CHAPTER 2: INTERNATIONAL EXPERIENCE IN TRANSFER PRICING CONTROL AND THE LESSONS FOR VIETNAM .... Experience has shown the ineffectiveness of controlling Transfer pricing in Vietnam motiv
OVERVIEW OF TRANSFER PRICING
CONCEPT OF TRANSFER PRICING
Globalization has significantly influenced world trade, with a substantial amount involving the transfer of goods, services, and intangibles among multinational enterprises (MNEs) and their affiliated companies operating in multiple countries Variations in national tax rates lead businesses to strategically manage their tax liabilities to maximize profits One of the most effective strategies for achieving this is through transfer pricing.
The basis for establishing such transfer pricing derives from the freedom of doing business Accordingly, affiliated companies have the power to determine the transaction pricing they deem appropriate (Stone, 2012)
Transfer pricing is a strategic practice used by multinational enterprises (MNEs) to reduce their tax liabilities by setting internal prices for products and materials that deviate from market rates This approach allows companies to optimize profit distribution within their corporate structure (Baistrocchi, 2007).
The practice of setting prices independent of market rates is a prevalent method for profit shifting among multinational enterprises (MNEs) These companies strategically manipulate costs and revenues, transferring profits from high-tax jurisdictions to those with lower tax rates.
Transfer pricing, as defined by the OECD in 2010, refers to the pricing policy applied to the transfer of products, including tangible and intangible assets, services, and loan interest, between related parties This practice often deviates from market transaction pricing and is primarily aimed at minimizing the overall tax liabilities of all global affiliates involved.
Transfer pricing refers to the strategy of setting prices for goods, services, and assets exchanged between affiliated entities across borders, often deviating from market rates This practice is primarily aimed at minimizing tax liabilities and enhancing the overall efficiency of the corporation.
TYPICAL TRANSFER PRICING METHODS
1.2.1 Transfer pricing by rising input costs and lowering output costs
Multinational enterprises (MNEs) frequently exploit rising input costs and declining output prices to minimize corporate income tax liabilities This strategy is particularly prevalent in countries with elevated corporate tax rates, such as Vietnam (25%) and China (30%) By inflating material prices and increasing marketing and advertising expenses, these corporations aim to reduce their reported profits significantly, sometimes even reporting "virtual" losses to evade taxation.
1.2.2 Transfer pricing from the first phase of an investment project
Tax evasion via transfer pricing often begins at the investment stage, where companies manipulate the valuation of intangible assets like technology and brand value This inflated capital contribution skews profit-sharing ratios, making them disproportionately high compared to actual capital Additionally, by increasing depreciation expenses, companies can further lower their taxable income, effectively reducing their corporate income tax obligations.
1.2.3 Transfer pricing through the determination of the value of capital contribution in joint ventures
The significant valuation of initial investment equipment enables multinational corporations (MNCs) to repatriate funds to their parent companies from the outset of their investments This process, coupled with annual depreciation costs, results in a reduction of tax revenue for the state.
1.2.4 Transfer pricing with the purpose of dominating the market
Foreign Direct Investment (FDI) enterprises often incur excessive expenses on brand promotion, consultant fees, management, and ownership protection, even in the face of losses Calculations indicate that many businesses exceed the recommended limit of 10% of their total advertising and promotion costs Furthermore, numerous subsidiaries are established with the primary goal of market dominance for their parent companies, leading to a willingness to operate at a loss to achieve this objective.
9 at a lower price than the cost and strengthen promotional and advertising activities to attract customers
1.2.5 Transfer pricing through transferring technology
Multinational companies enhance the value of capital assets in joint ventures by implementing technology transfer and collecting royalties This process involves a cost allocation related to the depreciation of intangible fixed assets.
1.2.6 Transfer pricing through tax spread
Due to varying corporate income tax rates and the rise of tax havens, multinational enterprises (MNEs) often repatriate profits to countries with lower taxes or lenient tax regulations, allowing them to reduce their overall tax liabilities.
METHODS OF DETERMINING TRANSFER PRICING
The CUP method involves comparing the prices of uncontrolled transactions, where parties are not affiliated, with those of controlled transactions To effectively apply this method, comparative data from commercial databases is essential Key requirements include ensuring that the transactions share equivalent characteristics as outlined by the OECD, such as product types, quality, and economic circumstances like market level and geography If discrepancies in pricing arise between two transactions, it may indicate a failure to adhere to the arm’s length principle among associated entities.
The CUP method is favored by OECD and national governments when comparative data is accessible, but it may not always be suitable, particularly in non-competitive markets or when dealing with unique assets that lack equivalent transactions This is particularly relevant for transactions involving intangible assets, which often present challenges in finding comparable data.
10 based on significant contractual negotiations and terms and the bargaining power in most cases cannot be observed
The CUP method is particularly effective when comparing transactions of the same product sold between affiliated and independent businesses For instance, consider rice transactions where two sales are deemed equivalent if they occur simultaneously under identical conditions within the same production or distribution stage However, if discrepancies arise, such as using rice from different sources in an unregulated transaction, governments must assess the impact on pricing to establish a precise comparative basis.
The Resale Price Method (RPM) is an effective approach for determining transfer pricing behavior, particularly when a reseller acquires products from an affiliated company to sell to independent buyers This method involves calculating the resale price, which is the amount received from independent businesses, and determining the resale price margin necessary to cover related selling and operating expenses while ensuring a reasonable profit By subtracting this margin from the resale price, businesses can accurately assess the transaction value between related companies within the same group.
The gross profit margin method is an effective way to assess whether the transfer price between affiliated companies reflects accurate market values, particularly for businesses that buy and resell identical tangible products It is important to note that alterations in packaging or labeling do not qualify as changes to the product itself However, this method is not suitable for taxpayers who utilize intangible assets to enhance the product's value.
The cost-plus method (CPM) establishes the selling price for a company's products to associated parties by adding a reasonable gross margin to the production cost This gross profit margin should account for the functions performed by the unit, as well as the unit's return on equity and the risks undertaken by the entity To determine the gross profit margin for a controlled transaction, it is compared to the gross profit rates from comparable uncontrolled transactions, ideally ensuring that these transactions are identical or similar (OECD, 2010).
