Integrated International Tax – Transfer Pricing

Integrated International Tax – Transfer Pricing

The year 2017 has marked a critical turning point in the course of state of affairs related to transfer pricing in Vietnam. With more than a decade of transfer pricing regulations in effect since 2006 and a visible upcoming tax reform announced by the Government, as delegated to the Ministry of Finance (MOF), to introduce regulatory changes to challenge the Base Erosion Profit Shifting (BEPS) practices, the Government has issued Decree No. 20/2017/ND-CP on the management of transfer pricing (Quy định về quản lý thuế đối với doanh nghiệp có giao dịch liên kết) dated February 24, 2017.

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More than ever, multinationals investing in Vietnam and Vietnamese corporations investing outbound are required to be much more prudent about their transfer pricing arrangements and prepare for the reform that will aim to focus on where the economic activities are undertaken and values created, together with the introduction of compliance requirements of Master File, Local File and Country-by-Country reporting.

The Decree is applicable from 1 May 2017, meaning it will have an effect from the 2017 financial year.

I. Decree on Transfer pricing - What’s new?

1. New reporting and documentation requirements

1.1 Contemporaneous transfer pricing documentation revisited

The contemporaneous documentation requirement now includes the adoption and implementation of the documentation requirements under Organisation for Economic Co-operation and Development (OECD)’s BEPS recommendations under Action 13. It is therefore a lot more precise and stricter in comparison to the previous regulations under Circular 66. Specifically, the transfer pricing  documentation package includes:

  • a Master File containing standardized information relevant for all Multinational Enterprises (MNE) group members;
  • a Local File referring specifically to related party transactions of the local taxpayer; and
  • a Country-by-Country (CbC) Report containing certain information relating to the MNE’s income and taxes paid together with certain indicators of the location of economic activity within the MNE group.

For taxpayers having overseas ultimate parent company, such taxpayers are required to submit a copy of their ultimate parent company’s CbC Report whereit is their ultimate parent company’s obligation to submit such CbC Report to the respective overseas tax authority. Failure to do so, taxpayers are obligated toprovide written explanation letter.

The CbC reporting is applicable for a Vietnamese Group having consolidated global revenue of VND18,000 billion (approximately €750 million) and above in the respective tax period.

The transfer pricing documentation package is required to be in Vietnamese before the taxpayers lodge their annual corporate income tax (CIT) return, and retained and submitted upon request of tax authority. In the event of a specific transfer pricing audit, taxpayers are requested to submit transfer pricing documentation package no longer than 15 working days upon receipt of request from tax authorities.

During the Consultation Procedure prior to the audit, taxpayers are required to submit transfer pricing documentation package to the local tax authorities within no longer than 30 working days upon written request of the tax authority. Where reasonable reason is provided, the submission deadline is extended only once to no longer than additional 15 working days upon the expiry date.

Safe harbor for transfer pricing documentation

Certain thresholds are provided to exempt multinationals from the documentation requirements. Specifically:

  • Threshold of revenue and value of related party transactions (“RPTs”): The taxpayer’s annual revenue does not exceed VND50 billion and the total value of the related-party transactions does not exceed VND30billion;
  • Taxpayer having Advance Pricing Agreement (APA) has submitted annual APA report in accordance with the APA regulations. For those related party transactions which are not covered by the APA, taxpayers are obliged to comply with the aforesaid transfer pricing documentation requirements.
  • Threshold of profit margin for taxpayers who perform routine functions and does not generate revenue orincur expense from exploitation and use of intangibles: the taxpayer’s annual revenue does not exceed VND200billion and the ratio of net operating profit before interest and CIT to net sales revenue (i.e. operating margin) exceeds:
    • 5% for distributors;
    • 10% for manufacturers; and
    • 15% for toll manufacturers.

Taxpayers are entitled to safe harbor for transfer pricing documentation are still required to comply with the mandatory disclosures noted below.

1.2 Mandatory disclosures - Form No. 01

Mandatory disclosure of related party transactions and transfer pricing information including: methods, values, type of transaction, country of residence of related parties, among other information is required within 90 (ninety) days of the end of a financial year. This information is to be filed on a specific Form No. 01 (together with the annual CIT return). The significant change in the New Form No. 01 is the requirement on voluntary transfer pricing adjustment regarding the operating results of taxpayers, with three (3) forms for (i) taxpayers in manufacturing, trading and servicessectors; (ii) taxpayers in banking sector; and (iii) taxpayers being securities companies, fund management companies for securities investment.

