In the context of the modern economy, raising capital through loans to expand production and business operations is essential for most businesses. However, not all interest expenses incurred are accepted by the Tax authorities as deductible expenses. Particularly for businesses with related-party transactions, the regulations on interest rate caps in Decree 132/2020/ND-CP have become a complex financial problem. Understanding the factors affecting this is crucial. Interest expense is capped. This will not only help businesses optimize corporate income tax but also avoid serious legal risks during the 2025 tax year.
Why is it necessary to control interest expenses?
Imposing a ceiling on interest expense deductions is not a business barrier but rather a tax management tool aimed at:
- Preventing transfer pricing: Some multinational corporations or domestic groups of companies often use a form of "thin capitalization." Instead of contributing charter capital, affiliated parties lend to each other at high interest rates or incur excessively large debts to inflate costs, thereby reducing taxable profits in high-tax jurisdictions.
- Combating Base Erosion and Profit Shifting (BEPS): This is an effort by the Vietnamese government to implement OECD recommendations on combating base erosion and profit shifting.
Understanding why interest expense needs to be controlled will help businesses accurately identify cases subject to adjustment, thereby determining the correct subjects to which Decree 132/2020/ND-CP applies.
Applicable subjects as per Decree 132/2020/ND-CP
According to Article 5 of Decree 132, enterprises with related-party transactions (LGs) will be subject to regulation. LGs may include the buying and selling of goods, lending, borrowing, and transferring assets between parties with a relationship of joint management, control, capital contribution, or investment.
Please note: If a business engages in even a small related-party transaction (for example, borrowing money interest-free from a director owning more than 25% of capital), then all of that business's interest expense (including borrowing from independent banks) will be considered below the 30% EBITDA threshold.
See details: How to identify businesses with related-party transactions.
How to determine the limitations on interest expense.
To properly apply the interest expense ceiling, businesses need to understand the calculation formula and how to determine net interest expense, thereby applying it accurately to each loan and related-party transaction.
Formula for calculating the 30% EBITDA ceiling.
Clause 3, Article 16 of Decree 132/2020/ND-CP stipulates that the total net interest expense deductible when determining corporate income tax shall not exceed 30% of the total net profit from business operations plus net interest expense plus depreciation expense in the period.
Recipe:
Ceiling = 30% EBITDA |
In there:
EBITDA = Net profit from business operations + Net interest expense + Depreciation expense |
Net interest expense is determined as follows:
Net interest expense = Total interest expense incurred – Interest on deposits |
Note: Businesses are only allowed to offset interest on deposits and loans arising within that tax period. Misunderstanding this formula is one of the factors affecting the limitation on interest expense, leading businesses to miscalculate their tax obligations.
Factors affecting controlled interest costs
To effectively manage costs, businesses need to conduct a thorough analysis of the following five core factors:
Volatility of the EBITDA index
EBITDA serves as the "denominator" in determining interest rate limits.
- Business profitability: If a business is in the investment phase, incurring losses, or experiencing low profits, its EBITDA will be small, resulting in a very low ceiling for deductible interest expenses.
- Depreciation policy: This is a factor that businesses can proactively control. Applying accelerated depreciation increases short-term expenses but simultaneously boosts EBITDA, thereby expanding the deductible interest expense limit.
Besides monitoring EBITDA fluctuations, businesses also need to consider their capital structure, as the debt-to-equity ratio directly impacts the limit on interest expense.
Capital structure: Debt versus Equity
Excessively high financial leverage ratios are a direct cause of interest rates exceeding the 30% threshold.
- When businesses prioritize raising capital through debt financing instead of increasing their charter capital, the total interest expense will balloon.
- The factors affecting the controlled interest expense here lie in whether the business borrows from related parties. If borrowing from the parent company at a non-market interest rate, the tax authorities have the right to reassess the expense at the market rate before calculating the 30% threshold.
Besides the capital structure, market interest rates also play a crucial role, as interest rate fluctuations can significantly increase or decrease borrowing costs, directly impacting the 30% EBITDA ceiling.
The scale and nature of other related-party transactions
This is the most common "trap." Many businesses think, "I don't borrow money from related parties, I only borrow from banks, so I'm not subject to the 30% restriction?" In reality, according to Decree 132/2020/ND-CP, if a business has any related-party transactions (such as selling goods to a subsidiary), then all interest paid to the bank is also subject to the restriction. Therefore, maintaining unnecessary related-party transactions is one of the factors that indirectly but extremely dangerously affects the restriction on interest expense.
