Anthony Assassa of VDB Loi in Laos discusses analyses the country's banking sector

Laos has more than 40 banks, evidence of the rapid growth in the banking sector over the past five years. Investment growth has now slowed down. A more stable market has given the Lao Tax Authority the opportunity to begin conducting some post-investment audits, revealing a raft of tax risks banks should address.

A moving market seeking growth

Although there are only five domestic banks, they have managed to maintain a dominant position by limiting their market share loss to about 30%. Foreign banks (36 by our count) have made their mark, but have encountered difficulties in addressing market expansion issues: lack of banking products, a weak demand concentrated on consumer credit, a limited customer base. Financial companies have been careful with regard to expansion, preferring internal growth rather than through M&As. Only half of the companies are considered to be driving competition and market expansion, with an announced yearly growth of 4-5% of outstanding loans.

The regulatory landscape has become progressively more constrained, with a stricter limitation on the margin for fixed-term loans, increased reporting requirements, and mandatory certification of accounts by independent auditors. Meanwhile, the Lao market seems to be offering fewer commercial opportunities other than the now-ended boom in vehicles and consumer goods.

Trends in managing banks

With tax risk recognised worldwide as a priority for banks and their affiliated companies, those operating in Laos have been focusing on securing their guarantees and collateral to reduce their exposure to credit default risk. Indirectly, the hiring of skilled workers with financial or accounting backgrounds, frequent periodic reporting and a sufficiently high level of transparency for external auditors has resulted in better tax reporting.

An observed consequence of this is the low incidence of outsourcing of accounting, payroll and tax compliance work to consulting firms. Banks tend to rely on professional services firms more for quality control or tax review services, allowing them to improve their ratings and risk exposure. Group policy, in particular, is a decisive factor in how banks manage tax in Laos.

Toward more tax audits of banks

Over the previous five years, the Tax Authority did not make financial companies an audit priority, and in fact, took a careful approach when dealing with them. Their view was that they were not their main responsibility, since banks are under the direct supervision of a regulator, the Bank of Lao PDR (the Lao central bank). They have very specific regulations and accounting schemes, certified financial statements and qualified staff capable of reporting, documenting and justifying their tax positions, while there has traditionally been a lack of capacity among tax officials, especially with regard to training on the intricacies of the financial markets.

Additionally, Laos does not have legislation or official precedents on the taxation of banking activities. There aren’t any specific provisions for financial activities in the Tax Law, although the value added tax law (VAT Law) does mention exemptions on loans and deposits. However, banks have expanded the scope of their product and service offerings to well beyond those two traditional products. As a matter of fact, banks’ day-to-day operations now create taxable areas from a corporate income tax, VAT and payroll tax perspective.

The Tax Authority is beginning to recognise this, particularly because of budgetary shortfalls, and its audit approach is now changing. The Tax Authority has begun scrutinizing banks and their activities with the objective of targeting what could potentially uncover tax non-compliance or even fraud. The first audit cases have been successful, though mostly by relying on the basics of the Tax Law rather than focusing on the particular transactions or operations of banks.

New risks identified: our analysis for Laos

The applicability of VAT on banking activities has shifted from a broad exemption regime under VAT Law No. 04/NA dated December 26 2006 for “operations relating to banking services, financial institutions”, to a limited exemption scope under VAT Law No. 52/NA dated July 23 2014 for “deposit interest, loan interest from the transactions of commercial banks or financial institutions authorized by the Bank of Lao PDR”.

In practice, even prior to the issuance of the most recent VAT Law, the Ministry of Finance has been taking a progressively more restrictive interpretation of the exemption scope through its Instruction No. 3111/MOF dated November 27 2009 in favour of six kinds of transactions, themselves restricted in their definitions: (1) granting of credit and guaranteeing of debts resulting from the granting of credit; (2) financial deposits and account operations; (3) exchange of currency and provision of cash; (4) supply of securities; (5) intermediation in financial transactions; and (6) management of investment funds.

The Tax Department recently conducted a series of VAT audits targeting banking and financial services. Assessments were made and penalties levied for FY2015 and year-to-date FY2016.

The VAT audits are focusing on areas such as fees derived from financial leasing investments or transactions, administration services, advisory services, telegraphic transfers, and the issuance of banking instruments.

To date, the Tax Authority has identified three common types of VAT non-compliance: (1) the failure to identify/separate taxable and exempted fees in their operations and accounting; (2) the failure to invoice VAT taxable services; and (3) the failure to declare monthly VAT.

Where an audit has uncovered compliance issues, the Tax Authority has assessed the bank for additional tax payments and penalties. The main penalties are 0.1% of the VAT due for the late submission of VAT and LAK1 million plus 50% of the VAT due for not issuing a VAT invoice.

Most of the banks that have been audited have accepted the assessments and negotiated the penalties. Those who have decided to take the litigation route with the Tax Authority have alleged that the assessments are arbitrary, despite providing a large amount of documentation. Banks are now relying on the Lao central bank to play an intermediary role in mitigating their tax audit risks and defending a favorable tax framework, including incentives, in order to support transaction growth.

Anthony L Assassa

Tax manager