In October 2021, Vietnam joined over 135 countries that are working together to tackle corporate tax avoidance. The major tax reform agreed by these countries is based on two pillars. The first pillar will shift taxing rights on more than $125 billion of profits each year from low tax jurisdictions (where profits are booked) to the countries where they are earned.

Patrick Lenain and Agustin Redonda from the Council on Economic Policies in Switzerland

The second pillar is designed to limit harmful tax competition through the implementation of a minimum effective corporate income tax (CIT) rate of 15 per cent, which will apply to multinational corporations (MNCs) with global sales above €20 billion ($20.3 billion) and profitability above 10 per cent. MNCs that benefit from tax incentives such that their effective tax rate is less than the minimum 15 per cent rate will have to pay the balance to their country of residence.

Hence, once the agreement is implemented globally, setting effective tax rates below the 15 per cent threshold would have little impact on businesses’ location decisions and, at the same time, reduce potential tax revenue collection.

Initiated by the Organisation for Economic Co-operation and Development (OECD), this new tax deal is a milestone for international tax coordination. It will protect countries – both advanced and developing – against the large losses of government revenue linked to tax avoidance and profit shifting, increasingly in the digital sector. The actual implementation of the minimum tax is not expected until 2023, but Vietnam should already prepare for this major reform, just like its neighbours are doing.

Today’s lack of international tax coordination encourages competition. Countries compete against each other to attract foreign investors by offering low tax rates and various tax incentives. Developing countries are particularly exposed, as they need foreign investors to help upgrade their technology, skills, productivity, and trade integration – all essential for their economic development.

Besides developing countries, several OECD member countries also offer particularly low corporate tax rates to attract MNCs, as well as a myriad of tax incentives such as patent boxes and other incentives aiming to boost research and innovation.

As a result of aggressive tax planning and profit shifting, the OECD estimates that $240 billion is lost every year worldwide due to corporate tax avoidance.

Vietnam’s tax laws require companies to pay taxes amounting to 20 per cent of their taxable income. This is very much in line with the international average, and close to tax rates in neighbouring south-east Asian countries. Taxes paid by businesses provide the Vietnamese government with revenue of about 3 per cent of GDP. Yet, whereas Vietnam’s statutory tax rate of 20 per cent is above the recently agreed 15 per cent rate, many MNCs pay significantly less in taxes.

Taking on a global corporate tax rate

Keeping Vietnam attractive

Indeed, Vietnam has a generous regime of tax incentives, which are based on location (industrial zones, difficult socioeconomic areas), incentivised sectors (such as high-tech, agribusiness, energy-saving) and the size of projects.

The incentives generally consist of a tax-free period as well as preferential tax rates. On top of CIT incentives, there are also import duty exemptions and accelerated investment depreciations that can push businesses’ tax liabilities further down.

According to Dr. Dang Ngoc Minh, deputy chief at the General Department of Taxation, preferential rates are offered to major multinationals in Vietnam ranging from 2.75 per cent to 5.95 per cent – considerably below the standard tax rate of 20 per cent as well as the recently agreed tax rate of 15 per cent.

Once the international tax deal is implemented, MNCs that invest in Vietnam may be subject to some form of “top-up tax” in their home jurisdictions: tax authorities in their countries of origin will have the right to claim this additional payment to the extent that the effective rate paid in Vietnam is below 15 per cent. As a result, the attractiveness of lower tax rates and incentives will be significantly diminished because companies will be taxed at a minimum 15 per cent tax rate anyhow, irrespective of where their activity is located.

The technical details, which are still being discussed, will be crucial when it comes to the implementation of the new rules in the different national tax codes and the net impact on different jurisdictions. But it is already clear that Vietnam will need to adapt to the new rules and review the use of tax incentives for investment.

Tax incentives are one of the main policy instruments by governments worldwide to attract investment. Yet, despite their prevalence around the world and their high cost in terms of revenue collection, their usefulness and effectiveness in reaching government objectives remain open questions. This is particularly worrisome for low-income countries where, according to the World Bank, the redundancy ratio of tax incentives for investment can be higher than 90 per cent – in other words, 9 out 10 investment projects would have taken place even if no tax incentive was in place.

Now is a good time for the government in Vietnam to take a closer look at the effectiveness of such incentives for investment. Eliminating ineffective incentives and keeping (or even expanding) those that are good value for money is crucial and several Southeast Asian countries are already doing it.

One of the expected outcomes of the new deal is that tax competition among countries will decline. But attracting foreign investors will remain paramount to countries’ prosperity. It is well established that foreign direct investment (FDI) has many benefits for economic development. Economic researchers have shown the benefits of such spillovers in countries with large MNCs such as Costa Rica. Likewise, the domestic electronic industry in Malaysia was born from a spin-off out of Intel. In Thailand, the suppliers of car parts to the automobile supply chain are owned by domestic investors.

A role to play for tax incentives

Vietnam has rightly set ambitious foreign investment objectives. Reaching goals made in the past few years while limiting the use of tax incentives will require further improvement in the policy framework of investment promotion, as advised by the OECD in recent years.

Investment promotion agencies play key roles to attract FDI, as they are the main contact for foreign investors. Vietnam’s Foreign Investment Agency provides an entry point and coordinates the contacts with various ministries. Its role could be further enhanced by focusing on high-value-added and knowledge-intensive activities, which are essential for the country’s catching-up process.

The agency could also have a greater responsibility in increasing support to poorer provinces in their investment promotion efforts, as foreign investment tends to be concentrated geographically.

In addition, Vietnam could open more sectors to foreign investment, especially services-related ones. Currently, the sector of telecommunications is largely off limit to foreign investors, in contrast to practices in other countries. Furthermore, foreign investors are not authorised to take an equity stake exceeding 40 per cent in many sectors, which artificially limits their potential investment in the country.

As acknowledged by the OECD, the global minimum tax agreement does not seek to eliminate tax competition but puts multilaterally agreed limitations on it. Hence, the new rules will not imply the end of all tax incentives and, up to a certain extent, Vietnam will still be able to rely on them. A comprehensive inventory of these tax incentives would contribute to ensuring that this is money well spent.

There is much scope for progress in decisions on tax incentives. A 2019 review by the Centre for Budget and Governance Accountability concluded that the main concerns regarding tax incentives in Vietnam are “ineffectiveness, redundancy, misuse, attracting footloose companies, not being based on sound economic analysis, and potential for corruption”.

To the best of our knowledge, there are no official figures on the revenue forgone by the government due to tax incentives for investment. Vietnam is one of the 116 non-reporting countries in the Global Tax Expenditures Database – i.e. it has never released an official tax expenditure report during the 1990-present period covered by the database.

In addition to such a report, analysing the effectiveness of the main tax incentives is essential to assess their impact on investment decisions by MNCs. As Vietnam embarks with 135 other countries on far-reaching international coordination to fight tax avoidance and mitigate harmful tax competition, it should seize this unique opportunity to review the use of tax incentives and improve its investment policy framework in order to remain an attractive destination, especially for high-tech MNCs.