Taxpayers that only carry out transactions with Vietnamese (domestic) related parties are exempted from filing the disclosure of Section III (information on the determination oftransfer prices for RPTs) and Section IV (business result after determining the transfer prices in related party transactions) of Form No. 01 where both entities are subject to the same CIT rate and none of the entities receive any CIT incentivesin the relevant tax period. However those taxpayers arerequired to declare the basis for exemption in Section I (information on related parties) and Section II (cases that areentitled to exemption of the disclosure obligation, provision of transfer pricing documentation) of Form No. 01.

2. New principles and rules

A number of new principles and rules are introduced and enhanced including

  • the “substance over form principle”, whereby the transfer pricing analysis can be beyond the review of contractual arrangements to an analysis of the substance linked to value creation. It is expected that tax authorities may consider contractual arrangements before reviewing the actual transactions based onbusiness facts and substance, in order to reduce the burden of proof for taxpayers
  • measures for the comparability of RPTs against independent transactions (the arm’s lengthrequirement); and
  • consideration of development, enhancement, maintenance, protection and exploitation (DEMPE) functions with respect to intangibles.

The application of the above principles will enable the tax authorities to disregard or re-characterize related-party transactions in instances when those transactions result in reduced tax revenue.

2.1 Revised related party relationship definitions

Under New Decree, related party relationship in cases of input and output control (i.e. an enterprise sells more than 50% of its total sales, or provides more than 50% of the raw materials or input products) is eliminated.

In addition, the thresholds for some types of relationship are revised. For instance, the threshold on direct or indirect contributed capital ratio increases from 20% to 25%; the threshold on debt to equity ratio in case of an enterprise guarantees or gives to the other enterprises loans increases from 20% to 25%.

The new decree also provides additional types of relationship in relation to other cases where (i) an individual who has controlling power based on the contributed capital to the other enterprises, or directly manage the operation of the enterprises; or (ii) enterprises are subject to management and control upon actual decision to the other enterprises’ operation.

2.2 Additional and new guidance for tax deduction of related party transactions which are not in line with nature of independent transactions, inter group services fees and inter-company loan interest expenses

These type of intercompany transactions are widely recognized as profit-shifting tools used in complex international tax planning. Similarly, an increased level ofreview is expected for local companies performing royalty payments related to the use of intangibles which may not be appropriate related to intermediate or semi-finished goods. In the absence of proper documentation, these transactions may be considered as harmful tax practices by the local tax authorities in Vietnam.

Related party transactions not in line with nature of independent transactions

Related-party transactions that are in consistent with the arm’s length principle or do not contribute to generating revenues, added value to the production and business activities of the taxpayer shall be considered as non deductible expenses, including:

  • Expenses paid to the related party that does not conduct any business activities relating to the taxpayer’s business activities;
  • Expenses paid to the related party that conducts business activities, however its scale of assets, number of employees and functions performed are not corresponding with the value of business transactions and the income such related party receives from the taxpayer.
  • Expenses paid to related parties who do not have right to and responsibility for the assets, goods and services provided to taxpayer; and
  • Expenses paid to related parties which are residents of a country or juridiction that does not collect corporate income tax, and do not contribute to generating revenue, added values to taxpayer’s business activities.

Provision of services between related parties

Service expenses are considered as deductible expenses if they satisfy the following conditions:

  • the provided services have economic, financial and commercial value and directly benefit taxpayer’s production or business activities;
  • intra-group services are determined as already rendered only under similar conditions where independent parties are willing to pay for such services;
  • the service fee is calculated based on the arm’s length principle and the transfer pricing methods must be applied consistently within the group for the similar services and sufficient supporting documents should be available to support its position. (e.g. contracts, supporting documents, invoices and information of calculation methods, factors to determine allocation ratio and pricing policy of the group for the provided intra-group service).

The Decree also provides cases where services expenses are considered as non-deductible, for example expenses incurred from services which are only used for the purposeof generating benefits and values to other related parties; services which benefit related parties’ shareholders; duplicative services, etc.

Loans between related parties

Total interest expenses incurred in the tax period, which are deductible should not exceed 20% of taxpayer’s net profit before interest, taxes, depreciation and amortization (EBITDA).

2.3 The hierarchy of comparables used for benchmarking purposes

The priority order in selection of comparables is provided for under the Decree, with requirements on the analysison quantitative and qualitative comparability and material differences when selecting foreign comparable in other geographic regions. Specifically, the priority order is stipulated as follows:

  • internal comparables of the taxpayers;
  • comparables located in the same country, territory of the taxpayers; and
  • comparables located in the region which have similar industry condition and economic development level.