The CPM method compares the functions performed, associated risks, and contract terms, utilizing equivalent accounting methods Any discrepancies between the accounting methods for controlled and uncontrolled transactions must be adjusted to maintain consistent costs and measures Additionally, the gross profit margin for both controlled and uncontrolled transactions should be continuously monitored to ensure that the uncontrolled comparator remains a reliable indicator of the arm's length price.
Company A manufactures shoe soles and sells them to its associate, Company B, located in another country, resulting in a gross profit from the transaction Notably, Company A excludes operating expenses from its production costs In contrast, independent enterprises Company C and Company D produce different shoe soles and sell to independent clothing brands, also achieving gross profit from their sales.
C and Company D include operating costs in their product costs Therefore, the gross profit margins of Company C and Company D need to be adjusted to be able to compare with Company A
The profit split method (PSM) is a key approach for determining transfer pricing, emphasizing the distribution of profits and losses among independent businesses engaged in comparable transactions.
The process eliminates the impact of special conditions in a controlled transaction by first assessing the profits generated from these transactions Subsequently, the profits are allocated among the associated businesses, ensuring that the distribution mirrors what would occur in a comparable transaction between independent entities.
There are two main approaches that can be taken to split profits These are:
Contribution analysis involves allocating combined profits according to the relative value of the functions performed by each entity in a controlled transaction, taking into account the assets utilized and the risks assumed.
Residual analysis involves a two-phase approach to dividing combined profits Initially, each entity receives market compensation for its functions related to the controlled transaction Subsequently, any remaining profit or loss is allocated based on an analysis of the events and circumstances surrounding the transaction.
The primary advantage of the Profit Split Method (PSM) lies in its applicability even when unregulated comparative transactions are not available PSM effectively distributes profits based on the functions performed by the involved entities, ensuring a balanced allocation that reflects their relative contributions This method is especially beneficial for evaluating the contributions of intangible assets in controlled transactions, as highlighted by the OECD in 2010.
This approach enables the analysis of transfer pricing in intricate business structures with highly integrated processes By utilizing a two-sided perspective, it accounts for transactions where both parties contribute distinct and valuable elements Nonetheless, accurately measuring total profit can be challenging, particularly when foreign branches are involved.
1.3.5 Transaction net margin method (TNMM)
The Transactional Net Margin Method (TNMM) is the second profit-based approach recommended by the OECD for determining transfer pricing This method assesses the net profit derived from controlled transactions in relation to a suitable benchmark, which may include metrics such as revenue or assets.
THE IMPACT OF TRANSFER PRICING
1.4.1 The impact of transfer pricing on Economy
Many countries worldwide attract substantial foreign investment from multinational enterprises (MNEs); however, the transfer pricing practices employed by these companies can lead to detrimental effects on their economies, resulting in significant financial losses.
Transfer pricing allows multinational corporations (MNCs) to effectively value inputs, enabling multinational enterprises (MNEs) to reduce their payback periods This practice often leads to capital being repatriated more quickly than anticipated, ultimately altering the capital structure of the host country's economy.
14 investment The consequence is to wrong reflect the results of the production and business activities of the economy, creating a dishonest economic picture
Multinational enterprises (MNEs) operating in host countries leverage transfer pricing to enhance their competitive advantage, which can undermine local businesses lacking sufficient financial resources This situation may lead to the failure or bankruptcy of domestic enterprises, allowing MNEs to establish monopolistic control over the market and manipulate prices Consequently, the host country's government faces challenges in formulating effective macroeconomic policies, hindering the growth of domestic manufacturing.
Transfer pricing can significantly inflate the import value of goods, negatively impacting both the trade balance and the balance of payments When associated companies source equipment, machinery, raw materials, and other goods and services from foreign entities, the inflated pricing often leads to a persistent trade deficit and adverse effects on the overall economic balance.
Foreign Direct Investment (FDI) businesses frequently acquire outdated equipment to facilitate transfer pricing, presenting lower costs compared to modern machinery However, this practice masks the true value of faulty equipment, which can be prohibitively expensive The importation of obsolete technology hinders economic development, leading to stagnation or decline once FDI enterprises conclude their operations and relocate Ultimately, the imported machinery and technology become obsolete and detrimental to the host economy.
1.4.2 The impact of transfer pricing on Taxation
Transfer pricing directly leads to tax evasion, resulting in significant losses in corporate income tax and profit repatriation tax revenue for the state Foreign Direct Investment (FDI) enterprises contribute substantially to a country's GDP, total import turnover, and state budget revenues, making the impact of tax evasion considerable Additionally, joint venture FDI enterprises often appropriate the capital and profits of domestic partners, further exacerbating tax losses for the government.
Foreign Direct Investment (FDI) enterprises can legally evade corporate income tax and profit repatriation tax However, preventing transfer pricing poses significant challenges, leading to substantial revenue losses for the government The tax arrears recovered by tax authorities represent only a fraction of the overall tax revenue lost due to transfer pricing practices.
1.4.3 The impact of transfer pricing on MNEs
While transfer pricing can negatively impact the economy of the host country, multinational enterprises (MNEs) leverage this practice to optimize their business strategies and effectively minimize tax liabilities, resulting in substantial financial advantages.
Multinational enterprises (MNEs) can leverage the favorable policies of nations aiming to attract foreign direct investment, allowing them to implement legal transfer pricing strategies that reduce tax obligations Furthermore, MNEs can efficiently transfer profits overseas without the constraints of monetary tightening measures.
The successful transfer pricing also helps MNEs have abundant financial resources, thereby creating a foundation to dislodge domestic companies, gradually creating a monopoly in the domestic market
Multinational enterprises (MNEs) face significant risks from local governments due to their transfer pricing practices If detected, these companies could incur severe penalties, including the loss of their business licenses and the termination of operations within that country Additionally, such violations can tarnish the company's reputation internationally, drawing the attention of tax authorities in other nations as they conduct their business activities.
LEGAL FRAMEWORK ON TRANSFER PRICING
"Transfer Pricing Guidelines for Multinational Enterprises and Tax
Administrations" was released in 1995 and the latest revision was published in 2017
The OECD Guidelines offer comprehensive guidance on transfer pricing, serving as a framework for countries globally to develop their transfer pricing and tax regulations While many nations adhere to these guidelines, some implement variations to suit their specific legal and economic contexts.
16 suit the actual situation of the country, the majority are still based on OECD guidelines And this guide is voluntary for all countries
The OECD establishes the principle of market prices as an international transfer pricing standard, detailed in Chapter 1 of Article 9 of the OECD Model Tax Convention This principle serves as the foundation for bilateral tax treaties between OECD member states and non-member countries.
