With the growth of the economy, Vietnam has become an investment hotspot attracting foreign direct investment. Foreign direct investments in Vietnam can take many forms and two prevalent structures are investing in new business and production facilities and/or investing in mergers and acquisitions (M&A).
Regardless of the type of foreign direct investment transactions, most foreign investors raise concerns as to the legal requirements in order for them to repatriate the profit as well as implement collections and payments in foreign currency which are related to their business activities in Vietnam. To address these concerns, we discuss the use of a direct investment capital account (DICA) and how it works to conduct collection and payment transactions related to foreign direct investment activities in Vietnam. We also highlight the key tax risks based on our interpretation of the relevant regulations and practical experiences.
Requirements of an Organization
The use of a DICA is governed by Circular No 06/2019/TT-NNN (Circular 06) which took effect on September 6, 2019. According to Circular 06, the definition of “foreign direct invested enterprise” (FDI) has been broadly defined to include:
- an enterprise established by a foreign investor and granted an investment registration certificate (IRC);
- a newly established enterprise with a foreign investor holding 51% or more of charter capital or with the same proportion of the foreign investor’s stake in an M&A transaction or which has been established by specific regulations; and
- an enterprise established by foreign investors to implement a Public-Private Partnership (PPP) in accordance with the investment law.
FDI enterprises, as defined in Circular 06, are required to open a direct investment capital account with a licensed bank to perform collection and payment transactions.
DICA Requirements and Risks Arising from Non-compliance of Opening a DICA
Implication of a DICA on Profit Repatriation and Loan Payments
Under Circular 06, a DICA in foreign currency is used to perform the following collection and payment transactions related to direct investment activities:
- receiving capital contributions in cash made by foreign investors of the relevant FDI enterprise;
- making payment of loans including foreign borrowings; and
- purchasing foreign currency from authorized credit institutions to transfer capital, profits and legal earnings overseas.
In light of the above, opening a DICA plays a critical and prerequisite role in the establishment and operation of a company established by foreign investors.
The use of a DICA is not only important at the establishment of the enterprise to ensure that it is able to utilize the account to initially receive the transferred fund of registered charter capital and loans and subsequently use these transferred amounts to carry out its operations in Vietnam, but also necessary to substantiate and expedite the repatriation of profits at a later stage in a smooth manner. Failure to comply with Circular 06 would expose the enterprise to the risk of not being able to remit the after-tax profits earned from carrying on a business activity in Vietnam to an overseas country as well as repaying the foreign loans and interests arising.
Implication of DICA on Settlement of M&A Transactions
Circular 06 specifies that payment for M&A transactions must be settled through the DICA if such a transfer is conducted between a foreign investor and a domestic investor. Where the local investor acquires capital in respect of an FDI company from foreign investors, the local investor must remit the assigned price to the foreign investor via an FDI enterprise’s DICA. This means that the amount of capital assignment cannot be transferred directly to the transferer’s overseas account, but the local buyer is compulsorily required to pay in Vietnam to the transferred company’s DICA and such company then remits money back to the foreign investor.
Failure to open a DICA may risk the transferred price not being settled through a DICA, thereby impacting the potential capital assignment implementation. From a tax perspective, when the foreign enterprise sells its shares/equity in an FDI, it is subject to capital assignment tax (CAT) in Vietnam. CAT is a type of corporate income tax (CIT), while the transaction of capital assignment is exempted from value-added tax. Under Vietnamese regulations, the CAT formula is:
Taxable income (a) = Transfer price (b) – Cost/purchasing price of capital (c) – Transfer expenses (d)
Without registration of a DICA, there is no evidence to justify the amount of capital that the foreign investor contributed to a foreign invested enterprise (FIE). Hence, there is the potential risk that the foreign investor is in the position of not being accepted by the tax authority to deduct the cost/purchasing price of capital regardless of whether the capital/consideration for equity interests has been actually transferred/settled to an FIE. In the worst scenario, CAT of 20% shall be imposed on the whole transaction price leading to unfavorable tax treatment in respect of capital assignment transaction.
DICA on Loans Taken Out by an FIE and Converted to FDI’s Capital
Another point to note is that, as mentioned above, Circular 06 provides that foreign-sourced loans (including principal, related interests and other associated expenses) are required to be paid through a DICA. Nevertheless, there are two exceptional cases in relation to the requirement of the settlement of foreign loans through a DICA:
- The foreign investor is allowed to open a payment account apart from a DICA to conduct the receipt and payment of foreign loans where the currency of the loans differs from that of a DICA.
- Point 2b, Article 24, Section 1, Circular 24/VBHN-NHNN provides that in respect of short-term foreign loans, an FDI is able to choose a DICA or its eligible bank through which such transaction is conducted. If the latter is applied and a bank account, apart from a DICA, is selected to conduct the loan-related transaction, this would have a potential impact on cases where the enterprise subsequently plans to convert the short-term loan into the enterprise’s capital.
Technically, the enterprise is allowed to convert the short-term loan which is conducted through another bank account apart from a DICA to its capital and the changes would be presented on its Enterprise Registration Certificate (ERC). However, when it comes to the transfer of capital at the latter stage, the transferer could be exposed to the potential challenge of the tax authority on the supporting documentation to justify and substantiate the value of original capital should the initial transaction of borrowing not be conducted through a DICA. The same tax risk, as mentioned above, should be brought to the foreign investor’s attention and consideration given to the tax authority’s challenges before giving a decision as to which type of account could be utilized for a short-term foreign loan.
A DICA acts as the “front door” of an FDI enterprise established in Vietnam, which the initial invested capital, the results of business activities and the transferred price related to M&A transactions are required to be processed through. In addition, the operation of a DICA comes with tax implications related to the profit repatriation and capital assignment tax. In this respect, a thorough knowledge of the licensing regulations and practical tax experience can help foreign investors to be compliant with the regulations and mitigate/address the analyzed tax risks and challenges of the tax authority in the affected transactions.
Nguyen Thu Phuong is a Tax Director and Nguyen Hung Du is a Tax Partner at Grant Thornton Vietnam.