Shipping sector hit by tax waves

31 May 2010 -- Why has there been so much focus on the taxation of international shipping companies? The short answer, as you may suspect is probably "cash".

Looking beyond the obvious response the more interesting question is whose money?

Will the government's coffers increase through an effective taxation policy or will the shipping industry be able to maximise its profits through a proper understanding of the tax rules and wise management of its operations? If shipping companies are proactive in their approach to tax planning in Vietnam, there are real opportunities to reduce their risk of tax exposure and improve their operational performance.

In recent years Vietnam has turned its attention to increase its investment in deep-water seaports and improve its handling systems to receive large capacity ships. Since late 2009, large foreign shipping lines such as MOL (Japan), OOCL (Hong Kong), "K" Lines (Japan), APL-NOL (Singapore) and more recently, Maersk Lines (Denmark) have opened direct transport routes from Vietnam to ports in the United States by using large container ships with a capacity of up to 9,000 20-foot equivalent units. Previously such large ships had to transit through the more developed ports of Singapore, Thailand, Malaysia and Hong Kong.

This record of foreign investment demonstrates that Vietnam has started to attract international shipping lines and it has the potential to compete with other regional countries on an equal footing to become a regional hub for international cargo.

With this potential for growth and opportunity, Vietnam can clearly make a business case to attract such world-class companies. However, the question that remains unanswered as to whether Vietnam's tax rules will be equally attractive to such companies. Foreign shipping companies should consider the tax consequences of Freight Tax, Foreign Contractor Tax, Value Added Tax ("VAT") and available exemptions, each of which are outlined herein.


Freight Tax

The Freight Tax was originally applied in 1999 based on Circular 16/1999/TT-BTC and formally abolished from 2009. Despite the short life-span of these rules, over the years, Freight Tax caused a number of controversies regarding the legal basis for taxation and applicable tax rates. These issues became more pronounced in the context of applying for tax relief under the various bilateral tax treaties to which Vietnam is a party. We shall look at this specific issue in some detail as it caused the most confusion for many shipping companies.

The legal basis for the Freight Tax was the 1998 law on Corporate Income Tax ("CIT"). Based on this logic, it seemed that Freight Tax should have been fully eligible for exemption under a double tax treaty.

However, under the provisions of the Freight Tax rules, foreign shipping companies were required to pay 3 per cent in tax but when they applied for exemption of such taxes under the relevant double tax treaty, they were generally only allowed to declare 1 per cent of this tax as eligible for exemption.

There was no guidance as to the nature of the other 2 per cent of the Freight Tax and why it was not eligible for exemption.

In spite of being officially abolished in early 2009 the Freight Tax is not really a closed issue as many disputes over the interpretation of the other 2 per cent tax still remain.


Foreign Contractor Tax

After the Freight Tax was abolished from 2009, foreign shipping lines' revenue was treated as taxable under the provisions of the Foreign Contractor Tax regulations ("Contractor Tax"), which includes a VAT and a CIT component and is governed by Circular 134/2008/TT-BTC. These changes can be summarised as follows. Before 2009 the application of freight tax and contractor tax was:

- Turnover of international shipping transportation: 3 per cent Freight Tax that included 1 per cent of direct tax and 2 per cent as an undefined tax.
- Other revenue: Contractor Tax for services is generally taxed at 5 per cent VAT and 5 per cent CIT.
Since 2009 the application of contractor tax is:
- Turnover of international shipping transportation: Contractor Tax 2 per cent which includes 0 per cent VAT and 2 per cent CIT.
- Other revenue: Contractor Tax for services includes 5 per cent VAT and 5 per cent CIT.

Based on these changes the taxation on international shipping transportation income is now only based on direct taxes and can generally be fully exempted under the applicable double taxation treaties. Aside from the positive aspects in the development of the taxation system applicable to shipping companies noted above, there remains a number of challenges regarding taxation of international shipping transportation that have not yet been solved.

In reality the income of the shipping companies not only includes international freight charges but also other fees at loading and discharging ports. These include documentation charges, demurrage charges, detention charges and terminal handling charges.

According to Circular 134/2008/TT-BTC taxable revenues of foreign shipping companies are all defined as compensation collected from charges for passengers or goods transportation and other surcharges from the loading ports in Vietnam to the final discharging ports. This means that the revenue of shipping companies must be considered as revenue related to all of their transportation activities.

However, the tax authorities generally have considered such other fees as service revenue separate from freight revenue. Applicable VAT in relation to payment method

Under the new VAT law which was applied in 2009 international transport revenues are now subject to 0 per cent VAT (previously they were exempt). However, according to Circular 112/2009/TT-BTC, the percentage tax rate for international transportation revenue is applied only if this revenue meets certain conditions such as payment through a bank. Otherwise, the revenue will be considered as not subject to VAT.

This interpretation was unexpected by many in the industry as the common view was that VAT and the VAT rate applicable to a commodity or services in principle should depend on the nature, as well as the supply and consumption of goods or services rather than the payment method agreed between buyers and sellers.


VAT on commission agents

Value Added Tax (VAT) on shipping agency commissions is an issue that remains under debate. Even within the tax authorities there appears to be no simple or clear interpretation and views may vary depending on which office or official is contacted.

In this regard, for foreign shipping lines doing business in Vietnam through their agents, care should be taken in structuring such payments and addressing VAT compliance and payment issues.

Before 2009, when international transport operations were not subject to VAT, the activities of agents selling international shipping services were, therefore, not subject to Value Added Tax and such agencies did not have to declare and pay VAT on agency commissions. Since 2009, international transport operations have changed from VAT exempt status to being subject to a zero Value Added Tax rate, the agency commissions should have to bear VAT at the same rate.

Recently, tax authorities have confirmed a tax rate of 10 per cent for Value Added Tax for certain foreign shipping lines, while in other areas no tax should be charged. This apparent lack of consistency leads to much confusion among shipping companies.


Exemption under tax treaties

The tax exemption for income from international shipping under the double taxation treaties has long been one of the main problems of taxation for foreign shipping companies. Overall the double taxation treaties of Vietnam have provisions related to international transportation income. Accordingly, income from international shipping activities should benefit from treaty protection if conditions are met.

Prior to June, 2007 when Circular 60/2007/TT-BTC on the implementation of the Tax Administration Law came into force, tax exemption under a double taxation agreement was based on guidance from Circular 133/2004/TT-BTC. Accordingly shipping companies were required to provide many documents to prove their clear legal ownership, charter arrangements and any other operations for the ship in question.

These records were also required to have necessary documents translated into Vietnamese, notarised and legalised.

After June, 2007 when the Circular 60/2007/TT-BTC took effect, the tax exemption under the treaty was not further applied, instead a self-assessment mechanism replaced the old rule. Every year shipping companies are entitled to define the conditions for tax exemption under the tax treaty and send a notice to the tax authorities at the beginning of the fiscal year.


In conclusion

In Vietnam the economic potential of its vast coastline and future development of a maritime economy have become a key policy issue and as such the government has devoted more resources to focus on the development the maritime economy.

Considering this, it seems only prudent that foreign companies operating in Vietnam spend an equal amount of time and resources to fully understand this complex set of rules to reduce their tax exposures, increase their cash flow and maximise their shareholder value.