Legal risks from a tax administrative case

For FDI enterprises, determining corporate income tax obligations arising from the transfer of contributed capital is always a big challenge, especially when tax authorities and enterprises have different interpretations of tax bases, exchange rates, and regulations on administrative procedures.

Source: The Saigon Times

In November 2016, Bumkoo Industrial C., LTD (Bumkoo), a 100% foreign-owned investor, transferred 20% of its stake in BK Vina (B) Co., Ltd. to two other foreign individuals.

Six years later, in 2022, the Tax Department of Binh Duong province issued a Notice of temporary calculation and payment of corporate income tax No. 8758/TB-CTBDU, requiring B to pay VND 1,009,760,303, including the original corporate income tax (CIT) arising from capital transfer activities of VND 608,397,751, the rest is fines for wrong declaration and late payment interest.

Company B initiated an administrative lawsuit at the People's Court of Binh Duong province requesting the cancellation of Notice 8758 for three main reasons: (1) The Department of Taxation wrongly identified the tax payer, (2) Fixed the cost price and exchange rate in contravention of regulations, and (3) Decided to sanction when the statute of limitations expired.

The People's Court of Binh Duong province issued the first-instance judgment No. 73/2023/HC-ST dated 14-12-2023, accepting Company B's request to initiate a lawsuit, annulling Notice 8758 and forcing the Tax Department of Binh Duong province to re-settle the tax payment obligation in accordance with the law. Despite this, Company B continued to appeal, requesting the appellate level to amend the judgment in the direction of accepting the entire lawsuit request, declaring that the company was not subject to any tax obligations.

The High People's Court in Ho Chi Minh City at the subsequent appeal session did not accept the appeal of Company B and at the same time upheld the first-instance judgment, canceled the entire Notice 8758/TB-CTBDU and forced the Director of the Tax Department of Binh Duong province to recalculate the tax obligation[1].

Tax obligations in capital transfer transactions

One of the basic legal problems in capital transfer transactions with foreign elements is the confusion between the capital transferor (the person generating taxable income) and the party declaring and paying tax on behalf of the person (the person with administrative responsibility).

Parent-subsidiary liability. In the above case, the Department of Taxation made a mistake when determining Company B as the transferor of contributed capital and issued Notice 8758 based on this basis.

The Court of Appeal has considered and clearly delineated that Bumkoo is the transferor of capital, generating taxable income. Company B is only the organization responsible for declaring, deducting and paying the CIT amount payable to Bumkoo on behalf of Bumkoo[2].

This provision applies when a foreign organization not operating under Vietnamese law engages in capital transfer activities. In case both the transferor and the transferee are not established and operate under Vietnamese law, the enterprise having the transferred capital in Vietnam shall have to declare and pay this tax amount on their behalf.

Tax at source principles. The argument of the Binh Duong Provincial Tax Department cited Article 5 of the Double Taxation Avoidance Agreement between Vietnam and South Korea, arguing that B is Bumkoo's permanent establishment in Vietnam, through which B must fulfill the obligation to pay on behalf of him.

Although the tax authority has confusion about the taxable subject, the Court's affirmation of B's responsibility to "declare and pay on behalf of" is in accordance with the principle of collecting tax at source for income arising in Vietnam of non-resident investors. This ruling helps FDI enterprises to be well aware that tax obligations belong to foreign investors. The responsibility for carrying out administrative procedures belongs to the Vietnamese company as the representative to submit on behalf of the company.

The tax authority's wrong identification of the subject made Notice 8758 lacking legal grounds from the beginning, leading to the Court annulling the issued decision.

Source: The Saigon Times

Taxation risks for exchange rate differences clarified by the Court

The most complicated professional problem in this case is the determination of the cost price of the transferred capital and the application of the exchange rate to the initial contributed capital.

As a general rule, CIT calculation income from capital transfer is calculated by:

Taxable income = [Transfer price] – [Purchase price (Cost price)] – [Transfer cost]

In this transfer, the Tax Department of Binh Duong Province fixed the cost price for 20% of Bumkoo's contributed capital by taking the total charter capital of 3,210,000 dollars (from the Investment Certificate), comparing it with the capital according to the 2017 financial statements (52,450,194,671 VND), thereby inferring the historical capital contribution rate of 16,339.62 VND/dollar. The Department of Taxation used this historical exchange rate to calculate the cost price for the transaction in 2016, when the actual transaction rate was 1 dollar = 22,580 VND.

Bumkoo's initial capital contribution was made in 2008, when the exchange rate of the US dollar and dong was still low and this exchange rate was different at the time of the transfer in 2016. Accordingly, the Court of Appeal rejected this method and affirmed that the revenue, expenses and taxable prices arising in foreign currencies must be converted into Vietnamese dong at  the actual exchange rate at the time of generating taxable income.

The fact that the Department of Taxation took the transfer price in 2016 to convert it back into dollars at the time of 2008, then converted it back into dong as a basis for calculating the cost price is not in accordance with the law. This calculation makes the Taxable Income increase irrationally. This increase is actually the profit from the exchange rate difference accumulated during the investment process, not the actual profit from the business activities of the enterprise.

Therefore, the Court requires that the exchange rate at the time of November 2016 is the time when taxable income is generated.

The Court's decision is an important protection for FDI investors, ensuring that they are only taxed on actual business profits incurred in Vietnam, avoiding taxation on the difference in the initial investment capital exchange rate.

Sanctioning administrative violations and tax arrears

Statute of limitations for sanctioning and issuance of decisions. According to regulations[3], the statute of limitations for sanctioning acts of making false declarations leading to a lack of payable tax amount is five years from the date of committing the violation. In this case, the time of violation is 27-11-2016 (the deadline for submitting declaration dossiers). Therefore, the five-year statute of limitations for sanctioning ends on November 27, 2021. However, the Sanctioning Notice 8758 was issued on May 23, 2022, which is more than six months past the statute of limitations, so "the act of falsely declaring tax has expired according to the law", according to the appellate court.

In addition, the Law on Handling of Administrative Violations stipulates that the maximum time limit for issuing a sanctioning decision is 60 days (for complex cases) from the date of making a record of administrative violations. The working minutes to determine the violation of Company B were made on March 21, 2022. Notice of Sanction 8758 issued on May 23, 2022, i.e. 62 days later, is an indisputable dual legal basis for competent Courts to declare the administrative sanction part of Notice 8758 invalid.

Distinguish between sanctions and tax arrears. According to current regulations[4], the statute of limitations for tax arrears collection for acts of underdeclaration of tax is ten years from the date of occurrence of violations. Because the violation occurred in 2016, the statute of limitations for tax arrears is extended until 2026. This is the reason why the Court only cancels the part of the erroneous administrative decision and invalidates the fine, but still forces the Department of Taxation to "re-settle the tax payment obligation" of Company B. Therefore, the tax authority still has the right to collect the underpaid/unpaid original CIT amount (if any) in this case.

This tax administrative case is very significant in providing clear guidelines on how to determine CIT liabilities from capital transfers with "foreign currency" elements. At the same time, the case has provided important legal bases for enterprises to protect their legitimate rights and interests against inappropriate decisions of competent authorities in the coming time.

Lawyer Nguyen Van Phuc

HM&P Law Firm

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