Proposed changes to interest deductibility rules may be welcomed by taxpayers

Challenges pertaining to related-party relationships via borrowing criteria

Many businesses encounter challenges related to the complexity of determining related-party relationships based on the borrowing criteria outlined in Point d, Clause 2, Article 5 of Decree 132. This includes cases where a credit institution, which would under normal circumstances be viewed as an unrelated party, is deemed to be a related party for transfer pricing purposes because the loans it makes are equal to at least 25 per cent of the borrower’s contributed capital, and more than half of the total medium-and long-term debts of the borrowing enterprise. In these circumstances, businesses are classified as having a related-party relationship with such credit institutions.

For transfer pricing compliance purposes, taxpayers must declare these credit institutions as related parties. If they are not exempt from the transfer pricing compliance requirements, the taxpayers are also obliged to prepare and maintain documentation to demonstrate that borrowing transactions with these credit institutions adhere to the arm's length principle, resulting in additional administrative responsibilities for the borrowing enterprises.

Challenges relating to non-deductible interest expenses

Another challenge arises when a credit institution is classified as a related party, potentially leading to the disallowance of some interest deductions. For instance, if a business does not engage in related-party transactions and only borrows from a credit institution deemed an independent party, the interest expenses would not be capped at 30 per cent of earnings before interest, taxes, depreciation, and amortisation (EBITDA).

However, if that credit institution is considered a related party due to meeting the criteria outlined in Point d, Clause 2, Article 5, the interest expenses are then capped at 30 per cent of EBITDA. This restriction poses significant challenges for businesses by limiting their ability to deduct legitimate interest expenses.

Given that many businesses encounter these challenges, potentially obstructing their ability to manage finances, secure funding, and grow operations effectively, the MoF has decided to revisit this provision to better align with the current economic environment.

Proposed changes

On July 5, 2024, the MoF released a draft decree to amend and supplement Point d, Clause 2, Article 5 of Decree 132. On November 6, 2024, the MoF also submitted a draft (version three) to the Ministry of Justice for opinions. This draft is currently under review by various government departments and the broader business community for comments.

Key proposed amendments include:

• Introducing a charter capital threshold of 20 per cent between an enterprise and credit institutions, whereby an enterprise and a credit institution are deemed related parties only if the enterprise owns at least 20 per cent of the credit institution’s charter capital.

• A credit institution will not be deemed to be a related party under the 25 per cent/50 per cent rule unless it participates in the “management, control or capital contribution” of the borrower.

• Providing provisions regarding the treatment of non-deductible interest expenses from prior years (before 2024).

These proposed amendments aim to enhance compliance and clarity in the transfer pricing framework. The amended decree is expected to be published in early 2025 and will apply to corporate income tax returns for 2024 and beyond.

Judith Henry, Transfer Pricing partner (left) and Ngo Thanh Tin, Transfer Pricing director at PwC Vietnam

Judith Henry, Transfer Pricing partner at PwC Vietnam, stressed the need to address the complexities in determining related-party relationships.

“It is essential for tax regulations to keep pace with the changing economic landscape, ensuring businesses can effectively manage their financial commitments without undue restrictions,” she said, underscoring the need for a more flexible regulatory framework.

“In a changing economic landscape, the regulatory framework must evolve to support businesses in overcoming challenges while maintaining transparency. These amendments are not merely regulatory updates; they represent a proactive response to the complex difficulties that businesses are currently facing. Regulations must be both adaptable and enforceable, creating a business environment that encourages growth and compliance.”

Relating to the proposed provision of a 20 per cent charter capital threshold between enterprises and credit institutions, this amendment aims to establish clearer criteria for determining related-party relationships.

According to the provision, an enterprise and a credit institution are considered related parties only if the enterprise owns at least 20 per cent of the credit institution's charter capital. This threshold is designed to ensure that only those credit institutions meeting this specific ownership are classified as related parties. In addition, the changes to the 25 per cent/50 per cent rule mean that fewer credit institutions will be classified as related parties.

The impact for taxpayers of these two changes is that they should reduce the administrative burden on enterprises by alleviating the need for additional compliance obligations associated with related-party transactions. The changes are intended to enhance the identification of genuine related-party relationships based on a significant ownership threshold and management and control, thereby streamlining compliance processes.

“This change to the definitions is crucial for both clarity and compliance. It allows businesses to operate with greater confidence in their transactions, as credit institutions will now only be considered related parties if there is a charter capital contribution of at least 20 per cent. That makes a lot more sense,” she added.

Under Decree 132, non-deductible interest expenses can be carried forward to subsequent tax years and deducted if the net interest expense/EBITDA ratio is below 30 per cent in those years.

The proposed changes in the draft decree in the definition of related-party relationships via borrowing criteria are applicable from 2024 onwards. Thus, there may be instances where a company borrows from a credit institution that is considered a related party before 2024 but no longer a related party from 2024 onwards.

In such a case, it opens the question whether the non-deductible interest expenses incurred before 2024 can be carried forward to the years from 2024 onwards. The draft decree provides transitional guidance in this respect, i.e., the non-deductible interest expenses as of the end of 2023 shall be equally allocated to the respective remaining years for claiming deduction in such years.

Ngo Thanh Tin, Transfer Pricing director at PwC’s Ho Chi Minh City office, said, “These proposed changes provide flexibility for enterprises in managing non-deductible interest expenses, allowing those without affiliated relationships to distribute these expenses across future periods, while offering those with such relationships a structured timeline to carry forward expenses, thereby easing the taxpayer’s financial burden over time.”

Looking ahead, businesses should proactively prepare for the changes set to take effect in the 2024 tax year by staying informed and ready to adopt the new regulatory framework. Conducting thorough assessments of current compliance processes and engaging in training sessions to familiarise teams with the upcoming regulations will be essential. This proactive approach reduces the risk of non-compliance and positions businesses to capitalise on the opportunities introduced by these amendments.

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