BUSINESS OWNERS LEND MONEY TO THEIR OWN BUSINESS – HOW TO DO IT RIGHT?

This is a common situation in owner-operated businesses, but it poses tax risks because the transaction is considered an associated transaction and not at arm's length ^{(1, 2, 3)} .

In essence, the principal loan is not taxable to the individual business owner. However, the absence of interest (0% interest) may result in the imposition of Personal Income Tax (PIT) on the individual lending the loan. Here is a detailed analysis:

1. Personal Income Tax (PIT) risks of individual business owners . Although the contract states an interest rate of 0%, according to regulations on tax management and related transactions, the tax authority may consider re-determining the interest rate according to market prices.

Legal basis:

* Loan interest (income from capital investment) of individuals is subject to personal income tax at a rate of 5% ^( 4) .

* Transactions between business owners (individuals) and businesses are affiliated transactions .

* Lending at 0% interest rate is considered a transaction not at the normal transaction price on the market and is subject to tax assessment (according to the Law on Tax Administration and Decree 126/2020/ND-CP).

Conclusion: * Tax authorities have the right to set reasonable lending interest rates (usually based on the average lending interest rates of commercial banks at the time of borrowing).

* Based on this fixed interest rate, the tax authority will collect 5% personal income tax on the "assumed" interest that the individual should have received.

* Tax payment responsibility: Enterprises must be responsible for deducting (or paying on behalf of) this 5% personal income tax and paying it to the state budget. The individual business owner is responsible for this tax.

2. Impact on Enterprises (Borrowers) : Enterprises may also encounter problems when tax is imposed:

* 0% interest expense: The enterprise will not have any deductible interest expense when calculating Corporate Income Tax (CIT) for this loan, because no actual expenses arise.

* Fixed interest expense: If the tax authority sets an interest rate to collect personal income tax from individuals, the enterprise is not automatically allowed to include the fixed interest in deductible expenses when calculating corporate income tax (because in reality the enterprise does not pay interest).

Advice: To ensure tax compliance , businesses should have a loan contract stating a reasonable market interest rate (should not be 0%) and fully deduct 5% personal income tax before paying interest (or paying on behalf of) the business owner. This interest payment will then be included in the deductible expenses of the business if other conditions are met.

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NOTE:

( 1 ) What is affiliate trading?

Associated transactions are transactions between parties that have an associated relationship with each other , that is, have mutual influence, control or capital contribution .
These transactions can be:

• Buying and selling goods and services between companies in the same group;
• Transfer of assets, intangible assets (such as trademarks, technology rights) ;
• Lending, borrowing internally , or allocating costs and profits among related parties.

Legal basis:
Clause 2, Article 5 of Decree 132/2020/ND-CP dated November 5, 2020 of the Government stipulates:

“ A related party transaction is a transaction arising between related parties in the production and business process, including buying, selling, exchanging, renting, leasing, borrowing, lending, transferring, assigning, providing services, borrowing, lending, paying interest, paying fees...”

( 2 ) What is “non-market price related party transactions”?

Transactions between related parties that are not established at independent market prices , but are adjusted to reduce taxes payable (usually in Vietnam).

Easy to understand example:

• The parent company in Singapore sells raw materials to the subsidiary in Vietnam at a price higher than the market price → causing costs in Vietnam to increase , profits to decrease , => Leading to less corporate income tax paid in Vietnam .
• In contrast, Vietnamese companies sell goods to foreign affiliates at unusually low prices to transfer profits abroad .

This practice is called transfer pricing .

( 3 ) Management principles of tax authorities - According to Article 6 , Decree 132/2020/ND-CP:

“Parties in related-party transactions must comply with the principle of arm's length transactions, that is, the price and terms of the transaction must be similar to those between independent parties under similar conditions.”

If not complied , the tax authority has the right to:

• Adjust prices, costs, and profits to redefine taxable income ;
• Tax collection, late payment penalties ;
• And may be subject to administrative sanctions according to the provisions of the Law on Tax Administration.

(4) According to Circular 111/2013/TT-BTC