Determining Foreign Contractor Tax Obligations For Demurrage Charges Paid To An Overseas Carrier

Background

Nghi Son 2 Power Limited Liability Company (NS2PC) signed a contract for imported coal transportation with a foreign carrier, Oldendorff Carriers GmbH & Co.KG (Germany). During the execution of the contract, a penalty was incurred for delayed cargo unloading (demurrage), which was paid to the foreign shipping line because the vessel was required to stay at the port longer than scheduled.

Problem Statement

NS2PC sent official letter No. NS2PC-THTD dated December 23, 2024, to the Thanh Hoa Provincial Tax Department to clarify the foreign contractor tax policy. Specifically, the question was: Is the penalty/compensation paid to Oldendorff subject to Foreign Contractor Tax (FCT)? If so, how should the tax be determined and declared?

Response From The Tax Authority

On February 18, 2025, the Thanh Hoa Provincial Tax Department responded via Official Letter No. 966/CT-TTHT.

1. Legal Basis Provided

• Clause 25, Article 3 of the Law on Tax Administration No. 38/2019/QH14, dated 2019, which stipulates the principle that the substance of an activity or transaction determines the tax obligation.
• Circular No. 103/2014/TT-BTC, dated August 6, 2014, from the Ministry of Finance, guiding the tax obligations for foreign organizations and individuals doing business in Vietnam or having income sourced from Vietnam:
• Clause 1, Article 1 specifies the scope of application: “Foreign organizations with or without a permanent establishment in Vietnam; foreign individuals who are residents or non-residents in Vietnam (hereinafter collectively referred to as Foreign Contractors, Foreign Sub-contractors) doing business in Vietnam or having income generated in Vietnam based on a contract, agreement, or commitment between the Foreign Contractor and a Vietnamese organization or individual, or between a Foreign Contractor and a Foreign Sub-contractor to perform part of the work of a main contract.”
• Article 7 regulates CIT (Corporate Income Tax) taxable income: “1. The CIT taxable income of a Foreign Contractor or Foreign Sub-contractor is the income arising from the activity of supplying or distributing goods; providing services, or services attached to goods in Vietnam on the basis of a contractor or sub-contractor contract (except for cases specified in Article 2, Chapter I). … 3. Income generated in Vietnam for a Foreign Contractor or Foreign Sub-contractor is any income received in any form on the basis of a contractor or sub-contractor contract (except for cases specified in Article 2, Chapter I), regardless of the location where the business activities of the Foreign Contractor or Foreign Sub-contractor are conducted. The taxable income of a Foreign Contractor or Foreign Sub-contractor in some specific cases is as follows:
• Penalties or compensation received from the contracting party for a breach of contract.”
• Article 11 regulates the subjects and conditions for application: “If a Foreign Contractor or Foreign Sub-contractor fails to meet one of the conditions stated in Article 8, Section 2, Chapter II, the Vietnamese Party shall pay tax on behalf of the Foreign Contractor or Foreign Sub-contractor in accordance with the guidance in Article 12 and Article 13, Section 3, Chapter II.”
• Article 13, Section 3, Chapter II provides guidance on CIT for cases where the Foreign Contractor or Foreign Sub-contractor pays tax using the direct method.
• Article 13 provides guidance on Corporate Income Tax

2. The CIT rate (%) calculated on taxable revenue

a) The CIT rate (%) on taxable revenue for business sectors:

3. Corporate income tax (cit) on compensation received from a partner for breach of contract, when the compensation exceeds the value of damages and is subject to taxable income:

For income from compensation for damages received, the foreign contractor may choose to declare and pay Corporate Income Tax (CIT) at a percentage rate on taxable revenue or based on declared revenue and expenses at the standard tax rate.

Per Clause 1, Article 5 of Circular No. 219/2013/TT-BTC, stipulating cases not subject to Value Added Tax (VAT) declaration and payment:

4. Tax Authority’s Opinion

Based on the above regulations and the Company’s description in the inquiry, in the case where Nghi Son 2 Power Company Limited (NS2PC) signed an imported coal transportation contract with the foreign coal carrier, Oldendorff Carriers GmbH & Co.KG (hereinafter referred to as Oldendorff).

The penalty or compensation for delayed cargo unloading is considered income arising in Vietnam for the foreign contractor.

This income is subject to Foreign Contractor Tax (FCT) at a rate of 2% on taxable revenue (applicable to international transportation activities).

This amount is not subject to VAT declaration and calculation.

As Oldendorff does not meet the conditions for self-declaration and payment of taxes in Vietnam, NS2PC will be responsible for paying the Foreign Contractor Tax (FCT) on Oldendorff’s behalf.

5. Conclusion

NS2PC is instructed to declare and pay Foreign Contractor Tax (FCT) at a rate of 2% on the penalty/compensation amount paid to the foreign carrier. Concurrently, this amount does not require VAT declaration or calculation.

Lessons Learned

• Non-core contract expenses (such as penalties, compensation, etc.) paid to foreign contractors may also be considered Foreign Contractor Tax (FCT) taxable income.
• Vietnamese businesses need to proactively check contract conditions and the foreign partner’s ability to self-declare taxes to ensure timely payment on their behalf, avoiding risks of retrospective collection or penalties.
• Consulting with the local tax authority is necessary when atypical payments arise.
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