The OECD guidelines outline transfer pricing methods to assess if the conditions set on trade or financial relationships between associated firms align with the arm's length principle These methods are categorized into two main types: traditional transaction methods and profit methods.
The OECD offers administrative procedures designed to reduce and resolve transfer pricing disputes that may occur between taxpayers and tax authorities, as well as among different tax authorities Even when adhering to the guidelines set forth in these Principles, disagreements can still arise regarding market price conditions for controlled transactions This is often due to the inherent complexity of transfer pricing issues and the challenges in interpreting and assessing individual cases.
Tax authorities are advised to establish clear guidelines for handling documents obtained from taxpayers during transfer pricing or risk assessment investigations These guidelines aim to assist taxpayers in identifying essential documentation that demonstrates their transactions align with the cost of raw meat, ultimately facilitating the resolution of transfer pricing and tax examination issues.
The OECD offers specific guidance for establishing arm's length prices in transactions involving intangible assets Article 9 of the OECD Model Tax Convention addresses the conditions for transactions between associated businesses, focusing on the transfer of economic value rather than the specific labeling of these transactions It is crucial to evaluate whether a transaction conveys economic benefits from one associated entity to another, regardless of whether these benefits arise from tangible assets, intangible assets, services, or other activities.
In 2002, the European Union established the EU Common Transfer Pricing Forum to address "Taxes and Development - Cooperation with developing countries to promote good governance in taxation." The forum's communication, COM (2010) 163, highlights the importance of enhancing the capacity of developing nations to mobilize domestic resources for development, adhering to the principles of effective tax administration.
In this context, PwC has prepared a report "Transfer pricing and developing countries"
Many EU countries are now implementing the OECD Principle of Transfer pricing The latest country of application is the Czech Republic, which issued a ruling in 2017 for financial arrangements
Moreover, in the European Union (EU), the "European Arbitration
The Convention outlines a framework for resolving transfer pricing disputes among member states, addressing the limitations of existing tax treaties that fail to mandate the elimination of double taxation By instituting binding obligations on transactions between businesses within the EU, the Convention enhances the environment for cross-border activities in the internal market, fostering improved economic cooperation among member states (EC 2011).
1.5.3 A practical guide of UN about transfer pricing for developing countries
In 2009, the United Nations Committee of Experts on International Cooperation in Taxation established a Subcommittee focused on transfer pricing to address practical issues This Subcommittee is responsible for creating a Handbook on transfer pricing practices, guided by key principles outlined in the UN's 2012 framework.
The article emphasizes the application of Article 9 of the United Nations Model Convention, highlighting the principle of market prices it embodies It aligns with the relevant commentary provided in the United Nations Model Convention to ensure coherence and compliance with international standards.
(b) It will reflect reality for developing countries at relevant capacity development stages;
(c) Particular attention should be paid to the experience of other developing countries;
(d) It will be based on the work being done in other forums
The draft presents guidelines that serve as a practical resource rather than a legislative framework, highlighting the manual's significant value Additionally, efforts have been made to ensure consistency with the OECD Transfer Pricing Guidelines during the manual's development.
In October 2012, the Committee of Experts approved a draft practice guide, with the final version published in May 2013 This guide is characterized as a living document, continually enhanced and updated through accumulated experience and professional insights.
The guidance will significantly impact the advancement of transfer pricing activities in emerging economies Similar to the OECD Transfer Pricing Principle, it is not a legal instrument; thus, its effectiveness and influence will rely on how domestic laws are referenced and implemented in each country.
Currently, global regulations on tax administration and transfer pricing for multinational corporations exist, but they are primarily advisory rather than mandatory Countries utilize these guidelines to develop their own tax and transfer pricing policies, tailoring them to fit their unique characteristics and circumstances.
Chapter 1 clarifies the concept of transfer pricing, providing insight into the strategies employed by multinational companies to meet their economic objectives It examines the methods used to establish transfer pricing practices, which support government efforts and regulatory authorities in combating transfer pricing abuses Additionally, the chapter explores the impact of transfer pricing on various entities and outlines the legal framework governing this practice This comprehensive analysis equips readers with a broad understanding of the multifaceted aspects of transfer pricing.
CHAPTER 2: INTERNATIONAL EXPERIENCE IN TRANSFER PRICING CONTROL AND THE LESSONS FOR VIETNAM
THE CASE OF TRANSFER PRICING IN THE US
2.1.1 The case of transfer pricing in the US
The United States boasts the largest and most advanced economy globally, with numerous multinational corporations expanding their operations overseas As a result, transfer pricing activities have surged and grown more intricate This practice has significantly harmed the U.S economy by impacting tax revenues and undermining fair competition among businesses.
A March 2009 report by Christian Aid revealed that between 2005 and 2007, approximately 1.1 trillion USD in bilateral trade was undervalued among the EU, the United States, and other countries Additionally, a Bloomberg report highlighted similar discrepancies in trade valuation from 2006 to 2010.
A recent study revealed that 135 major US companies experienced a remarkable 70% surge in their international sales, escalating from $590 billion to over $1 trillion This significant growth has been attributed to the strategic use of international transfer pricing Notably, two cases exemplify how multinational corporations leveraged transfer pricing to minimize their tax liabilities in the United States.
Forest Laboratories Inc (FRX), founded in 1956 in Delaware and headquartered in New York City, is a notable pharmaceutical company recognized for its licensed pharmaceutical sales from Europe in the United States The company was acquired by Actavis, now known as Allergan, on July 1, 2014.
FRX purchased Lexapro - the company's best-selling pharmaceutical product
Forest Laboratories Ireland Ltd, a subsidiary of FRX located in Ireland, facilitated the transfer of profits generated from the sales of Lexapro products, which were exclusively sold in the United States This profit transfer was executed through strategic transfer pricing practices.
Wholesale revenue from subsidiaries accounted for approximately 70% of FRX's net revenue To minimize its tax burden, FRX opted to shift sales overseas through its subsidiary in Ireland, where the corporate income tax rate is significantly lower at just 12%, compared to the US rate of 35%, one of the highest in the world.
