The issue of implementating vat on L/C services

In this article, Lawyer Nguyen Nhat Duong and Cao Nguyen Bao Lien (HM&P) will  focus on the analysis of the appropriateness of applying VAT to L/C services at current credit institutions. The article was published in The Saigon Times No. 12-2024, dated on March 21, 2024. Below is the English version:

Recently, the General Department of Taxation has issued Official Dispatch No. 5366/TCT-DNL dated November 30, 2023[1] on the conclusion of the Deputy Prime Minister on VAT on L/C (Letter of Credit) activities to announce the application of Value Added Tax (“VAT” ) to credit institutions and foreign bank branches in Vietnam that provide L/C services. In the field of international trade, L/C has become a popular payment method due to its safety and reputation, and charging VAT on this activity will provide a huge source of revenue for the State budget. However, the question is whether the recent decision to apply VAT to L/C services is reasonable or not when legal regulations and opinions of competent authorities are still inconsistent. In this article, we will focus on the analysis of the appropriateness of applying VAT to L/C services at current credit institutions.

1. L/C regulations are still not really clear

(Source: https://thesaigontimes.vn)

According to the provisions of the Uniform Customs and Practice for Documentary Credits (UCP 600), a letter of credit is a commitment of the issuing bank (bank guaranteeing the buyer) to pay a sum of money to the beneficiary (seller) within a certain period of time to the beneficiary (seller) on condition that the beneficiary presents a valid set of documents in accordance with the provisions of the letter of credit[2]. It can be seen that according to the definition of UCP 600, the L/C has the nature of a conditional payment guarantee and the parties can agree to choose the conditions of the L/C then the documents that meet this condition will ensure payment. Meanwhile, in Vietnam, the nature of the L/C has not been clearly and uniformly defined, specifically as follows:

According to the provisions of Clause 14 Article 4 of the Law on Credit Institutions 2010, credit granting is an agreement for an organization or individual to use a sum of money or a commitment to allow the use of a sum of money on the principle of repayment through lending, discounting, financial leasing, factoring, bank guarantee and other credit granting operations. Based on this definition, although it is not specifically listed, a letter of credit can be considered a credit transaction because there is an agreement between the importer and the bank issuing the letter of credit that this bank will make payment when the conditions set forth in the letter of credit are met. Of course, to obtain a letter of credit, the importer must have a deposit with the issuing bank, or it depends on the importer's reputation based on the bank's assessment. After the letter of credit issuing bank makes payment to the advising bank (bank in the exporter's country), the importer is obliged to pay this amount to the letter of credit issuing bank.

However, according to Clause 15 Article 4 of the Law on Credit Institutions 2010, the provision of payment services through accounts is the provision of payment instruments; provision of services of payment by check, payment order, payment authorization, collection, collection authorization, bank cards, letter of credit and other payment services to customers through their accounts. Pursuant to this regulation, letters of credit are listed as a payment service through an account.

According to the provisions of Clause 8 Article 5 of the Law on Value-Added Tax 2008, amended by the amended Law on Value-Added Tax 2013, credit granting activities are not subject to VAT. Meanwhile, the provision of payment services via accounts is subject to VAT. It can be said that the unclear regulations in the Law on Credit Institutions 2010 have made the determination the VAT on L/C services much more difficult .

From the point of view of tax administration, according to the content of the Official Dispatch No. 1606/TCT-DNL dated April 22, 2020 of the General Department of Taxation, this agency relies on the provisions in Clause 15 Article 4 of the Law on Credit Institutions to confirm that L/C service is a form of providing payment services through account, therefore, tax authorities are required to collect taxes from credit institutions that engage in this activity since the Law on Credit Institutions 2010 came into effect.

