Service Contracts are a mechanism commonly used by Vietnamese entities to formalise and document arrangements with individuals, without the need to enter into formal employment agreements.
However, caution needs to be applied when contemplating Service Contracts, as there are implications and tax consequences that Vietnamese entities should carefully consider before proceeding.
Client Alert, October 2018 - Service Contracts in Vietnam, Risks & Concerns
KEY ISSUES WHEN USING SERVICE CONTRACTS
1. Can Service Contracts Be Deemed Employment Contracts?
Labour Laws cover Employment Contracts, whereas the Civil Code and Commercial Laws cover Service Contracts, however the definitions between these are arguably not distinguishably different. Both are agreements between a entity and an individual, where the entity pays the individual for their actions.
The Tax Authorities have previously released Official Letters (for example, Official Letter 1019/ TCT-TNCN, dated 25 March 2015, issued by the General Department of Taxation) stating that income received from contracts signed by individuals that have not registered their own business, will be regarded as salary income.
Notwithstanding the above, many rely on the fact that where the Vietnamese entity withholds the requisite taxes (10% for a tax resident individual, and 20% for a non-tax resident), then the contracts are fully effective. However, the courts may not see it this way and may deem the relationship otherwise - as the Tax Authorities have in their Official Letters.
Should it be determined that the Service Contract is ineffective, and the relationship is in fact one of employer and employee, there are quite a number of implications arising - including employment rights and the application of labour laws to what was intended to be a purely commercial matter.
2. Business Travel Expenses Subject To Personal Income Taxes
Vietnam Tax Authorities have recently reiterated in Official Letter 37313/CT-TTHT issued 4 June 2018 by the Hanoi Tax Department, that where individuals have a Service Contract with a Vietnamese entity, any travel costs paid by that entity (whether work or personal) will be subject to additional Personal Income Tax as a benefit to the individual.
This arises where the entity cannot satisfy the deductibility requirements for business travel expenses (which have a nexus with “employees” – ie, having an employment agreement) as stated in Circular 111/TT-BTC.
3. Foreign Individuals and Service Contracts
Labour Laws require all foreign individuals to have Work Permits before undertaking any employment activities in Vietnam, unless they are covered by an exemption category. One exemption widely used is for foreign individuals “entering Vietnam for a duration of less than 3 months to offer services” (Article 172, Labour Code 2012) being exempt from a Work Permit. Many companies (potentially incorrectly) treat this as an opportunity to use Service Contracts for foreigners for 90 days to avoid the need for Work Permits, and are often entering into consecutive contracts, each of 90 days.
The exemption in Article 172 is quite narrow, and is certainly not intended to allow foreign individuals to avoid the need for a Work Permit and be employed (“offering services” is quite different to “employment”), so companies that use this are exposing themselves to risk upon inspection, as are the individuals agreeing to the Service Contracts.
4. Tax Obligations For Individuals
The taxation obligations for Service Contracts are that individuals are to have 10% Personal Income Tax withheld as a pre-payment for their annual obligations (non-tax resident individuals have 20% deducted as a full and final tax).
It is often disputed who is responsible for the tax; is it to be withheld from the payment, or paid in addition to the negotiated fee? Both parties need to make it clear in the contract who is responsible for the tax portion, so that tax can be applied correctly.
Additional tax confusions arise for the individuals, as the 10% withheld is not a full and final tax, but instead it is a pre-payment and held as a credit by the Tax Authorities against the individuals’ annual tax obligation at the end of the financial year. Depending on the total income derived during the year, the actual tax due on the income from the Service Contract can be considerably higher than the 10% withheld and remitted by the contracting entity. Individuals will need to finalise their taxes and pay the difference within 90 days from the end of the financial year to remain tax compliant in Vietnam.
5. Insurances And Lack of Employee Protections
The benefits of employment contracts for individuals include the statutory protections under labour laws, but also include the calculation and remittance of compulsory insurances. These insurances include Social Insurances (which apply for any employment contract exceeding 1 month), Health Insurance and Unemployment Insurance (for employment contracts exceeding 3 months). Note that foreign employees are only subject to Social Insurances where they hold a Work Permit or similar, and are not subject to Unemployment Insurance.
As Social Insurance covers matters like sick leave, retirement contributions, maternity leave and accident insurance, the absence of these potentially important personal protections within Service Contracts can have a long term impact on individuals, versus what they would receive as an employee. This is on top of employment benefits, such as annual leave provisions and paid public holidays, that are also commonly absent from Service Contracts.
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We encourage Vietnamese entities to carefully consider their approach to using Service Contracts in Vietnam, and to understand the limitations and potential implications when they enter into these with individuals, both Vietnamese nationals and foreign individuals.
For further information contact:
Matthew Lourey, Managing Partner
Phan Thi Thu Thuy, Senior Manager - Accounting
Do Thi Thao, Manager - Accounting