In 2005, FRX launched a subsidiary, Forest Laboratories Holdings Ltd, in Bermuda, a known tax haven Subsequently, it sold the patent of Forest Laboratories Ireland Ltd to this subsidiary, with payments funneled through a Dutch intermediary By 2007, the Dutch subsidiary reported licensing income of $1.1 billion, primarily from this transaction, allowing the Irish company to sidestep a 20% patent deduction tax and lowering its maximum export tax rate from 10.3% to 2.4% This strategic use of subsidiaries enabled FRX to reduce its tax burden by $183 million However, despite increased revenue, the company's net income plummeted by 31% in 2009 due to rising costs, leading to criticism by 2010 for shifting legal profits overseas to evade taxes.
Google, a multinational company with its international operations control center in Dublin, USA, reported approximately 12.5 billion USD in revenue, representing 88% of its revenue outside the United States However, the majority of its profits have been funneled to Bermuda, a tax haven with a zero corporate income tax rate This profit shifting is achieved through intricate strategies known as the "Double Irish" and "Dutch Sandwich," utilized by tax lawyers to minimize tax liabilities.
When companies in Europe, Asia, or Africa purchase search ads from Google, they remit payments to Google Ireland, a subsidiary of the tech giant The Irish government imposes a corporate tax rate of 12.5%, allowing Google to minimize its tax burden in the US, as the company's earnings are not officially recorded in Dublin In 2008, Google Ireland reported pre-tax revenue of less than 1% of its total revenue, highlighting the tax strategy employed by the company.
Irish law complicates direct payments from Google to Bermuda due to high profit repatriation taxes, prompting the company to route funds through the Netherlands, where certain payments to EU countries are not taxed In the Netherlands, Google benefits from favorable tax regulations, utilizing its shell subsidiary, Google Netherlands Holdings, which has no employees and transfers approximately 99.8% of its collected funds to Bermuda This intricate legal framework has enabled Google to significantly reduce its tax burden abroad, saving $3.1 billion since 2007 and boosting last year's overall income by 26%.
The transfer pricing strategies employed by the two companies not only minimized their tax liabilities in foreign jurisdictions but also had a significant impact on U.S tax revenues By shifting profits from the domestic market overseas, and conversely, directing international profits to countries with favorable tax incentives, particularly tax havens like Bermuda, these companies effectively reduced their overall tax burden Importantly, all of these actions were conducted within the bounds of the law.
2.1.2 Experience in transfer pricing control in the US
The United States recognized the significant economic losses caused by transfer pricing, particularly affecting the tax industry, leading to the establishment of regulatory laws aimed at limiting and controlling these practices As the world's most developed economy and a key market for multinational enterprises (MNEs), the U.S faces the challenge of implementing complex compliance requirements for MNEs, making it a significant issue in international business.
In the 1990s, the United States initiated a comprehensive reform of transfer regulations, which included updates and expansions to laws governing cost allocation, services, and the transfer of intangible assets within multinational corporations.
In January 1992, the IRS introduced three new pricing methods based on the analysis of transaction results Subsequently, in 1993, provisional regulations were issued, applicable to taxable years beginning after April of that year.
21, 1993, and before October 6, 1994 These regulations emphasize the use of transactions with comparability between unrelated parties and flexibly apply valuation methods to reflect specific events and circumstances
In 1995, final regulations on cost-sharing were issued (possibly with minor amendments in 1996) These regulations were in effect for taxable years beginning on or after January 1, 1996
On February 9, 1996, the final transfer penalty provisions under article 6662 were enacted from that date
In 2003, final regulations were established regarding the treatment of costs related to stock options within qualifying cost-sharing arrangements, following proposals from 2002 Subsequently, regulations for intragroup services were introduced, initially proposed and later replaced by temporary regulations on July 31, 2006 Ultimately, the new services regulations were finalized on July 31, 2009.
THE CASE OF TRANSFER PRICING IN CHINA
2.2.1 The case of transfer pricing in China
China, recognized as an economic superpower, presents a promising market for global multinational enterprises (MNEs) The rising presence of foreign companies in China has spurred the evolution of transfer pricing strategies, aimed at maximizing economic advantages for these MNEs.
Scania, established in 1911 through the merger of Vabis and Scania, has become one of Sweden's leading manufacturers of trucks, cars, and buses With a global presence, the company operates sales departments in five countries, including China, and maintains manufacturing facilities in six nations Additionally, Scania has a widespread network of product distributors worldwide, reinforcing its position in the automotive industry.
Scania strategically established a subsidiary in China to import and sell its products in the domestic market, incorporating group operations into its navigation strategy The subsidiary purchased Scania's products at prices above the arm's length rate and incurred an additional 2% surcharge on each sale, with pricing determined through annual negotiations between the buying and selling entities within the corporation As a result, despite increased sales revenue, the subsidiary struggled to achieve profitability due to elevated input costs.
27 avoided China's 25% corporate income tax and transfers the profits to the parent company through product value
Scania Trucks strategically opts to sell through connected companies to maximize economic benefits and avoid taxes in China Instead of establishing a production facility in China, Scania has chosen to set up an import company, as navigating Chinese legal requirements for factory establishment proved too complex Additionally, Scania refrains from forming joint ventures with Chinese firms due to concerns over potential technology theft, fearing that partners might replicate their products and market them under different brands at lower prices.
Volvo Group, headquartered in Gothenburg, Sweden, is a leading multinational corporation specializing in the manufacturing and distribution of trucks, buses, and construction equipment In 2016, Volvo achieved recognition as the second-largest heavy-duty truck manufacturer globally.
Volvo's transfer pricing strategy is centered around an obligation-sharing policy among its subsidiaries, primarily involving intermediaries and service providers Intermediaries like Volvo Trucks, Buses, and Aero, based in Sweden, assume all business risks, while service companies operate with 100% capital In China, foreign investment will be influenced by specific business outcomes throughout the contract duration, with services offered including research and development (R&D), production, and distribution.
During prosperous times, entrepreneurs enjoy significant profits, while in challenging periods, they bear the brunt of losses In contrast, service providers experience more stability, as their business outcomes are often secured in advance, minimizing the impact of external market fluctuations The guaranteed results for these providers are influenced by corporate tax regulations and equivalent transactions Generally, Volvo has consistently aimed to implement this resulting model in their operations.
