Failure to manage permanent establishment risks when doing cross-border business activities may result in an unexpected negative impact on a multinational corporation’s tax position.
With the trend of globalization, companies increasingly have extensive business operations across many territories and jurisdictions but not all of them have a good understanding of domestic tax regulations, in host countries, as well as tax treaties.
Meanwhile, the tax authorities in many countries are paying increased attention to and have aggressive policies on issues related to Permanent Establishment (“PE”), especially since the release of Base Erosion and Profit Shifting (“BEPS”) Action Plan by the Organisation for Economic Cooperation and Development (“OECD”) in 2015.
Therefore, one of the potential common tax exposures that international and global enterprises encounter in their normal course of tradeoff business is the situation in which an unintended “taxable presence,” i.e. PE, is created in a jurisdiction.
In practice, a PE is not exactly what it sounds like.
It might be created through business activities of corporations in the host countries and it is not easy to recognize in some circumstances. Consequently, failure in managing PE risks when doing cross-border business activities might result in unexpected negative impact on the tax position and worldwide business results of international and multinational corporations (e.g. tax claw-back, penalty and interest).
Permanent Establishment Conditions
The creation of a PE is determined by application of the domestic laws, relevant tax treaties entered into by the countries, and BEPS Actions.
The current Vietnamese regulations stipulate the following three conditions to identify whether the foreign company’s business activities constitute a PE in Vietnam:
- A business establishment is maintained (e.g. branches, executive offices, plants and a location in Vietnam where natural resources are exploited, or construction sites, installation or assembly works, establishments providing services, agents, and representatives, buildings, vehicle, machinery or equipment or merely a specific place without an identifiable management system, etc.)
- The business establishment must be fixed. This means that it must be established at a specified place in Vietnam and/or maintained on a permanent basis. However, the definition of fixed does not necessarily mean that such establishment must be located in a specific place for a specific time.
- The business activities in Vietnam are partly or wholly conducted by a foreign company through this establishment.
Meanwhile, the PE definition, in most Avoidance of Double Taxation Agreements (“DTAs”), is generally a fixed place of business through which the foreign entity carries out partly or wholly its business activities.
In this regard, it is worth noting that in the event that there are different provisions on the definition of a PE provided under a DTA, these provisions shall take precedence over the domestic regulations.
PE Creation in Vietnam—Some Specific Cases
Even though the existence of a PE is technically determined through the above-mentioned criteria, in practice there are cases where foreign companies are reluctant to identify whether their activities trigger PE risks according to the Vietnamese tax authority’s strict view. Below are some common specific scenarios where the foreign companies are considered to have a PE in Vietnam:
- In Official Letter 1934/TCT-HTQT issued by the General Department of Taxation regarding PE creation of Bayer Hong Kong in Vietnam: the company in Vietnam performs activities such as managing purchase orders, following-up and collecting debts for the parent company. Therefore, the Vietnamese company is deemed by the tax authority as a PE in Vietnam, of the foreign company.
Additionally, as mentioned in the official letter, with the foreign company’s right to check all files and documents of the local company, the tax authority once again re-affirms the existence of a PE in Vietnam of the foreign parent company through the local company.
- Another notable case of PE tax exposure is related to the delivery activity from a bonded warehouse. In this regard, a foreign company is deemed, by the tax authority, as having a PE in Vietnam, based on the following conditions:
- The foreign company maintains a bonded warehouse not only to store the goods but also to actually carry out its regular delivery of goods from the bonded warehouse to its customers, which is regarded as part of its trading activities rather than pure storage of goods.
- The foreign company has a representative in Vietnam responsible for controlling its inventory and delivery from a Vietnamese bonded warehouse
- In case a foreign company carries out business activities through a broker or agent whose pricing, distributing and/or other relevant activities are still under control of the foreign company, then such agent is considered as the foreign company’s dependent agent and hence creates a PE in Vietnam.