2.4 Clarifications on use of secret comparables versus commercial databases and public information/data

It is understood from the drafting process that the use of secret comparables is considered for tax risk assessments by the Tax Authority only, with the consideration for the use of commercial databases and public information to prevail incase of a proposed tax assessment during a transfer pricing audit. However, the current text of the Decree is not crystal clear, saying that the Tax Authority may use different sources of information, including commercial databases and publicly available data, including their own database and information provided by some ministerial bodies for the purposes of transfer pricing risk assessment and tax adjustment.

However, in some transfer pricing audit cases, where taxpayers fail to submit the forms or the transfer pricing documentation within the statutory timeline, the tax authorities will have absolute power to assess the price and/or profits of the taxpayers based on their secret comparables.

Per KPMG’s experiences in recent transfer pricing audits, taxpayers’ benchmarking analyses were accepted provided that they are robust and proven.

2.5 Clearer bases for the tax authorities to make transfer pricing assessment

The Tax authorities will have clearer bases for imposing price; profit margin; profit split ratio or imposing taxable income or tax amount in the following cases:

  • Taxpayer does not declare, does not declare sufficiently or does not submit Form No. 01;
  • Taxpayer does not provide sufficient information on Transfer pricing documentation in accordance with Form No. 02 (i.e. Local File) and Form No. 03 (i.e. Master File) or does not present transfer pricing documentation and data, document and source documents used as the basic of comparative analysis, determination of transfer price of related-party transaction in transfer pricing documentation at request of tax authorities within the permitted period of time;
  • Taxpayer uses dishonest and untruthful information of the independent transactions to perform comparability analysis and determine the transfer prices of related party transaction or taxpayer determines the price, the basis of profit ratio or profit split ratio applied in the related-party transactions on the basis of documents, data and source documents which are illegal or improper or originate from an unclear source;
  • Taxpayer who violates the regulations under article 11 of the Decree.

Companies are strongly recommended to pay special attention to the cases of arbitrary assessments that the tax authorities have ability to make under laws to avoid inadvertent consequences which are sometimes heavy interms of the amounts of tax reassessed or imposed and related penalties and late tax payment interest.

II. Important administrative issues

1. Transfer pricing audits
The Tax Authority has deployed relevant efforts and resources to enforce and manage the compliance of transfer pricing regulations at both central and provincial levels, with specialized transfer pricing audit teams.

During 2016, tax audits were conducted on 84,472 companies, with the additional tax amount of VND17.164 trillion. Specifically, 329 transfer audit cases were conducted, with the recollected tax amount and penalties of VND607.52 billion, loss reduction of VND5,612.21 billion.

Higher audit activity is expected for the upcoming years as part of the tax administration’s fiscal management program to bring down Budget deficit to a sustainable level (3.5% of GDP by 2020 under the national finance plan resolved by the National Assembly in accordance with Resolution No. 25/2016/QH14).

2. Advance Pricing Agreement (APA)
APAs are available in unilateral, bilateral or multilateral forms under Circular 201/2013/TT-BTC dated 20 December 2013 of the Ministry of Finance. There are now over ten (10) APA under different stages of the process, including pre-filing, evaluation, negotiation.

KPMG assisted a client to have concluded Vietnam’s first APA.

3. Transfer pricing administrative appeals, judicial procedures and Mutual Agreement Procedures (MAPs)
Technically all of these alternative dispute resolution options are available under Vietnam’s laws and Double Tax Treaties in effect. In practice, the appellation process is often lengthy with mixed results, judicial process unpopular and MAPs not very productive.

The common effective options are to be compliant and defensive in an audit that requires taxpayers to be responsive to and cooperative with the tax authorities.

4. Transfer pricing tax reassessment
Non-arm’s length transfer pricing and failure to report transactions or provide transfer pricing documentation are subject to the tax authorities’ reassessment of transfer prices or profits for corporate income tax purposes under laws and practice.

5. Penalties
Penalties are in accordance with the Law on Tax Administration, under payment penalties are from 10 or 20 percent of the shortfall amount depending on different tax periods, associated with late payment interest charges (0.05 to 0.07 percent per day on overdue (0.03 percent per day from 01 July 2016) or evasion penalties (from one to three times the tax liability amount) apply, depending on the nature of the offences and circumstances.

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