U.S.-Vietnam Tax Treaty: Status and Key Provisions

An international tax treaty is a formal agreement between two countries that allocates taxing rights to prevent the double taxation of income. These agreements also combat tax evasion through cooperation and encourage cross-border trade by reducing tax barriers. The United States and Vietnam signed such an agreement to establish clear rules for individuals and businesses on the taxation of their cross-border income.

While the agreement was signed in 2015 and ratified by Vietnam in 2017, it has not been ratified by the United States and is not in effect. Changes to U.S. tax law required renegotiation of certain parts of the agreement. Until the ratification process is complete, the treaty’s provisions do not apply, and taxpayers must use the domestic tax laws of each country.

Current Status and Tax Implications Without a Treaty

The U.S.-Vietnam tax treaty is not in force because it has not been ratified by the United States. As a result, the tax relationship is governed by each country’s domestic laws, creating a risk of double taxation for individuals and businesses. The United States is Vietnam’s only major trading partner without an active tax treaty.

U.S. citizens and resident aliens are taxed on their worldwide income, regardless of where it is earned. Any income from Vietnam must be reported on a U.S. tax return, while Vietnam imposes its own taxes on income generated within its borders. For instance, non-residents in Vietnam face a flat 20% tax on employment income, while residents are taxed on a progressive scale from 5% to 35%.

To mitigate double taxation, U.S. taxpayers can use the Foreign Tax Credit (FTC). The FTC provides a dollar-for-dollar reduction of U.S. income tax liability for income taxes paid to a foreign country. Taxpayers must file Form 1116 to calculate and claim this credit, which is limited to the amount of U.S. tax that would have been paid on that foreign-source income.

An alternative is to take foreign income taxes as an itemized deduction. This option is less advantageous for most taxpayers because a deduction reduces total taxable income, whereas a credit directly reduces tax liability. The choice between the credit and the deduction is made annually.

Defining Residency for Treaty Purposes

The proposed U.S.-Vietnam tax treaty contains specific rules in its Article 4 to determine who qualifies as a “resident of a Contracting State,” as only residents can claim treaty benefits. An individual or a company is considered a resident of a state if, under that state’s domestic laws, they are liable to tax there based on factors like domicile, residence, place of management, or place of incorporation.

It is possible for an individual to be considered a resident of both countries simultaneously under their respective laws. To resolve this dual-residency conflict, the agreement establishes a sequence of tie-breaker tests to assign a single state of residence for treaty purposes.

• The permanent home test, where residence is assigned to the country where the individual has a permanent home available to them.
• The center of vital interests test, which examines where the individual’s personal and economic ties are closer, considering family and business activities.
• The habitual abode test, which looks at where the individual more frequently lives.
• The nationality test, where residence is assigned based on citizenship if the individual is a national of only one of the countries.

If none of these tests resolve the issue, the competent authorities of the U.S. and Vietnam must settle the question by mutual agreement.

Key Provisions for Business and Investment Income

A central concept in the proposed treaty for businesses is the “Permanent Establishment,” or PE. A PE is a fixed place of business through which an enterprise of one country carries on its business in the other, and includes a branch, office, factory, or workshop. The treaty also sets a time-based threshold, where a building site or construction project constitutes a PE only if it lasts for more than six months.

The “Business Profits” article works with the PE definition, stipulating that the profits of an enterprise from one country can only be taxed by the other country if the enterprise maintains a PE there. Furthermore, only the profits that are directly attributable to that PE can be taxed. The treaty also proposes to reduce withholding taxes on certain types of investment income that flow between the two countries.

Dividends

Under the proposed treaty, the withholding tax on dividends is capped. The rate is limited to 5% of the gross amount of the dividends if the beneficial owner is a company that owns at least 25% of the voting stock of the company paying the dividend. For all other cases, the withholding tax rate is capped at 15%.

Interest

For interest income, the proposed treaty limits the withholding tax to 10% of the gross amount. The treaty also provides for certain exemptions, such as for interest paid to the government of the other state or to a financial institution owned by that government, like the U.S. Export-Import Bank.

Royalties

The treaty sets different withholding tax rate caps for royalties depending on the type of intellectual property. For payments received for the use of industrial, commercial, or scientific equipment, the rate is limited to 5% of the gross amount. For all other types of royalties, such as for patents, trademarks, or copyrights, the rate is capped at 10%.

Taxation of Income for Individuals

The proposed treaty sets out specific rules for the taxation of income earned by individuals. For “Income from Employment,” the general rule is that salary and wages are taxed in the country where the employment is actually exercised. This means if a U.S. resident works in Vietnam, Vietnam generally has the primary right to tax that income.

An exception to this rule is the “183-day rule.” Under this provision, a resident of one state will be exempt from tax in the other state on their employment income if three conditions are met. The employee must be present in the host country for a period not exceeding 183 days in any twelve-month period; the remuneration must be paid by an employer who is not a resident of the host country; and the remuneration must not be borne by a permanent establishment which the employer has in the host country.

For “Income from Self-Employment,” which applies to professionals like physicians and consultants, income is taxable in the other country only if the individual has a “fixed base” regularly available to them there. If a fixed base exists, only the income attributable to that fixed base can be taxed by the host country.

The treaty also addresses specific income types. Pensions and other similar remuneration paid for past employment are taxable only in the individual’s country of residence. Payments received by a student or business trainee who is present in a host country solely for education or training are exempt from tax in that host country, provided the payments for their maintenance or education arise from outside that country.

Core Mechanisms for Treaty Operation

The treaty includes several core operational articles. The “Relief from Double Taxation” article formally obligates each country to alleviate double taxation. For the United States, this article reinforces the foreign tax credit mechanism. It requires the U.S. to allow its citizens and residents to credit the income taxes they have paid to Vietnam against their U.S. income tax liability, subject to the provisions and limitations of U.S. law.

A “Saving Clause” is a standard provision that allows the United States to retain its right to tax its citizens and certain former citizens as if the treaty did not exist. The purpose is to ensure that a U.S. citizen cannot use the treaty to reduce U.S. tax liability on their worldwide income. However, the saving clause has specific exceptions, meaning certain treaty benefits, such as those related to pensions or dispute resolution, are preserved for citizens.

The treaty also includes a “Limitation on Benefits” (LOB) article. This is an anti-abuse rule designed to prevent “treaty shopping,” which occurs when a resident of a third country structures investments through a company in one of the treaty countries to gain access to its reduced tax rates. The LOB article sets forth a series of objective tests that an entity must meet to prove it has a sufficient connection to its country of residence and is therefore eligible for treaty benefits.