28 described based on comparable transactions, but depending on the service, other methods might occur to divide profits between companies
The results-based business model allows a company to assume all risks associated with product development and production across various countries, while funding research and development from Sweden, alongside the subsidiary's operating costs This structure enables the seamless sale of products within the company group to any country, eliminating the need for transactions between the manufacturing and purchasing countries Consequently, all financial transactions are efficiently consolidated in Sweden.
By coordinating transactions, it streamlines profit arrangements, allowing offerings to traverse international borders Additionally, Volvo successfully established its corporate income tax obligations to Chinese authorities by first assessing its business results.
2.2.2 Experience of transfer pricing control in China
2.2.2.1 Legal framework for transfer pricing in China
Since the late 1990s, China has acknowledged the significance of preventing and regulating transfer pricing behaviors; however, in recent years, the complexity and prevalence of actual transfer pricing practices in the country have escalated significantly.
The Chinese tax authority is actively combating Base Erosion and Profit Shifting (BEPS) by enforcing stringent transfer pricing rules and regulations Additionally, they have established comprehensive compliance requirements and heightened inspection protocols for transactions between related companies.
In 2007, China implemented the Enterprise Income Tax Law (CIT) along with its Detailed Implementation Regulations (DIR), which play a crucial role in regulating the taxable income of enterprises These regulations ensure that taxpayers declare their earnings in accordance with established market rules, promoting transparency and compliance in the taxation process.
In January 2009, China's State Administration of Taxation (SAT) issued a circular “Guo Shui Fa [2009] No 2 ”or Circular 2 - 'Special tax adjustment measures
- trial version', providing further guidance on the concepts of transfer pricing and the
29 concepts of preventing transfer pricing in China Circular 2 marks a significant step forward in China's efforts to control transfer pricing
China requires taxpayers to demonstrate their compliance with tax obligations, particularly in related party transactions conducted at market prices According to Clause 2, Article 43 of the Corporate Income Tax (CIT) law, if the tax authority initiates a transfer pricing investigation, taxpayers and their related parties must furnish the necessary information as requested by the competent authorities.
According to DIR, the information requested by the tax authorities during the transfer pricing investigation may include:
• Documents of current transfer pricing of the taxpayer
• Relevant information abroad relating to the resale price (or transfer price) or final sale price of tangible goods, intangible goods, and services related to related party transactions
• Other relevant information related to related party transactions
China's transfer pricing rules extend beyond corporate income tax to encompass various taxes, including VAT, consumption tax, and business tax Furthermore, due to China's tax sharing system, these regulations apply not only to cross-border transactions but also to domestic transactions between associated businesses, ensuring comprehensive scrutiny of transfer prices.
- although it seems that China's transfer pricing audit has focused primarily on cross- transactions (Rolfe, 1997; Quach, 2000)
Taxpayers who fail to submit annual related party disclosures to tax authorities or fail to maintain current documents and other relevant information under Circular
2 will be subject to penalties ranging from 2,000 CNY to 50,000 CNY, according to Articles 60 and 62 of the Law on Tax Administration and Collection
Taxpayers who do not provide contemporary documents or related information on related party transactions or provide false or incomplete information
According to Article 70 of the Tax Administration and Collection Law and Article 96 of the Tax Collection Regulations, companies that fail to accurately reflect their related party transactions may face fines ranging from less than 10,000 CNY to 50,000 CNY Furthermore, tax authorities have the discretion to assess a taxpayer's taxable income by referencing the profits of similar companies, evaluating the taxpayer's expenses along with appropriate costs and profits, or considering a reasonable portion of the group's total profits This assessment may also be based on other reasonable methods as outlined in Article 44 of the CIT Law and Article 115 of the DIR.
LESSONS LEARNED FOR VIETNAM FROM INTERNATIONAL
By examining the practical cases of the United States and China in managing and preventing transfer pricing, valuable lessons can be drawn for Vietnam to enhance its own transfer pricing regulations and practices.
To enhance the economic legal framework, it is essential to focus on regulating transfer pricing activities effectively Establishing a robust legal foundation will ensure preparedness for any future transfer pricing cases With Vietnam attracting significant foreign direct investment (FDI), the complexities surrounding transfer pricing have intensified, necessitating improved oversight and legal measures.
To align with Vietnam's economic integration, it is essential to develop and update tax policies that cater to the needs of economic organizations and the trade agreements in which the country is involved These tax policies should ensure fairness and equity among all stakeholders.
31 economic sectors but must generate tax revenues for the State Budget and attract foreign direct investment
Transfer pricing involves transactions between related companies, necessitating proper documentation to justify these relationships Both the United States and China enforce information disclosure policies for related parties, highlighting the importance of transparency Therefore, it is crucial for the Vietnamese Government to strictly adhere to and implement regulations regarding this matter.
Penalties for transfer pricing practices must be strictly designed and enforced, as these behaviors often do not breach legal standards However, severe consequences should be imposed for violations related to the reporting of transactions between related parties or for engaging in tax evasion in disadvantaged situations.
The State must clearly identify and strictly enforce penalties for violations of transfer pricing laws, as this serves as a deterrent to other businesses Failing to address these issues thoroughly could encourage more companies to engage in transfer pricing practices without fear of repercussions.
The government should prioritize the training and qualification enhancement of tax officials to ensure they possess the expertise necessary to effectively address tax violations and recover lost tax revenues Additionally, it is crucial to consistently update their knowledge of economic trends and management practices, particularly in relation to transfer pricing strategies from developed nations.
Chapter 2 addresses cases of price transfer in the two largest economies in the world - the US and China In the context of a growing global economy, transfer pricing also increases with the increasing activity of global businesses The analysis of these transfer pricing practices helps readers to better understand transfer pricing Moreover, the experiences of practical controlling transfer pricing are good lessons for Vietnam, if it can be applied reasonably to the real situation of transfer pricing control in Vietnam In the final chapter, the practice of transfer pricing control in Vietnam will be analyzed, as well as advice given to the Vietnamese government to enhance the efficiency of transfer pricing control
THE PRACTICAL SITUATION OF TRANSFER PRICING
TRANSFER PRICING SITUATION IN VIETNAM
Vietnam's developing economy stands out in Southeast Asia, driven by its affordable labor and political stability, which attract significant foreign investment, particularly from multinational corporations relocating their factories and headquarters to optimize operations However, this influx has led to a rise in transfer pricing practices, where companies shift economic benefits back to their parent countries Consequently, transfer pricing in Vietnam has grown increasingly complex, resulting in serious repercussions for the nation's economy.
