions for advertising and promotion expenses) due to the potentially large magnitude of TP adjustments. Hence, taxpayers in tax incentive years now risk tax liabilities on TP tax audit adjustments, even if the year is a zero percent tax year under an incentive agreement.

Circular 134/2007/TT-BTC (dated 23 November 2007 and issued by the Ministry of Finance) provides guidelines on implementation of Decree 24/2007/ND-CP, which deals with clawback of underpaid corporate income tax (CIT). Circular 134 provides that when a tax audit of an entity entitled to CIT incentives increases the amount of taxable income, the rate of tax imposed on the taxable income adjustment will be at the overall incentive rate or the full current rate of CIT (28 percent in 2007 and 2008). These provisions apply only for tax years 2007 and 2008 and currently do not apply to any other tax years due to the specific time periods during which the circular was in force.

Official Letter No: 3090/TCT-PC (dated 30 July 2009) does not discuss the nature of the tax audit adjustment involved, but the national office of the GDT instructs the provincial tax authorities to apply the tax law cited above for the years 2007 and 2008. Although a taxpayer was entitled to a CIT reduction or exemption, the provincial tax authority was instructed to levy tax using the overall incentive rate and not the 50 percent reduced rate applicable to the audit year. In addition, the OL states that if tax evasion is involved, penalties of one to three times the amount of tax can be additionally assessed.


Example

A typical tax incentive period in 2007 and 2008 might have been as follows:
- 12 years with an overall incentive rate of 15 percent starting with the first revenue year;
- Three years of complete CIT exemption (zero percent tax rate or 100 percent reduction) starting in the first profit year; and
- 50 percent of the overall incentive rate (that is, 7.5 percent rate) for the following seven years.

For example, assume a company's first revenue year was 2006, and that it had start-up losses in 2006 and 2007, with 2008 as its first profit year based on its returns as filed. The company would have commenced its three years of CIT exemption (zero percent tax rate) in 2008, even though it might have used carryforward tax losses to offset the taxable profit in 2008.

A tax audit by the GDT of 2007 and 2008 eliminates the tax losses in those years as a result of TP adjustments and the denial of certain other claimed deductions. The 2007 taxable year is now the first profit year, and the three years of complete CIT exemption now are 2007, 2008, and 2009.

However, under the tax law in effect for 2007 and 2008, the taxable income resulting from the tax audit adjustments, including TP adjustments is ineligible for the zero percent tax rate under the tax incentive period and, instead, results in tax payable at the overall 15 percent tax incentive rate. Note that such a company does obtain the zero percent rate for 2009 (which is now the third year of the 100 percent tax holiday) and an audit for 2009 would not result in application of the 15 percent rate to any adjustment, because the circular applies only to 2007 and 2008. Any tax audit adjustment for 2009 should be at the zero percent tax rate of the third year of complete CIT exemption, and not result in a tax liability, under the GDT's current approach.

Many companies in Vietnam in tax incentive periods assume that a corporate tax audit will not result in tax payable if an adjustment relates to a CIT exemption year, or a lesser tax payable in the 50% reduction of incentive rate years. Hence, many taxpayers tend to ignore the transfer pricing rules for reporting related-party transactions, and have not undertaken the necessary transfer pricing documentation for such tax years. However, recent tax audit activity as shown in the OLs indicated that for tax years 2007 and 2008 there is a real risk of tax payable at the higher overall incentive rate, rather than at a reduced incentive rate.


Recommended taxpayer actions

Taxpayers in tax incentive periods for the 2007 and 2008 tax years should reassess their transfer pricing and other tax adjustment risks and perform a tax health check for those years. When a real risk of a substantial tax audit adjustment exists, taxpayers should consider preparation of transfer pricing documentation or voluntary disclosure to the GDT prior to the commencement of a tax audit.

U.S. companies subject to FIN 48 procedures for uncertain tax positions should reassess the amount of tax exposure of their  Vietnamese operations using the applicable tax incentive rate to quantify the amount that is more likely than not to be paidin the event of a tax audit.