Most commonly identified violations in transfer pricing practices
The typical operational model of Foreign Direct Investment (FDI) enterprises in Vietnam currently relies heavily on inputs provided by parent companies, such as technology licenses and technical services. The parent company also supplies the majority, or even 100%, of the primary raw materials needed for production. The subsidiary purchases a small portion of raw materials, auxiliary materials, or packaging from independent suppliers in Vietnam.
On the output side, the subsidiary sells most, or 100%, of its finished products to affiliated companies abroad for further production and distribution in the market.
Due to operations in multiple countries, businesses utilize transfer pricing (defined as the prices in business transactions such as buying, selling, leasing, and transferring goods, services, and assets between affiliated parties) as a tool to allocate income among companies within the same group. This allows them to shift internal group transactions by transferring revenue and costs to countries with more favorable tax rates, referencing the transfer pricing regulations of each respective country.
Based on years of consulting experience in the tax field, the author identifies several typical manifestations of transfer pricing violations, including:
Firstly, reporting losses while simultaneously expanding business operations and continuously increasing investment capital in Vietnam. Secondly, reporting losses after tax incentives expire.
Thirdly, parent companies selling assets to subsidiaries at prices above market value to increase profits abroad and raise depreciation costs in Vietnam. Next is FDI companies recording service costs such as royalties, management fees, and consulting fees to affiliated parties, without actual transactions or evidence that these services support the company's operations in Vietnam.
Last but not least, maintaining low profit levels and paying minimal taxes to avoid attracting the attention of tax authorities.
The challenge for state management agencies in these cases is to eliminate factors influenced by affiliated relationships to determine transfer prices equivalent to market prices. Some measures commonly applied by tax authorities include setting profit margins based on independent transaction value ranges to reduce losses and increase taxable income for businesses; adjusting the purchase price of assets, leading to reduced depreciation value of fixed assets; or completely or partially excluding service costs from reasonable and valid expenses when calculating corporate income tax.
Challenges in implementing current regulations
To safeguard state interests and combat tax revenue loss, Vietnamese authorities have issued numerous regulations related to transfer pricing. The tax authorities have also had to invest significant resources in terms of time and personnel to combat transfer pricing. According to a report from the Ministry of Finance, in 2022, tax authorities conducted 1,380 tax inspections at companies with affiliated transactions, recovering nearly 914 billion VND, reducing losses by nearly 18.1 trillion VND, and increasing taxable income by over 3.7 trillion VND. In 2023, although the number of inspections decreased to 1,250, the increase in taxable income rose to over 5.43 trillion VND.
However, during the implementation of policies, many prolonged disputes have arisen, negatively affecting the investment environment. For instance, disagreements between a company and the tax authority regarding the application of the comparable uncontrolled price method for determining transfer prices. In other cases, differing expectations regarding the application of specific prices within the independent transaction value range have emerged. In some instances, the application of Decree 132/2020/ND-CP on transfer pricing has also been inconsistent, leading to complaints and wasting time and resources. The necessity for numerous inspections and the lengthy inspection process have also impacted companies' production and business plans, reducing Vietnam's investment attractiveness.
APA as a solution
So, what is the solution to both prevent violations of transfer pricing and create more favorable conditions for businesses? Currently, several countries in the region are implementing APAs, a practice that has shown significant benefits. An APA is a written agreement between the tax authority and the taxpayer, or between the tax authority and the taxpayer and the tax authorities of countries or territories with which Vietnam has signed Double Taxation Avoidance Agreements, aimed at preventing tax evasion for a specified period. It specifically defines the tax bases, methods for determining taxable prices, or market-based taxable prices.
This method has notable advantages, including reducing uncertainty and tax risks, helping businesses predict their future tax obligations, and minimizing risks of audits and subsequent tax adjustments. When an APA is issued to a business, they are exempt from preparing transfer pricing documentation, leading to reduced administrative procedure times and compliance costs.
Secondly, APAs are often conducted between the tax authorities of two or more countries, helping to avoid double taxation on the same income of a business. Additionally, APAs help minimize legal costs and time associated with tax audits and disputes. The implementation of APAs will create a stable and predictable business environment, fostering healthy and cooperative relationships between businesses and tax authorities, as well as among tax authorities of different countries.