Since the implementation of the Law on Foreign Investment in 1987, Vietnam has seen significant growth in foreign direct investment (FDI), with both registered and disbursed capital on the rise By December 31, 2015, Vietnam boasted over 20,000 active FDI projects, accumulating a total registered capital of approximately 281.88 billion USD.
By 2019, Vietnam attracted investments from 125 countries and territories, with South Korea leading at $7.92 billion, representing 20.8% of total investment Hong Kong followed closely with $7.87 billion, or 20.6%, which included a significant $3.85 billion investment in Vietnam Beverage Co., Ltd Singapore ranked third with $4.5 billion, accounting for 11.8% of the total This marked the highest level of foreign investment in Vietnam in the past decade.
Table 3.1: Amount of foreign direct investment into Vietnam in 2019 (Unit: percentage)
(Source: Report of Foreign Investment Department, Ministry of Planning and Investment in 2019)
Vietnam has adopted various preferential policies, particularly in taxation and finance, to attract foreign direct investment (FDI) Consequently, FDI enterprises have significantly contributed to the country's GDP; however, many of these enterprises have not fully declared or effectively met their tax obligations.
A report evaluating the operational status of foreign direct investment (FDI) enterprises and financial incentive policies from 2012 to 2017 revealed that out of 16,718 FDI enterprises in Vietnam, 8,666 reported losses, representing 52% of the total These losses amounted to 86,180 billion VND Furthermore, 10,582 enterprises experienced cumulative losses, accounting for 63% of the total, with a staggering cumulative loss of 397,996 billion VND Additionally, 2,673 enterprises faced capital losses, which is 16% of the total, resulting in a negative equity value of 85,604 billion VND.
Amount of foreign direct investment into Vietnam in 2019
35 enterprises included 90% of enterprises dealing in finance and insurance, 70% of enterprises manufacturing textile and garment, 51% of enterprises producing automobile components
Foreign Direct Investment (FDI) enterprises in Vietnam have reported significant losses, leading to a shortfall of tens of billions of dong in tax revenue for the state budget, yet they continue to expand their production and business activities This loss-making trend is primarily attributed to transfer pricing practices, which allow these companies to evade tax obligations in Vietnam Notably, around 50% of FDI enterprises contributed only 9% to 10% of the total state budget revenues from FDI (excluding crude oil), with their overall contribution peaking at just 12% in a given year From 2012 to 2017, the percentage of businesses reporting losses while simultaneously expanding operations rose dramatically, reaching 52% in 2017, highlighting the complex issue of transfer pricing in the Vietnamese economy.
Table 3.1: Loss declared by some FDI enterprises in 2016 (unit: VND billion)
(Source: The Report on assessing the actual situation of FDI enterprises' operation by the Ministry of Finance)
Meiko Vietnam Toshiba Asia Olympus
Loss declared by some FDI enterprises in 2016
Foreign Direct Investment (FDI) enterprises in Vietnam engage in various transfer pricing strategies Notable examples include Adidas and Coca-Cola Vietnam, which transfer economic interests abroad by inflating the declared value of their goods and services Similarly, Keangnam Vina employs transfer pricing through loans from its parent company, charging interest rates significantly above the market average These practices highlight the diverse methods of transfer pricing utilized by FDI companies in the region.
Keangnam Vina Co., Ltd., a 100% foreign-owned subsidiary of the Korean Keangnam Group, was established under Investment Certificate No 011043000161 by the Hanoi People's Committee on June 29, 2007 The company is licensed to develop the Keangnam Hanoi Landmark Tower project, which spans 46,008 m² in Nam Tu Liem District, Hanoi This ambitious project features a 72-story building and two 47-story buildings that will house hotels, luxury apartments, and various support facilities Keangnam Vina Co., Ltd is tasked with overseeing investment procedures, land allocation, and the construction of the project's infrastructure and related items.
Keangnam Korea Corporation established and operated a subsidiary company
Keangnam Korea Co., Ltd., based in Korea, serves as the general contractor (EPC) for a significant contract with Keangnam Vina Co., Ltd., which encompasses a wide range of project tasks including surveying, design, equipment supply, construction, and financial advisory services This turnkey contract, valued at $871 million, was found to exceed the arm's length price upon auditing, with specific costs including a financial advisory fee of $30 million and loan arrangement services amounting to $20 million, as well as additional expenses recorded as of December 31, 2011.
Keangnam Co., Ltd has opted for tax registration using the deduction method, applying a corporate income tax (CIT) rate of 25% Additionally, the company is permitted to register as a foreign contractor, utilizing a mixed tax approach that involves paying value-added tax (VAT) through the deduction method and a fixed income tax set at 2% of gross revenue.
The contractual relationship between the investor and the construction contractor has led to a reduction in the general corporate income tax payable in Vietnam, resulting in profits being transferred from Vietnam to Korea.
Since its revenue generation from the Landmark Tower project began in 2011, exceeding 5,200 billion VND, Keangnam - Vina Company has faced significant financial challenges, reporting losses over 140 billion VND An investigation by tax authorities revealed that in May 2007, the company incurred over 2,000 billion VND in financial expenses to secure a 400 million USD loan from Kookmin Bank, a subsidiary of Korea Keangnam Corporation These financial burdens led to ongoing losses, resulting in the company's failure to pay corporate income tax in Vietnam.
Adidas AG, a prominent German sports equipment manufacturer founded in 1948, ranks as the second-largest sports equipment producer globally In 2009, the company expanded its presence by establishing a subsidiary in Vietnam, which serves as a distributor of Adidas sports products throughout the Vietnamese market.
By 2012, Adidas Vietnam exhibited signs of transfer pricing, operating as a wholesaler while incurring costs typical of a retail business The company paid royalties to its parent company, despite not being a manufacturer, with 6% of copyright costs directed to Adidas AG Additionally, Adidas Vietnam was required to allocate 4% of its net revenue from product sales towards international marketing fees and pay an 8.25% purchase commission to Adidas International Trading B.V for each transaction.
Adidas Vietnam has faced significant challenges due to rising intermediate input costs, leading the company to import goods at substantially higher prices than usual As a result, Adidas has experienced ongoing losses, which has exempted it from paying corporate income tax in Vietnam.
