In 2020, based on the State Audit’s recommendation, the General Department of Taxation issued Circular 1606 instructing that Letter of Credit (L/C) services be considered a form of payment service and therefore not exempt from Value Added Tax (VAT) as prescribed.  Following this circular, the Vietnam Business Forum (VBF), the Banking Association, and numerous credit institutions sent a series of letters of recommendation to relevant ministries/agencies to reconsider the VAT taxation on this service.

Conflict in Legal Interpretation

In 2010, after the issuance of the Law on Credit Institutions in 2010 (which had not yet taken effect), the Ministry of Finance issued Circular 11754 on September 6, 2010, instructing that “revenues from the issuance, confirmation, and notification of letters of credit are non-taxable items subject to Value Added Tax (VAT).” Following this guidance, commercial banks uniformly implemented not charging VAT on revenues related to guarantees within Letter of Credit (L/C) transactions. By 2017, the General Department of Taxation even reaffirmed this guidance through Circular 4520 sent to a major commercial bank.

However, during the period from 2019 to the present, the State Audit, through its auditing activities at state-owned commercial banks, recommended the collection of VAT on L/C activities, arguing that the 2010 Law on Credit Institutions classified L/Cs under the field of “providing payment services through accounts” (Article 15, Clause 4), rather than as “credit provision.” This interpretation by the State Audit suddenly shifted the status of L/C services from being VAT-exempt after a long period. The Ministry of Justice also shares a similar perspective with the State Audit regarding this legal interpretation.

The government should carefully reconsider the issue of VAT taxation on letters of credit and present a clear explanation to the Standing Committee of the National Assembly to achieve uniformity and alignment with practical realities.

Regarding the State Bank of Vietnam (SBV) and commercial banks, based on the inherent nature of the business, these entities have repeatedly affirmed that Letters of Credit (L/C) are dual, meaning they serve both as a credit facility and a payment instrument.

Firstly, the payment aspect of Letters of Credit (L/C) has been specifically regulated by banking laws since 2002 in Decision 226/2002/QD-NHNN dated March 26, 2002, issued by the State Bank of Vietnam (SBV), which clearly stated that domestic and international payment services, including letters of credit, are included. Furthermore, this was codified in Article 15, Clause 4 of the 2010 Law on Credit Institutions. Therefore, it was not until 2011, when the 2010 Law on Credit Institutions took effect, that L/C became recognized as a payment service. This also implies that when Circular 11754 of the Ministry of Finance was issued, it should have been aware of the dual nature of L/C. Thus, the Ministry of Finance cannot claim that Circular 11754 was consistent with the law at the time of issuance and automatically ceased to be effective when the 2010 Law on Credit Institutions took effect on January 1, 2011.

On the other hand, regarding the credit provision aspect, the SBV had consistently managed L/C both before and after 2011 as a form of credit, specifically as a type of guarantee. From Decision 226 (Article 7, Clause 2) to Circular 12/2012/TT-NHNN (Article 6) by the SBV regulating bank guarantees, they all clearly stated that the balance of guarantees includes commitments issued in the form of credit instruments. Subsequently, Circular 22/2019/TT-NHNN clearly defined credit provisions to include commitments issued in the form of letters of credit (L/C). Although the inclusion of L/C under credit provision is only explicitly stated in regulatory documents rather than in the law itself, the 2010 Law on Credit Institutions granted the SBV the authority to approve other forms of credit provision not explicitly mentioned in the law (Article 98, Clause 3). Thus, the legal basis for considering L/C as a form of credit is fully supported.       Furthermore, a letter of credit (L/C) falls under the category of “providing payment services through accounts” only when it occurs at the stage “through accounts,” meaning when the commercial bank executes its payment commitment.  In the initial stage, when the commercial bank is only at the issuance stage and providing a commitment to the seller, there is no actual payment taking place.

Therefore, the argument that L/C is solely a form of payment is based on the premise that the law defines L/C as part of “providing payment services through accounts,” and thus it cannot be considered credit. Conversely, the viewpoint that L/C has a dual nature argues that the law does not define L/C as a form of payment but rather includes it in the category of payment.

From a logical perspective, the writer concurs more with the second viewpoint. This is because if A encompasses X, but X also belongs to B, then X is a shared aspect of both A and B, rather than exclusively belonging to either A or B. Therefore, the concept of “providing payment services through accounts” or “credit provision” in the law does not exclude the possibility that L/C can belong to both categories.

Furthermore, even though the law does not explicitly mention the term “letter of credit,” the 2010 Law on Credit Institutions stipulates the authority to apply international trade practices issued by the International Chamber of Commerce (ICC). Regarding L/C, commercial banks universally apply the Uniform Customs and Practice for Documentary Credits (UCP 600) issued by the ICC. This practice uses the term “Credit” for letters of credit and explicitly defines it as the “irrevocable undertaking of a bank to pay, accept, or negotiate when presented with documents that comply with the terms and conditions.” Thus, the very definition in international trade practices governing civil transactions in the letter of credit transactions already demonstrates the credit nature (payment guarantee) of L/C.