The choice of method for determining transfer pricing.
When a company engages in related-party transactions, net profit may be adjusted using market-comparative pricing methods. If net profit is adjusted downward due to a violation of market-comparative pricing principles, EBITDA will decrease accordingly, leading to a narrowing of the interest expense ceiling.
Along with profit adjustments come strict financial penalties under Decree 125/2020/ND-CP and the Law on Tax Administration:
- Corporate income tax arrears: Businesses must pay additional corporate income tax (20%) on the increased adjusted profit (or the portion of interest expense that was disallowed).
- Administrative penalties: The usual penalty is 20% on the amount of underdeclared tax or the amount of tax exempted, reduced, or refunded in excess of regulations.
- Late payment penalty: Calculated at a rate of 0.031 TP3T/day on the amount of tax overdue. This amount can be very large if the case drags on for many years.
- Penalties for failure to declare GDLK: If not submitted related party transaction appendix In the case of a National or Global Profile violation, the business may be fined from VND 8,000,000 to VND 25,000,000, and its tax liability may be assessed by the tax authorities as per regulations.
Key points to note regarding Decree 132/2020/ND-CP
Besides understanding the principles of controlling interest expense, businesses need to pay special attention to some core points in Decree 132/2020/ND-CP. The following regulations will directly determine whether interest expense is accepted or disallowed during tax settlement.
Regulations for carrying forward interest expense to subsequent periods.
Decree 132/2020/ND-CP allows businesses to carry forward non-deductible interest expense to the next tax period if the following year's EBITDA has a surplus.
- Carry-over period: No more than 5 consecutive years from the year following the year in which the non-deductible interest expense was incurred.
- This is a humane regulation that helps businesses avoid losing all their investment costs if they only experience temporary difficulties with EBITDA in the first few years of investment.
Although Decree 132/2020/ND-CP allows businesses to flexibly carry forward non-deductible interest expenses to subsequent tax periods, this limitation does not apply to all cases. In fact, the law also clearly defines the entities that are exempt from the scope of application.
Those who are exempt
Not all businesses with related-party transactions are subject to these restrictions. The following entities are outside this scope:
- Credit institution (Bank).
- Insurance organization.
- ODA loans, preferential loans from the Government.
- Loans for implementing national target program projects (social security, worker housing).
Understanding the key points in Decree 132/2020/ND-CP not only helps businesses comply with legal regulations but also serves as a foundation for developing effective and practical strategies to optimize interest costs.
Strategies for optimizing interest costs for businesses.
Based on an analysis of factors affecting the control of interest expense, businesses can implement the following solutions:
- Rebalancing capital structure: Instead of excessive debt, businesses should consider increasing their charter capital or seeking strategic investors to reduce the pressure of interest payments.
- EBITDA Planning: Optimize revenue and tightly manage operating costs to maintain high EBITDA levels. Consider adjusting depreciation methods to optimize interest expense limits each year.
- Capitalization of interest expense: For projects involving assets under construction (basic construction, real estate), interest expense incurred during the investment phase should be capitalized into the asset value instead of being included as a financial expense in the period. This helps avoid the 30% EBITDA limitation.
- Review unnecessary related-party transactions: If a related-party transaction generates low value but results in the business being completely constrained by interest expenses, consider terminating those transactions or changing the ownership structure so that it is no longer an related party.
When solutions such as capital structure balancing, EBITDA planning, interest capitalization, and related-party transaction review are implemented synchronously, businesses not only reduce the pressure of controlling interest expenses but also lay the foundation for a sustainable long-term financial strategy.
Conclude
The limitation on interest expense under Decree 132/2020/ND-CP is not merely a technical regulation, but a factor that directly impacts tax obligations and the financial performance of businesses. By correctly understanding the nature of the issue, fully identifying the influencing factors, and proactively developing optimal strategies from capital structure and EBITDA to related-party transactions, businesses can completely control risks and avoid unnecessary tax arrears during the tax settlement period.
Early review and appropriate solutions will help businesses save costs, ensure compliance, and maintain sustainable operations. If your business needs a quick assessment of interest expense risk or the development of an optimal plan in accordance with Decree 132/2020/ND-CP, the expert team at MAN – Master Accountant Network is ready to provide in-depth consultation.
Contact information MAN – Master Accountant Network
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Content production by: Mr. Le Hoang Tuyen – Founder and CEO of MAN – Master Accountant Network, CPA Vietnam with over 30 years of experience in accounting, auditing, and financial consulting.
Editorial Board of MAN – Master Accountant Network