Transfer pricing is the pricing of goods, services and intangibles between related parties, like a parent company and its affiliates.
Apart from tax avoidance, it has also been used to charge unduly high prices for certain goods in markets without intense competition.
Over the years, several big multinational firms operating in Việt Nam have showed losses in their books while doing obviously well in the market.
Soft-drink maker Coca-Cola, for instance, has been accused in the US of avoiding billions of dollars in taxes through transfer pricing adjustments.
Việt Nam has taken a significant step forward in dealing with transfer pricing with Decree 20, which was issued this February and took effect on May 1.
Experts say the decree has brought Vietnamese law more into line with global legal standards.
The decree expands on existing regulations and introduces new concepts under the Organisation for Economic Co-operation Development (OECD)’s guidelines for fighting base erosion and profit shifting (BEPS) tax avoidance strategies.
Nguyễn Thị Lan Anh, deputy head of the General Department of Taxation (GDT)’s inspection division, said at a recent conference that the decree marks significant changes in tax registration and evaluation of related-party transactions in Việt Nam.
These include a three-level tax declaration, new transaction registration forms, and new guidance on derived expenses from related-party transactions.
The operating income margins of tax paying companies or individuals will be compared with that of independent entities through a master file, a local file and a country by country report.
New price evaluation standards for related-party transactions are also introduced by comparison to independent transactions, based on product distinctions or functions and contract clauses.
Earnings appropriation (income retained for a specific purpose that cannot be used for issuing dividends) will be one of the aspects of related transactions that will be dealt with by the decree.
PricewaterhouseCoopers (PwC) Vietnam’s Tax Partner Nguyễn Hương Giang said that Decree 20 was the most important legal procedure on related-party transactions that Việt Nam has initiated in decades.
"This shows that the authorities and companies are becoming more and more committed to building a set of tax policies in accordance with global tax frameworks, in an effort to create transparency and fight tax avoidance.
“The Ministry of Finance is showing great zeal in setting clearer rules that are closer to world standards,” Giang said in a PwC’s press release in March.
The GDT said that it has collected records and precedents from international taxation institutions to construct the legal foundation for Decree 20, and they expect it to facilitate an effective tax monitoring system for associated firms, while minimising calculation and evaluation risks.
Firm hand needed
With the rise of globalisation and dominance of multinational companies, transfer pricing among affiliates that fall under different countries’ jurisdictions has become common practice.
However, it has often been a means for tax avoidance that unfairly exploits lower tax rates in other countries. This has created a need for more effective regulations to deal with this practice.
Vietnamese authorities have been working hard to monitor transfer pricing within foreign companies, chiefly by inspecting books and tax details.
Cao Anh Tuấn, deputy head of the GDT, said at the conference that tax avoidance through transfer pricing is posing a challenge for many countries in the world, and Việt Nam is no exception.
Tougher regulations on related-party transactions are a must for the country to move towards fair competition and a market economy, he added.
Lan Anh said the GDT has conducted price adjustment inspections on 130 firms since 2010, retrieving VNĐ724 billion (US$32.3 million), adjusting loss reduction by VNĐ2.96 trillion ($132.1 million) and increasing taxable income by VNĐ3.43 trillion ($153.1 million).
Decree 20 regulates that total amount of abated borrowing costs (abatement cost is borne by businesses for removing or reducing an undesirable item they have created, like effluents in a factory) must not exceed 20 per cent of the company’s earnings before tax depreciation and amortisation.
This requires the taxpaying company to file a detailed report on earnings and independent transactions, and proving the economic benefits wrought by these transactions.
The new decree also deals with other types of relationship wherein an individual or entity has controlling power over a firm based on capital contributed, or directly manages its operations. It also deals with cases where enterprises are subject to the management and control of operational decisions taken by another enterprise.
Any mother company whose main office is in Việt Nam and whose total international annual profit surpasses VNĐ18 trillion ($803.4 million) must complete a multinational earnings report and submit it to the tax authority in Việt Nam. In many other countries, this figure is 750 million euros ($846.1 million).
In addition, the thresholds for some types of relationship have been revised. For instance, the threshold on directly or indirectly contributed capital ratio increases from 20 per cent to 25 per cent; and that on the debt to equity ratio increases from 20 to 25 per cent if an enterprise guarantees loans or grants them directly to a related company.
Higher audit activity is expected in the coming years as part of the tax administration’s fiscal management initiative to bring down the nation’s budget deficit to a sustainable level, at 3.5 per cent of GDP by 2020, said Resolution 25/2016/QH14.
“Taxpayers must take the initiative to research and evaluate the effects that Decree 20 may have on their operations in order to comply with Vietnamese tax regulations in the near future,” said Giang.
Some experts have pointed out that there a few problems remain when trying to implement international standards in Việt Nam, like a lack of data at local levels.
Furthermore, the decree does not provide detailed instructions on related-party transactions and price adjustments, and its impact on other kinds of tax including value added tax and retention tax.
A report released last year by audit company KPMG in Việt Nam said that multinationals investing in the country as well as Vietnamese corporations investing abroad should be much more prudent about their transfer pricing arrangements and prepare for reforms that will focus on where the economic activities are undertaken and values created.