In the era of the digital economy and international integration, businesses frequently expand their scale through the formation of conglomerates and parent-subsidiary companies. However, this also brings the risk of transfer pricing through internal financing. To control this situation, the Government has issued regulations on the limit of deductible interest expenses when determining corporate income tax. This is one of the most significant changes in the government. Decree 132/2020/ND-CP, This directly impacts the company's cash flow and profits.
Understanding and correctly applying the limits on deductible interest expenses is not only a compliance obligation but also part of each entity's strategy for optimizing its financial structure.
Overview of limits on deductible interest expense
In Vietnam, regulations on interest expense limits are not new, but since Decree 132/2020/ND-CP came into effect, these standards have been standardized according to international practices (especially according to OECD recommendations on combating base erosion and profit shifting – BEPS).
The limit on deductible interest expense refers to the maximum amount that tax authorities accept as a deductible expense when calculating corporate income tax. If the actual expense exceeds this limit, the difference will be excluded from taxable income for the period. The regulation on the limit on deductible interest expense aims to prevent thin capitalization, where related parties intentionally finance capital through debt instead of equity to take advantage of the tax shield provided by interest expense.
The subjects to which the regulations of Decree 132 apply.
It should be noted that not all businesses are subject to the limit on deductible interest expenses. This regulation only applies to entities that meet two conditions: being a corporate income tax payer and having related-party transactions.
- Corporate income tax payers with related-party transactions: This includes businesses engaged in the production and sale of goods and services that have transactions with related parties (for example, a parent company borrowing capital from a subsidiary, companies within the same group lending to each other, or cases of joint management...).
- Scope of transactions: Related party transactions include, but are not limited to: buying, selling, exchanging, leasing, renting, borrowing, lending, transferring, assigning goods, providing services, borrowing, lending, financial services, financial resources and other financial instruments.
For businesses that struggle to identify these relationships, using related party transaction advisory services This is a safe solution to ensure compliance with legal regulations regarding the limits on deductible interest expenses.
Important Note: If a business has absolutely no related-party transactions during the fiscal year, it will not be subject to the 30% EBITDA deductible interest expense limit, but will only need to comply with the usual conditions regarding invoices, documentation, and interest rates not exceeding 150% the State Bank's base interest rate.
Formula for determining the 30% EBITDA limit
According to Clause 3, Article 16 of Decree 132/2020/ND-CP, the determination of the limit for deductible interest expense is based on the EBITDA (Earnings Before Tax, Interest, and Depreciation) adjusted for tax purposes. This is the core formula for determining the amount of tax payable.
The specific formula for determining the limit on deductible interest expense is as follows:
Net interest expense ≤ 30% x [Net profit from business operations + Net interest expense + Depreciation expense] |
In there:
- Net interest expense: This is the difference between (Total interest expense incurred during the period) minus (Interest on deposits and loans incurred during the period).
- Taxable EBITDA: This is the sum of the three components in square brackets, representing the ability of a business to generate cash flow from its core operations.
To understand the variables and accurately calculate the figures for the tax period to meet the regulations on deductible interest expense limits, businesses can refer to additional guidance on... Formula for calculating interest on related-party transactions In accordance with current tax and accounting standards.
Detailed analysis of how the components in the formula are calculated.
To correctly apply the limits on deductible interest expenses, accountants need to perform extremely careful data analysis from the financial statements, especially the income statement and cash flow statement:
Net operating profit
This component plays a fundamental role in the formula for calculating the limit on deductible interest expense.
- Data source: Taken from Code [30] on the Business Performance Report.
- This includes: Net revenue, cost of goods sold, financial revenue (after deducting interest on deposits/loans), financial expenses (after deducting interest on loans), selling expenses, and administrative expenses.
- Exclusion: Other income and expenses (Codes 31, 32) are not included in the calculation of the deductible interest expense limit because they are not income from core business operations.
Net interest expense
This is the subject of the regulation regarding the limit on deductible interest expense.