In summary, after a lengthy debate, on August 12, 2023, the Government Office issued Notice 324/TB-VPCP, conveying the direction of Deputy Prime Minister Lê Minh Khái instructing the Ministry of Finance to direct the General Department of Taxation to collect VAT on L/C transactions by the regulations.

Too much fuss about words, without focusing on the essence

On a fundamental level, according to UCP 600 (Uniform Customs and Practice for Documentary Credits), commercial banks follow the procedure for letters of credit (L/C) as follows: (1) the buyer and seller agree to use an L/C for payment; (2) the buyer requests a bank (issuing bank) to issue an L/C with a commitment to pay the seller when the seller presents compliant documents; (3) the issuing bank issues the L/C; (4) the seller delivers the goods and submits the required documents as per the L/C to the issuing bank; (5) the issuing bank examines the documents, and if they are compliant, pays the seller; and  (6) the issuing bank collects the money from the buyer or extends credit to the buyer.

Thus, it can be seen that the payment activity occurs only at step (5).  From steps (1) to (4), the payment amount exists only in the form of the issuing bank’s commitment, and there is no transfer of funds between the parties’ accounts.  Even in cases where the issuing bank requires the buyer to place funds in reserve, the reserved amount remains in the buyer’s account. Therefore, when comparing this to the definition of payment, it is clear that in the initial stages of an L/C transaction, it is not considered a payment.

Conversely, the nature of payment guarantees is evident in steps (1) to (4) mentioned above.

From this analysis, it is evident that L/C has a credit nature at its core in terms of its business operations. Therefore, disregarding its essence and relying solely on wording within the law is not appropriate.

Additionally, if L/C is not considered a form of credit, it would lead to the conclusion that many legal documents issued by the State Bank of Vietnam (SBV) from 2011 to the present are contrary to the law. Furthermore, commercial banks providing services with clear credit risks but not regulated as credit provision could lead to a tendency for banks to bypass credit regulations, credit ceilings, and an increase in systemic risk.

Interpreting the law according to its purpose of issuance

As analyzed above, relying solely on the law’s definition of “providing payment services through accounts,” which includes letters of credit, without recognizing L/C as a form of credit, is not consistent with the nature of the business, contradicts other legal provisions, and contradicts subordinate legislation.

According to Article 158, Clause 1 of the Law on Promulgation of Legal Normative Documents, in cases where there are different interpretations of the law’s provisions during enforcement, the law’s interpretation shall be applied.  Therefore, this situation meets the conditions and is necessary to apply the activity of interpreting the law. The principles of law interpretation are mentioned in Clause 2 of Article 158, which includes (a) being consistent with the spirit, purpose, requirements, and guiding principles of the Constitution, laws, and ordinances; (b) being consistent with the content and language of the Constitution, laws, and ordinances; and (c) not amending, supplementing, or adding new provisions.

Interpreting L/C as having a dual nature aligns with points (b) and (c) mentioned above, as demonstrated in the analysis presented in this article. To handle this situation, it is crucial to pay special attention to applying point (a), especially the principle of being consistent with the law’s purpose. The principle of “consistent with the purpose” is also applied in the interpretation of the law in many countries such as the United States (purpose rule – interpreting in line with the law’s purpose), and France (interpreting based on the function of the provision).

Examining the provisions in Article 15, Clause 4 of the 2010 Law on Credit Institutions, this clause is categorized as a definition of terminology.  The terminology being defined here is “providing payment services through accounts.” Therefore, it is evident that the purpose of this clause is not to define a “letter of credit.” Thus, it cannot be relied upon to conclude that the law defines L/C as a form of payment rather than credit. Placing Article 15 within the overall context of Article 4, which deals with terminology definitions, also shows that this clause is intended to explain terminology, not to classify business activities. Therefore, the provisions in this clause do not exclude a “letter of credit” from the situation where a choice must be made between the two categories.

Both the provisions in Article 14 regarding “credit provision” and those in Article 15 regarding “providing payment services through accounts” are open definitions that list specific types of services but also include other unspecified services as long as they meet the general definition. This definition is designed to ensure consistent treatment of well-established activities while also providing for potential emerging issues, ensuring the stability of the law. Therefore, when a “letter of credit” meets the definition of credit provision (allowing the use of a sum of money subject to reimbursement), it must be considered a form of credit. The fact that the term “letter of credit” is included in payment activities but not in credit provision in the current law does not mean that the law prohibits letters of credit from being considered credit. In practice, credit card services provided by banks also have similar characteristics, serving as both credit provision and payment.

For these reasons, it is strongly recommended that the government carefully reconsider the issue of VAT taxation on letters of credit and provide an explanation to the Standing Committee of the National Assembly to achieve consistency and alignment with practical realities.

Read the original article in Vietnamese at The Saigon Times.