THE PRACTICAL SITUATION OF TRANSFER PRICING
Since the introduction of the Foreign Investment Law in 1987, Vietnam has evolved its tax legislation, implementing its first tax law in the 1990s The introduction of transfer pricing rules in late 2005, effective from 2006, signifies the government's growing focus on transfer pricing issues and highlights Vietnam's advancements in taxation practices.
On October 20, 1997, the Ministry of Finance (MOF) released Circular 74-TC/TCT, marking the first legal document to define stakeholders within the Vietnamese context, though its application was restricted to foreign-invested enterprises Subsequently, Circular 89/1999/TT-BTC, issued on July 16, 1999, offered further guidance on stakeholder definitions However, both circulars failed to outline specific transfer pricing methods or documentation requirements.
On March 8, 2001, the Ministry of Finance (MOF) released Circular 13/2001/TT-BTC to guide the implementation of the Corporate Income Tax Law for foreign-invested enterprises While this Circular outlined three conventional transfer pricing methods, it fell short of offering comprehensive guidance on the application of these statutory methods and lacked detailed requirements for documentation.
The Law on Corporate Income Tax (BIT Law) enacted in 2003, effective from
1 January 2004, required all transactions between related parties to be carried out at arm’s length prices
In 2005, Circular No 117/2005/TT-BTC was introduced on December 29, guiding the determination of market prices in transactions among associated parties This circular established a more independent and comprehensive framework that aligns closely with OECD guidelines.
Circular 117 of 2006 offers guidance on related party transactions, outlining the necessary documentation and information required for compliance This circular applies to both international and domestic transactions, mandating that companies adhere to its provisions.
Companies must adhere to market price standards and submit annual transfer pricing declaration forms, along with maintaining relevant transfer pricing documents dating back to 2006 Non-compliance may lead to fines of up to 5 million VND.
Circular 66, issued in 2010, maintains the compliance requirements established by Circular 117, while also implementing stricter transfer pricing regulations Notably, it specifies that the average value of inter-regional transactions will be utilized to evaluate company profits for adjusting transfer prices Additionally, the circular mandates increased disclosure in the annual transfer pricing declaration form, which now requires a new list of related party transactions, details about the nature of the related party relationships, as well as the addresses and tax codes of the related parties involved.
Prior to the implementation of Decree 20/2017/ND-CP in February 2017, Vietnam's transfer pricing regulations were lax and ineffective However, with the introduction of this decree, both new and existing companies investing in Vietnam must now adhere to more stringent legal requirements that align with OECD guidelines and BEPS actions.
Decree 20/2017/ND-CP marks a significant shift in Vietnam's tax landscape by enhancing the control of transfer pricing among foreign direct investment (FDI) enterprises This regulation imposes greater compliance requirements on businesses, necessitating a thorough understanding of potential risks associated with tax declaration and payment processes in Vietnam.
TRANSFER PRICING CONTROL ASSESSMENT
3.3.1 Achievements in transfer pricing control
Vietnam has acknowledged the significance of transfer pricing control and has initiated measures to address this issue through the introduction of regulations in Circular No 74-TC/TCT, issued in October.
20, 1997, of the Ministry of Finance
Circular No 66/2010/TT-BTC, issued by the Ministry of Finance on April 22, 2010, provides guidelines for determining market prices in transactions between associated parties This Circular enhances the tax authorities' ability to effectively regulate transfer pricing practices, leading to increased scrutiny and examination of transfer pricing, particularly among foreign direct investment (FDI) enterprises.
Circular No 201/2013/TT-BTC, effective February 5, 2014, provides guidance on the implementation of Advance Pricing Agreements (APA) in tax administration, marking a significant advancement in enhancing the legal framework This initiative establishes a solid foundation for Vietnam's tax authorities to effectively combat transfer pricing among associated companies.
In 2017, Vietnam introduced Decree 20/2017/ND-CP, a significant regulation aimed at enhancing tax management for associated transactions and marking a crucial advancement in controlling transfer pricing This decree aligns Vietnam's legal framework with international standards by incorporating guidelines from the OECD and BEPS Additionally, Decree 20/2017 establishes mandatory documentation requirements, which helps minimize tax violations among associated enterprises operating in Vietnam.
Vietnam's enhanced measures against transfer pricing have yielded positive outcomes, as stricter controls on businesses have deterred potential transfer pricing practices Tax authorities have effectively inspected and collected outstanding taxes, with 2,500 enterprises flagged for transfer pricing in 2015 alone This initiative led to a remarkable reduction in losses exceeding 6,500 billion VND, alongside the recovery of over 600 billion VND in arrears, refunds, and fines for the State Budget.
3.3.2 Many multinational corporations take advantage of preferential tax policies in Vietnam
In an effort to attract a large amount of foreign investment from multinational corporations as well as small companies, Vietnam has implemented preferential
41 policies for these businesses, such as land policies, labor policies, and especially tax incentives
Most of Vietnam's tax policies offer many tax incentives for investors but lack the appropriate constraints or criteria to receive them The CIT law was enacted in
In June 2013, Vietnam enacted Law No 32/2013/QH13, which amended several articles of the Corporate Income Tax (CIT) law, marking a significant shift towards more favorable policies Effective January 1, 2014, these changes aim to attract foreign investment by offering various incentives for international businesses looking to invest in Vietnam.
Accordingly, the preferential tax rates for these businesses reach 10% for up to 15 years and 20% for up to 10 years; tax exemption or reduction is valid for up to
9 years; allow the transfer of losses within 5 years; Exemption from taxation of profits transfer abroad; tax refund for reinvestment profits, or allow these businesses to depreciate quickly
Newly established enterprises in sectors such as education, vocational training, health care, culture, sports, and the environment may qualify for a reduced corporate income tax (CIT) rate of 10% This preferential rate applies to businesses involved in high-tech investment projects or significant state infrastructure developments The tax incentive is available for a duration of 15 years, starting from the first year of taxable income generated by the investment project If an enterprise experiences losses during this period, the 15-year limit can be extended accordingly.
3.3.3 Vietnam lacks effective anti-transfer pricing measures
The Vietnamese government has made certain efforts to control and prevent transfer pricing, but the reality shows that Vietnam's measures have not been really effective
Decree 20/2017 / ND is considered the most comprehensive transfer pricing regulations in Vietnam today, but there are still issues that have not been effectively addressed:
The absence of specific regulations allowing agencies to choose independent units for comparing uncontrolled and controlled transactions can lead to significant issues Selecting non-standard independent units may result in inaccurate comparisons, ultimately causing substantial harm to the evaluation process.
