OECD TAX REFORM AND WHAT IT MEANS FOR VIETNAM
On 5 June 2021, the G7 finance ministers published a communiqué that sets out a high-level political agreement on global tax reform, including the reallocation of a share of the global residual profit of certain businesses to market countries and a minimum effective tax rate in each country in which a business operates of at least 15%.
On 8 October 2021, The Organization for Economic Cooperation and Development (OECD) announced a major breakthrough on a global minimum corporate tax rate of 15%.
“The landmark deal, agreed by 136 countries and jurisdictions representing more than 90% of global GDP, will also reallocate more than USD 125 billions of profits from around 100 of the world’s largest and most profitable MNEs to countries worldwide, ensuring that these firms pay a fair share of tax wherever they operate and generate profits,” the OECD said in a statement on 8 October 2021.
The OECD/G20 Inclusive Framework, agreed to by 136 countries, is the OECD’s and G20’s vision for the international tax future. There are two aspects (referred to as “Pillars”):
Pillar One will introduce a new nexus rule that will replace the old permanent establishment rules and provide taxing rights where products are sold, or services provided (referred to as “market jurisdictions”). This seeks to align the market value of goods and services with where they are consumed rather than produced.
It will apply where:
– Global turnover of a Multi-national Enterprise (MNE) exceeds 20 billion euro, and its profitability exceeds 10%,
– 25% of the profit in excess of 10% will be allocated to market jurisdictions, and
– The MNE would need to derive at least 1 million euros from that country (for smaller economies, with GDP less than 40 billion euros, the nexus will be 250,000 euros).
The OECD also announced that an agreement had been reached for the removal of all existing Digital Services Taxes and similar unilateral measures.
Pillar Two will introduce a global minimum tax rate set at 15% (i.e., the minimum floor beneath which the global tax rate cannot fall), so that if countries have a tax rate below this threshold, other countries will have the right to impose a top-up tax.
It will apply to MNEs that have a global turnover that exceeds 750 million euros.
How would a global minimum tax work?
The basic idea is simple: countries would legislate a global minimum corporate tax rate of at least 15 per cent for very big companies, those with annual revenues over 750 billion euros ($1.2 trillion). Then, if companies have earnings that go untaxed or lightly taxed in one of the world’s tax havens, their home country would impose a top-up tax that would bring the rate to 15%.
That would make it pointless for a company to use tax havens since taxes avoided in the haven would be collected at home. For the same reason, it means the minimum rate would still take effect even if individual tax havens don’t participate.
Here’s an example of how such a system might work, as explained in a paper for the Atlantic Council by Jeff Goldstein, a former special assistant to the chairman of the White House Council of Economic Advisers:
“Assume Country A has a corporate tax rate of 20% and Country B has a corporate tax rate of 11%. The global minimum tax rate is 15%, and Company X is headquartered in Country A but reports income in Country B. Country A would ‘top-up’ the taxes paid on profits earned by Company X in Country B in a manner equal to the percentage-point difference between Country B’s rate of 11% and the global minimum of 15% (e.g., Company X would pay in taxes an additional 4% of profits reported in Country B). This approach would set a floor on the collection of global tax revenue and help alter corporate incentives because companies would know that profits shifted to tax havens would face incremental taxation”.
A new approach of transfer pricing
Pillar 1 also involves a portion of residual profit being reallocated to market jurisdictions using formulary apportionment concepts, which were rejected by OECD members only a few years ago.
This allocation of profits may not be the same as the allocation of profits currently under the arm’s length principle (ALP). The ALP’s critics usually view the principle itself as plainly wrong since it defies reality. They highlight that multinational groups exist for the purpose of generating a profit by internalizing transactions that would be more costly if conducted with unrelated parties. Critics also argue that the application of the principle is complex and potentially subject to manipulation, giving companies the possibility of locating their profit in low-tax countries.
Of the various alternatives to the ALP proposed by its critics, the one that most often emerges is a system based on apportionment, where the taxable profit of a multinational group would be allocated to its constituent entities based on predetermined formulas and factors (often sales, employees and assets — the so-called formulary apportionment or “FA”).
According to its proponents, the use of an FA system would reduce compliance costs for tax administrations and taxpayers alike, as it would only be necessary to compute the multinational group’s global profit and the value of factors included in the formula. Therefore, FA would give all involved parties more certainty about the amount of taxes to be paid on international business activities.
What does it mean for Vietnam?
First, the corporate income tax rate in Vietnam currently is 20%, above the minimum rate. However, Vietnam offers tax incentives e.g., four years of tax exemption, nine years of 50% tax reduction, and 10% preferential tax rate for 15 years to companies/projects invest in encouraged sectors and areas e.g., scientific research and technology development; software production; manufacturing composite materials, light construction materials; clean energy, etc. If the minimum global tax rate is applied, then any tax savings enjoyed by qualified multinationals in Vietnam will be muted.
Second, Vietnam shall have global merit to tax Tech giants without worrying about the retaliation of developed countries.
Recently the Ministry of Finance is proposing a draft circular on tax (Draft Circular) that would compel tech giants like Google, Facebook, Amazon, and Netflix to pay taxes. Furthermore, the Ministry of Information and Communications is also proposing a draft decree of the amendments to Decree No. 181/2013/NDCP on Elaboration of Some Articles of the Law on Advertising (Draft Decree) which imposes tax obligations on the cross-border service providers.
Accordingly, Foreign based enterprises who do not have a commercial presence in Vietnam but provide goods or services to Vietnamese customers shall be considered as Permanent Establishments (PEs) in Vietnam and subject to 2% to 5% of Value Added Tax and 0.1% to 10% of Corporate Income Tax on the revenue generated in Vietnam. PEs may declare and pay tax by themselves or through tax agencies, bank and non-bank financial institutions or Vietnamese customers.
In the case of the PEs do not declare and pay tax:
– The Vietnamese customers being organization shall declare and pay tax on behalf of the PE;
– With respect to Vietnamese customers being individual:
• the commercial banks or non-bank financial institutions are obliged to deduct tax from the payment to the PEs;
• the General Department of Taxation shall make a “black list” (including name, website…) of the PEs who have not registered, declared and paid taxes and send this black list to commercial banks and non-bank financial institutions in order for identifying non-compliant PEs and deduct tax from the payment to the PEs;
• if the payment is made via cards or other forms that the commercial banks or non-bank financial institutions are unable to deduct tax then the commercial banks or non-bank financial institutions are obliged to track the payments and report to the General Department of Taxation.
Third, the risk of double taxation.
Most Big Techs are based in America. Vietnam and the US signed the Agreement for the Avoidance of Double Taxation and The Prevention of Fiscal Evasion with respect to Taxes on Income (DTA) on 7 July 2015. However, the US government has not ratified it, therefore, the DTA has not yet come into effect. As a result, the revenue generated in Vietnam of US based companies may be taxed in both Vietnam and the US.
Finally, although Vietnam is not a member of OECD, transfer pricing is a major concern of the Vietnam tax authority. In fact, Vietnam law makers used to adopt OECD’s concepts and principles on transfer pricing into its laws e.g., Decree No. 20/2017/ND-CP dated 24 February 2017 providing tax administration applicable to enterprises having controlled transactions (Decree 20) adopted the principle of three-tiered transfer pricing documentation approach to collect more tax-related information on the business operations of MNEs. It is the principle set out in BEPS Action 13 of OECD. Therefore, it would be likely that Vietnam law makers and tax authorities may revise the laws on transfer pricing to be in line with OECD’s new approach on transfer pricing and international practice.