Transfer pricing is used by most foreign-invested enterprises to reduce corporate income tax payable in Vietnam. This leads to Vietnamese businesses not realizing that regulations on transfer pricing also target them, or that Vietnamese businesses are also subject to these regulations. However, this is incorrect; detailed information is presented below.
What is transfer pricing?
Transfer pricing is understood as the application of measures or changes in pricing policies in transactions (related-party transactions) involving goods, with the aim of altering the intrinsic value of goods, services, and assets transferred between members of a group or affiliated entity (related parties) without adhering to established market prices, with the ultimate goal of reducing the amount of capital payable to the state.
Affiliate transactions are buy and sell transactions, exchange, rent, lease, borrowlending, transferring, assigning goods, providing services; lending, lending, financial services, financial guarantees and other financial instruments; buying, selling, exchanging, leasing, renting, borrowing, lending, transferring, assigning tangible and intangible assets and agreements for buying and selling, sharing resources such as assetscapital, labor, cost sharing between related parties, except for business transactions involving goods and services subject to state price regulation, which are carried out in accordance with the law on pricing.
See more details on regulations regarding affiliates and related-party transactions in the article "Understanding Transfer Pricing – Part 3: Classification of Related-Party Transactions and the Principle of Substance Determining Form"
7 common violations related to related-party transactions.
1. Price shifts through input factors
Excessively high input costs compared to market prices, through foreign investment in assets, machinery, equipment, and technology transfer, when businesses set high prices themselves or when input materials are too expensive, result in the cost of goods sold exceeding the selling price, leading to negative profits or very low profits. Examples include: purchasing raw materials from the same group, importing components for automobiles, computers, and electronic components for domestic production and sale…
2. Transfer pricing through output factors
Setting a selling price for products, goods, and services to the parent company that is lower than the market price. Examples include: processing fees, products in the garment, footwear, software, and electronics industries, etc.
3. Transfer pricing through the provision of services
Transfer pricing occurs through the provision of services such as marketing, advertising, management consulting, and support, even though no services are actually performed.
4. Expenses allocated by the parent company to the subsidiary.
Expenses allocated by the parent company to the subsidiary. Payments made on behalf of others within a corporation are often opaque and lack proof of the services provided.
5. Payment of trademark and copyright fees.
Payments related to trademarks and copyrights. The training and development costs cannot be justified.
6. Pay interest on loans to related parties.
Paying high interest rates to related parties. This is higher than the interest rate offered by commercial banks, or it involves interest-free loans to transfer profits to affiliated companies that are incurring losses, or to receive tax incentives (tax exemptions, reductions, or low corporate income tax rates).
7. Deal with companies that have preferential tax rates.
Deal with companies that have preferential tax rates or companies located in "tax havens".
Transactions that are subject to transfer pricing documentation are often overlooked.
Case 1: "The company borrowed over 25% of its equity from commercial banks to finance its business operations, as stipulated in Decree 132. Is this transaction considered a related-party transaction?"
The General Department of Taxation responded on [date] On March 18, 2021, the following appeared on the website:
Points d and l of Clause 2, Article 5 of Decree No. 132/2020/ND-CP stipulate:
d) An enterprise guarantees or lends capital to another enterprise in any form (including third-party loans secured by related-party financing and similar financial transactions) provided that the loan amount is at least 25% of the owner's equity of the borrowing enterprise and accounts for more than 50% of the total value of the borrowing enterprise's medium and long-term debts.
Based on the above regulations, if a company borrows from a bank with a loan amount exceeding 25% of the company's owner's equity and accounting for over 50% of the total value of the company's medium and long-term debts, then the company and the bank are considered to have an affiliated relationship. In that case, transactions arising between the company and the bank are considered related-party transactions.”
Case 2: "During the year, the company had loan transactions with the business owner, who is also the legal representative, exceeding 10% of the equity capital."
The General Department of Taxation also based its response on points d and l of Clause 2, Article 5 of Decree No. 132/2020/ND-CP on March 18, 2021, as follows on its website:
"If a company borrows money from a business owner who is also the legal representative managing and controlling the business, and the amount exceeds 10% of the company's equity, it is considered an affiliated relationship. In this case, the loan transaction between the company and the business owner is an affiliated transaction."
Case 3: "Can a joint-stock company lacking working capital borrow from an individual – not a shareholder but a family member of a shareholder – at a 0% interest rate? Would this be considered a related-party transaction? If so, how would it be applied?"
The General Department of Taxation responded on its website on March 18, 2021, as follows:
Point l, Clause 2, Article 5 of Decree No. 132/2020/ND-CP stipulates:
- l) The enterprise has transactions involving the transfer or acquisition of at least 25% of the owner's capital contribution during the tax period; or borrowing or lending at least 10% of the owner's capital contribution at the time the transaction occurs during the tax period with individuals managing or controlling the enterprise or with individuals in a relationship as stipulated in point g of this clause.
Based on the above regulations, if a company borrows money from an individual who is related to a shareholder (the person managing or controlling the business) and the amount exceeds 10% of the company's equity, it is considered an affiliated transaction. Therefore, the loan transaction between the company and that individual, who is related to the shareholder, is an affiliated transaction.
Businesses that have related-party transactions are obligated to declare and determine the transfer pricing in accordance with the provisions of Decree No. 132/2020/ND-CP.”
What should businesses do when dealing with related-party transactions?
Taxpayers with related-party transactions falling within the scope of this Decree are responsible for declaring and determining the transfer pricing, without reducing their corporate income tax liability in Vietnam as stipulated in Decree 132/2020/ND-CP dated November 5, 2020.
Taxpayers with related-party transactions falling within the scope of this Decree are responsible for declaring information on related-party relationships and related-party transactions according to Appendix I, Appendix II, and Appendix III issued with this Decree and submitting them within the same deadline as the Corporate Income Tax Return.
Risks incurred if a business fails to file a tax return for related-party transactions.
Businesses are likely to make errors when preparing their corporate income tax return if they do not exclude interest expense as stipulated in Decree 132/2020/ND-CP, leading to underpayment of corporate income tax if applicable. Specifically, the total interest expense after deducting interest on deposits and loans incurred during the period, which is deductible when determining taxable corporate income, must not exceed 30% of the total net profit from business operations during the period plus interest expense after deducting interest on deposits and loans incurred during the period plus depreciation expense incurred during the period.
According to this Decree, the Tax Authority has the right to determine the price; profit margin; profit allocation ratio; taxable income or the amount of corporate income tax payable for taxpayers who do not comply with regulations on declaring and determining related-party transactions; or who do not provide or provide incomplete information and data for declaring and determining the price of related-party transactions.
In addition, the tax authorities also impose administrative penalties on businesses for late filing of tax returns, as well as any accrued interest charges.
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