The use of internal data by tax authorities to investigate or adjust prices of improper transactions may lead to disputes and conflicts among these authorities.
Inspecting and reviewing multinational enterprises (MNEs) poses significant challenges due to their global business activities Determining profit and loss for companies exhibiting signs of transfer pricing is particularly complex, especially as these businesses adeptly leverage such practices to achieve their transfer pricing objectives.
Ineffective coordination among agencies significantly hampers anti-transfer pricing efforts, as many foreign direct investment (FDI) enterprises report income losses to tax authorities while showing different figures in their bank documents This highlights the critical need for collaboration between banks and tax authorities to identify transfer pricing indicators Currently, the banking system is not actively involved in sharing information related to banking services, payments, money transfers, and foreign exchange transactions with tax authorities The Government Inspectorate has acknowledged that the lack of coordination between tax and customs authorities, along with existing regulatory gaps, complicates transfer pricing control Additionally, the collaboration between Economic Police and taxation agencies remains questionable in several regions.
Despite efforts to inspect tax payment situations, effectiveness remains lacking The increasing complexity of transfer pricing complicates tax authorities' ability to accurately assess businesses' tax contributions Coercive measures have proven less effective when tax arrears represent only a fraction of the total tax owed In 2016, the State Audit Office projected a rise in the amounts payable to the state budget.
43 by 11,365 billion VND, especially through reconciling 1,653 enterprises, the State Audit Office proposed that the amounts payable to the state budget would increase by 2,050 billion VND.
RECOMMENDATIONS FOR TRANSFER PRICING CONTROL IN
Based on insights gained from the United States and China, the two leading global economies, alongside an analysis of Vietnam's current transfer pricing control practices, several recommendations are proposed to enhance the effectiveness of transfer pricing prevention and control methods.
3.4.1 Supplementing and completing the legal framework for transfer pricing in Vietnam
Transfer pricing policies and regulations have significantly influenced control mechanisms in Vietnam The evolution of the transfer pricing legal framework aligns closely with international standards; however, several unresolved issues persist within this system To effectively tackle these challenges, the government must implement new and more efficient strategies.
The legal framework governing transfer pricing must be upgraded and improved to align with the fast-paced economic developments It is essential for policies to adapt to the current economic landscape to effectively meet its evolving demands.
Conflicting regulations hinder businesses' ability to comply with the law, emphasizing the need for mutual support and cooperation among them Conversely, gaps in regulations can create opportunities for companies to legally circumvent laws and evade taxation.
Foreign enterprises operating in Vietnam are the primary entities engaged in transfer pricing, necessitating the issuance of regulations and documents in both English and Vietnamese Utilizing a clear and accessible writing style enhances comprehension, enabling businesses to better grasp the regulatory content.
3.4.2 Improving the professional qualifications of officials, especially tax officials
To achieve optimal transfer pricing laws and policies, the influence of human factors is crucial Effective implementation requires government officials to not only comprehend the intricacies of these policies but also to possess strong law enforcement skills.
Tax officials engaging with foreign businesses must enhance their foreign language proficiency to facilitate effective collaboration Additionally, it is crucial for them to stay informed about the current landscape of transfer pricing in developed nations, as this knowledge provides valuable insights for improving transfer pricing regulation and control.
To enhance effective policy implementation, the government should conduct training courses for staff in relevant departments whenever new policies are issued or modified Implementing preferential policies for government officials, particularly regarding remuneration, is crucial for improving transfer pricing control and reducing bribery cases Ensuring financial security for officials can significantly diminish the likelihood of corruption Furthermore, it is essential to enforce strict penalties for bribery among state officials during law enforcement to uphold integrity and accountability.
3.4.3 Developing a legal information channel on transfer pricing
Ensuring information about the transfer pricing legal framework to the business community is also an important part of the success of anti-transfer pricing
A thorough understanding of the legal system allows enterprises to comply with laws more effectively, reducing the risk of missing or incorrect records during tax declaration and payment This not only minimizes administrative procedures but also enhances operational efficiency for both businesses and the state.
Past transfer pricing cases should be accessible on the legal information page to enhance transparency This availability poses a challenge for foreign businesses operating in Vietnam as they navigate the complexities of transfer pricing regulations.
3.4.4 Undertaking other effective preventive measures of transfer pricing
To enhance economic efficiency, it is crucial for the government to implement mandatory measures that prevent transfer pricing from occurring in the first place Proactively addressing this issue, rather than reacting to its consequences, will lead to more effective outcomes in challenging situations.
One of the most effective methods for determining taxable prices is to prevent businesses from altering prices in transactions with associated entities for transfer pricing purposes Advance Pricing Agreements (APAs) have been implemented in various countries to establish market prices in advance through agreements between taxpayers and tax authorities, based on specific criteria such as transfer pricing methods, comparisons, necessary adjustments, and key assumptions about future events When this method is mandated as a standard procedure, it is anticipated to significantly enhance the regulation of transfer pricing in Vietnam.
The hypothetical tax approach, found in the laws of certain countries, empowers tax authorities to make arm's length price assumptions based on government-collected information This allows them to re-assess a taxpayer's taxable income if the taxpayer does not provide market price documentation in a timely manner, particularly during audits Presumptive tax provisions are typically viewed as a last resort to combat transfer pricing manipulation.
Chapter 3 shows that, in Vietnam, Transfer pricing activities are becoming more intricate and sophisticated The consequence of this phenomenon is a major tax loss that the government suffered Although the authorities have undertaken certain steps in the effort to control transfer pricing, the reality of the effectiveness of these measures is not high Chapter 3 has outlined suggestions for Vietnam to control transfer pricing more accurately and effectively These measures are based in part on international experiences analyzed in chapter 2 and partly drawn from the practical situation in Vietnam If applied in practice, it is believed that they will make a positive contribution to Vietnam's transfer pricing control, thereby limiting economic losses and creating a healthy competitive environment for businesses and significant opportunities for Vietnam's economic development
In today's globalized economy, transfer pricing has emerged as a significant challenge for many nations, including Vietnam While globalization offers various economic benefits, it also brings negative repercussions, particularly for developing countries As Vietnam continues to pursue new avenues for economic growth, it must navigate the risks associated with transfer pricing, which can undermine its economic development efforts.