Strong reforms in tax incentives needed

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Nguyen Viet Anh (photo), World Bank Senior Tax Specialist

Vietnam has offered many preferential corporate income tax (CIT) policies to attract investment and promote economic growth. How do you evaluate these policies?

Vietnam has a diversified system of tax incentives, which are regulated in many different legal documents. The common point of the majority of these tax incentives is profit-based incentives such as CIT exemptions and reductions, import tax exemption for equipment, and personal income tax incentives. Besides, there are other financial incentives such as land rent exemption and reduction, application of special land lease period, support for job training and recruitment.

International experience in CIT exemption in most developing countries shows that this incentive is very ineffective. This is because CIT exemption does not aim for investment spending and therefore the actual amount of the tax relief may not be commensurate with the investment amount. Companies can benefit even if they don't invest. In addition, CIT exemptions and reductions also facilitate tax avoidance, such as transfer pricing between investment projects with tax rate differences.

Motivated by applicable tax incentive policies, the Effective Average Tax Rate (EATR) for firms eligible for enjoying the highest tax incentives is much lower than the nominal corporate income tax rate of 20%. The following chart shows that, after applying tax incentives, Vietnam’s EATR is just lower than Singapore, which is considered a tax paradise in the region and much lower than other economies in the region such as Thailand, Cambodia, China and Indonesia.

Notably, the tax-to-GDP ratio from 2010 shows a decreasing trend (from 22.4% in 2010 to 18.4% in 2019). But value added tax, special consumption tax and personal income tax has tended to rise slightly while import-export tax and corporate income tax has tended to fall.

The decrease in import-export tax has resulted in the implementation of commitments on tariff cuts. Meanwhile, the CIT reduction has only come from the reduction of this tax for many years (from 25% in 2008 to 20% in 2016).

However, comparing these two tax rates in 2008 and 2016, the nominal tax rate was only down by 20% (from 25% to 20%), the CIT revenue-to- GDP ratio dropped to 35% (from 6.9% of GDP in 2010 to 4.5% of GDP in 2019). This requires a review of the irrationalities or loopholes in policies on tax incentives as well as tax administration to combat tax base erosion. Lessons from countries in the region such as Cambodia, Laos, Indonesia and the Philippines show if investment incentives cannot be changed, though we attract investment and GDP growth remains at a high level, the budget willnot grow proportionally and as a result, it cannot meet spending needs, especially investment and development spending.

The FDI sector is enjoying a lot of tax incentives, do you think those policies are the driving force to attract investment?

Many international studies show investment incentives are rarely the top reasons when multinational corporations consider investing in a country. Conditions like political stability, institutions, size of the domestic market, human resources, and quality of infrastructure are more important factors. Investors only consider investment incentives in the final stage, when comparing potential investment destinations.

Vietnam's CIT rates are among the lowest in Southeast Asia.

Given that corporate income tax lowered to 20% from 2016, this is a very competitive tax rate in the region. Vietnam's CIT rate is lower than the average rate of the global; Asia's as well as ASEAN-5's (including Indonesia, Malaysia, the Philippines, Thailand and Vietnam).

Thus, the low CIT rate itself is a great incentive for all investors. If we do not understand driving forces for investors and expand scattered investment incentives, it will be wasteful because one of the effects of incentives is to reduce budget revenues.

To continue to attract investment, which fields should tax incentives focus on? How can tax incentive rates ensure both incentives for enterprises and fairness and transparency?

If Vietnam wants to attract new-generation investors, and more closely align tax incentives with investment efficiency, strong reforms in developing tax incentive policies are needed. The first priority is to gradually reduce and eventually eliminate corporate income tax exemptions and reductions, and instead, to introduce methods of cost-based tax incentives, like accelerated depreciation method, increase the discount rate upon calculating taxable income of the enterprise.

Accordingly, tax incentives/subsidies will be determined as the percentage of investment cost in research or development or training or other areas. This is likely to be a discounted spending higher than the actual investment and development expenses by the firm when calculating income tax. Therefore, the tax reduction is calculated annually, when the final settlement and full and clear statement of the annual expenses are provided.

The development of cost-based investment incentives will also contribute to helping state management. Specifically,tax incentives will be calculated directly on the annual CIT declaration. Thereby, the tax authority will have information to check the contents such as investment value, the actual number of jobs and prevent tax fraud tricks though former investment incentives.

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In addition, the State management agency also collects data to analyse the benefits/costs of tax incentives, because these incentives are associated with each actual investment item. Thus, it is possible to ensure economic efficiency of State investment through tax incentives.