2. Is this basis really appropriate?

(Source: https://vietnamembassy-turkey.org)

From the point of view of wording, there are clear shortcomings in the provisions of the Law on Credit Institutions 2010, in particular in the provisions of Clause 14 and Clause 15 Article 4 of this Law. As mentioned above, the L/C service is essentially understood as a payment obligation of the bank. This activity differs from the guarantee activity only in that in the case of a guarantee, the bank pays only if the guaranteed party fails to perform its obligations. Meanwhile, in the L/C service, the issuing bank pays the advising bank in advance on behalf of the importing party when it has received all valid documents. This activity does not require the importer to pay the exporter in advance. According to Clause 15 Article 4 of the Law on Credit Institutions 2010, the listed activities are simply payment activities through accounts, the inclusion of letter of credit issuance activities in this regulation is quite forced that it only consider the perspective of payment method through the account of this service without considering the nature of L/C still is a credit granting activity of the bank.

Another fundamental difference that we believe the competent authorities should pay attention to is the difference between credit granting activities and the provision of payment services through accounts. Specifically, in the case of credit granting activities, e.g. loans, the bank allows the borrower to use a sum of money, based on the principle of repayment, but still based on the borrower's ability to pledge assets to banks as collateral (except for unsecured loans). The amount of money that the borrower can use and the amount of money that the borrower guarantees to the bank are different. Meanwhile, when payment services are provided through accounts, the service users can only use the service based on the balance in their account opened at the service providing bank. In other words, the amount of money the service user uses to pay is the amount of money he has in the bank. For L/C services, the amount of money that the issuing bank uses to pay the advising bank is the amount of money that this bank allows the importer to use in advance to pay for the transaction. This amount is absolutely not the amount that the importer deposits with the issuing bank.

For the above reasons, we believe that the application of the provisions of Clause 15, Article 4 of the Law on Credit Institutions by the General Directorate of Taxation for the collection of taxes on activities related to the issuance of letters of credit from 2011 to the present is not really reasonable.

3. Putting credit institutions in a difficult situation

VAT is essentially an indirect tax and is levied on a percentage of the added value of goods and services from the act of using the service. Therefore, companies using L/C services are the ones who directly and ultimately bear the VAT, while credit institutions are only intermediaries who declare and pay the tax. Therefore, the Directorate General of Taxation's requirement to collect tax on the activities of providing L/C services from the effective date of the Law on Credit Institutions 2010 not only puts great pressure on credit institutions, but also puts these institutions in an awkward situation when, until now, L/C services have not been subject to VAT according to the instructions in the Official Dispatch No. 11754/BTC- CST dated September 6, 2010 of the Ministry of Finance[3] or even the Official Dispatch No. 4520/TCT-DNL dated October 4, 2017 of the General Department of Taxation itself [4].

In addition, Clause 2 Article 9 of Decree 125/2020/ND-CP stipulates that there shall be no administrative penalty for tax violations and no late tax payment fees for taxpayers who commit tax administrative violations due to the implementation of tax regulations in accordance with the guidelines and handling decisions of tax authorities and competent state agencies related to the content of determining the taxpayer's tax obligations (including guidelines and handling decisions issued before the effective date of this Decree). Failure of credit institutions to declare and pay VAT for L/C services is carried out in accordance with written instructions of tax authorities and other competent authorities. Therefore, according to the above-mentioned regulations, this behavior will not be subject to tax administrative sanctions. In other words, the announcement by the General Department of Taxation that it will impose administrative sanctions on credit institutions that issue L/Cs in violation of the regulations on declaration and payment of VAT according to the content of Official Notification No. 5366/TCT-DNL dated November 30, 2023 does not seem to really convince credit institutions operating in Vietnam.

In short, in our opinion, the controversy as to whether the L/C service is a credit granting activity or the provision of payment services through an account has now almost been resolved. Because according to the provisions of the Law on Credit Institutions 2024, which was approved on January 18, 2024 and will take effect from July 1, 2024, the L/C service has been listed to become a credit granting activity instead of providing payment services through accounts. Therefore, the current concern is only to resolve the issues related to the VAT applicable to the issuance of L/Cs from the time the Law on Credit Institutions 2010 takes effect until before July 1, 2024. With regard to this issue, we believe that the competent authorities, in particular the General Department of Taxation, need to have a handling plan and specific instructions appropriate to the nature of the problem, as well as the actual implementation, in order to relieve credit institutions from the awkward position as soon as possible.