To introduce regulatory changes challenging Base Erosion Profit Shifting practices, the government has recently issued Decree No.20/2017/ND-CP on the management of transfer pricing, applicable from May 1, 2017. KPMG in Vietnam discusses the implications of this sea-change.
The new decree sets out a number of new and/or enhanced principles and rules, including the “substance over form principle”, whereby the transfer pricing analysis can go beyond 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 on business facts and substance, in order to reduce the burden of proof for taxpayers; measures for the comparability of related-party transactions against independent transactions (the arm’s length requirement); consideration of development, enhancement, maintenance, protection, and exploitation (DEMPE) functions with respect to intangibles; and whether application of the above principles will enable tax authorities to disregard or re-characterise related-party transactions in instances when those transactions result in reduced tax revenue.
Under the new decree, related-party relationships in cases of input and output control (i.e. an enterprise which makes more than 50 per cent of its total sales to another, or one which provides more than 50 per cent of the raw materials or input products needed for another) is eliminated.
In addition, the thresholds for some types of relationships are revised. For instance, the threshold on direct or indirect contributed capital ratio increases from 20 to 25 per cent; the threshold on debt to equity ratio in cases of enterprise guarantees or loans to other enterprises increases from 20 to 25 per cent. The new decree also provides additional types of relationships, in relation to cases where an individual has controlling power based on contributed capital to other enterprises, or directly manages the operation of these enterprises; or enterprises which are subject to management and control of another enterprise.
New guidance for tax deduction of related-party transactions which are not in line with the nature of independent transactions, inter-group service fees, and inter-company loan interest expenses
These types of intercompany transactions are recognised as profit-shifting tools used in complex international tax planning. Similarly, an increased level of review 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 the nature of independent transactions
Related-party transactions that are inconsistent with the arm’s length principle or do not contribute to generating revenues or added value to the production and business activities of the taxpayer shall be considered non-deductible expenses, including expenses paid to:
lThe related party that does not conduct any business activities relating to the taxpayer’s business activities;
lThe related party that conducts related business activities, however its scale of assets, number of employees, and functions performed do not correspond with the value of business transactions and the income such related party receives from the taxpayer;
lRelated parties who do not have the right to and responsibility for the assets, goods, and services provided to taxpayer;
lRelated parties which are residents of a country or jurisdiction that does not collect corporate income tax, and do not contribute to generating revenue or added value 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 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 are applied consistently within the group for similar services – with sufficient supporting documents available to support its position (i.e. contracts, supporting documents, invoices and explanations of calculation methods, factors to determine the allocation ratio and the pricing policy of the group for the provided intra-group service).
The decree also provides examples where service expenses are considered non-deductible (i.e. expenses incurred from services which are only used for the purpose of generating benefits and values to other related parties, services which benefit related parties’ shareholders, and duplicate services).
Loans between related parties
Total deductible interest expenses incurred in the tax period should not exceed 20 per cent of the taxpayer’s net profit before interest, taxes, depreciation, and amortisation (EBITDA).
The hierarchy of comparables used for benchmarking purposes
The priority order in the selection of comparables is provided for under the decree, with requirements on the analysis on quantitative and qualitative comparability and material differences when selecting foreign comparables in other geographic regions. Specifically, the priority order is stipulated as follows:
1.Internal comparables of the taxpayers;
2.Comparables located in the same country or territory as the taxpayers;
3.Comparables located in the region which have similar industry conditions and economic development level.
Clarifications on use of secret comparables versus commercial databases and public data
It is understood from the drafting process that the use of secret comparables is considered for tax risk assessments by the tax authorities only, with the consideration for the use of commercial databases and public information to prevail in case 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 authorities may use different sources of information, including commercial databases, publicly available data, their own databases, and information provided by 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.
Clearer bases for the tax authorities to make transfer pricing assessments
The tax authorities will have clearer bases for imposing price, profit margin, profit split ratio, and imposing taxable income or tax amounts 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, documents and source documents used for comparative analysis, and determination of transfer price of related-party transactions 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 transactions or the basis of the profit ratio or profit-split ratio applied in the related-party transactions, or uses data and source documents which are illegal, improper, or originate from an unclear source;
- Taxpayer 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 the ability to make, to avoid inadvertent consequences which are sometimes heavy in terms of the amounts of tax reassessed or imposed, related penalties, and late tax payment interest.