- Potential PE risk also arises in the operation of a Representative Office (“RO”) of a foreign company, in Vietnam. The reason is that the RO is not allowed to perform business activities in Vietnam, and in the event it carries out supporting services, which are not included in its function as stipulated by laws, the tax authority may access the RO’s supporting roles and deem the RO as its parent company’s PE in Vietnam.
For example, in case the RO maintains (i) an engineering team to provide maintenance services for the customers who purchase the goods from the parent company, or (ii) a sales team to assist the parent company’s sales activities in Vietnam (i.e. sales promotion, product launching/ endorsing, etc), those activities might trigger a PE exposure.
- A foreign company assigns its employees to provide services (e.g. maintenance services, consultancy services, technical support, sales, etc.) in Vietnam over a prolonged period. Accordingly, the local tax authority may deem PE existence for service provision through the assigned employees due to revenue generation.
Tax Implications on PE and Tax Treaty Protection
With an aim to provide a clear definition of PE, imposition of tax on PEs and to avoid or eliminate double taxation on the same income (e.g. revenue attributed to the PE) in two countries, the tax protection under DTA signed between Vietnam with approximately 75 countries could be applied.
In general, most DTAs provide that when a foreign company with a PE in Vietnam derives income from its home country and has paid tax under the provisions of the tax treaty and under its home country’s domestic laws, Vietnam may still tax such income, which is attributed to the PE in Vietnam. However, simultaneously, the methods for elimination of double taxation could be applied so that the taxpayer does not have to pay double tax.
In Vietnam, DTA impacts corporate income tax (“CIT”) and personal income tax (“PIT”) only.
Accordingly, a foreign enterprise with a PE in Vietnam will pay (i) Foreign Contractor Tax (“FCT”) comprising Corporate Income Tax and Value Added Tax (“VAT”) on all income arising in Vietnam regardless of whether the income is related to the PE and (ii) CIT on foreign income arising out of Vietnam that is attributable to the PE; and then may be able to apply tax treaty protection to deduct CIT liability associated with the PE in Vietnam from the tax liabilities imposed on that income in the home country.
Notwithstanding, the tax amount paid, in Vietnam, is likely not to be accepted for full tax credit in the home country and vice versa based on the domestic laws.
In general, when a foreign entity is taxed in Vietnam on its PE’s revenue, it is permitted to subtract an amount equal to the tax paid in Vietnam from the tax imposed on income of the PE by their home country’s tax regime. Such tax credit, however, cannot exceed that part of the tax, as computed, before the deduction is given, which is levied on such income derived from Vietnam.
On the other hand, a foreign enterprise without a PE in Vietnam is subject to FCT (including CIT and VAT) only on income arising in Vietnam. Likewise, the DTA’s provide tax protection in this case when a foreign company (i) is able to apply a DTA for tax exemption in Vietnam without paying CIT, or (ii) still pays FCT in Vietnam, and submits the certification of tax declaration and payment in order to enjoy a tax credit against the relevant tax liability, in its host country.
In addition, please note that tax treaty claims are not automatically granted to beneficiaries even if the conditions for tax exemption/ reduction are satisfied. The application dossier is required and subject to the final approval/assessment from the tax authority.
Based on the above, the PE situation might cost companies more tax, as well as administration costs to apply for tax protection. Particularly, in case the home country has not signed an agreement with Vietnam, it seems that the foreign company must bear double tax in both countries on the same income related to the PE.
Consequently, it is the responsibility of the taxpayer to prove that the local activities are preparatory or auxiliary in order to avoid triggering a PE. Additionally, given that the tax authorities generally target to increase revenues in their own jurisdictions, the multinational and international companies should take the following into account when doing business across borders to minimize the unexpected financial burden caused by unexpected PE issues:
- perceive tax exposures relating to creation of a tentative taxable presence in a jurisdiction;
- pay attention to likelihood of constituting a PE; and
- proactively manage the creation of a potential taxable presence to mitigate tax risks.
Nghiem Xuan Hong An
Senior Tax Manger, Grant Thornton Vietnam