- Offsetting principle: Businesses subtract interest income from deposits and loans incurred during the same period from the total interest expense incurred during the tax period.
- Recognition conditions: Interest expense must be directly related to business operations and supported by complete documentation as required. If, after offsetting, the result is negative, the business is not subject to the limit on deductible interest expense.
Depreciation expense
This component helps increase EBITDA, thereby increasing the limit on deductible interest expenses. Businesses add up all depreciation costs of fixed assets and allocate intangible assets that have been accounted for to the cost of goods sold during the year.
Transfer interest expense to subsequent periods.
Decree 132/2020/ND-CP stipulates a flexible mechanism for carrying forward expenses exceeding the deductible limit for interest expenses:
- Nature: The portion of net interest expense exceeding the 30% EBITDA is not completely lost but is recognized to offset it in subsequent years.
- Transfer period: Not more than 5 consecutive years starting from the year following the year in which the excess amount exceeding the deductible interest expense limit was incurred.
- Method of implementation: In subsequent tax periods, when determining the total deductible interest expense, the business is allowed to add the carried-over portion of the expense. However, the total deductible amount must still remain within the deductible interest expense limit (30% EBITDA) for that year.
This mechanism is particularly beneficial for businesses that are in the initial stages of infrastructure development or have just started operations, helping them avoid losing their right to reasonable costs when they do not yet have large cash flows.
Exemptions from the 30% limit apply.
Even with related-party transactions, the law allows for certain exceptions to the limits on deductible interest expenses in order to encourage priority sectors:
- Financial institutions: Credit institutions and insurance companies (as these are professional capital-management businesses).
- Development assistance funds: ODA loans or concessional government loans that are then re-lent.
- National priority project: Loans to implement national target programs on new rural development and sustainable poverty reduction.
- Welfare policy: Loans for investment in social housing projects, housing for workers, or resettlement projects in accordance with state policies.
In these cases, interest expense will be deductible according to general regulations and not subject to the 30% EBITDA deductible interest expense limit.
Common risks and errors when settling taxes
In reality, tax audits reveal that many businesses face significant back taxes due to incorrect application of limits on deductible interest expenses. Common risks include:
- Misunderstanding of the related party relationship: Borrowing money from individual executives (Directors, Board members) without interest is often overlooked, but it actually triggers the regulation limiting deductible interest expenses for all other business loans (including bank loans).
- Incorrect offsetting of interest earned on deposits: Using interest earned on deposits from previous years but received this year to offset and increase the limit of deductible interest expense is a violation of regulations.
- Lack of supporting documentation: Many entities only calculate 30% EBITDA and forget their obligation to declare the Appendix on related-party transactions. This lack of documentation can lead the tax authorities to reassess the limit on deductible interest expenses in a way that is unfavorable to the business.
Conclude
Complying with the deductible interest expense limit is a challenge for businesses with high financial leverage and related-party transactions. However, by mastering the calculation formulas and expense transfer rules, businesses can proactively plan their tax obligations. Always closely monitor EBITDA and restructure loans if necessary to ensure interest expenses do not exceed the deductible limit, thereby optimizing corporate income tax obligations and ensuring financial sustainability.
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Content production by: Mr. Le Hoang Tuyen – Founder & CEO MAN – Master Accountant Network, Vietnamese CPA Auditor with over 30 years of experience in Accounting, Auditing and Financial Consulting.
Frequently Asked Questions about the Limit on Deductible Interest Expense
When EBITDA is negative, the limit on deductible interest expense for that year is zero. All net interest expense incurred will be disallowed and carried over to the following year, pending positive business results.
If the business has any other related-party transactions (even if not loans), the bank loan is still subject to the 30% EBITDA deductible interest expense limit.
The period is calculated continuously from the year following the year in which interest expenses exceed the deductible limit. If the entire amount is not carried forward after 5 years, the remaining expense will no longer be deductible from taxable income.What happens if a company's EBITDA is zero or negative?
Are business bank loans included in this limit?
From what point does the 5-year period for carrying over-limit expenses begin?