By Tu Ha, Transfer Pricing Director, Duff & Phelps, Vietnam
Vietnam’s government has issued new transfer pricing regulations effective from 20 December 2020 that replace all former transfer pricing regulations.
This marks the fourth time transfer pricing regulations have been officially revised or replaced in Vietnam since the first official transfer pricing regulation was issued in 2006.
Under new Decree 132/2020/ND-CP (Decree 132), taxpayers with cross-border related party transactions during the tax year must lodge the transfer pricing declaration form (Form 01) as an appendix to the annual income tax filing.
Further, transfer pricing documentation must be submitted to the tax authorities in Vietnamese upon receipt of a written request during inspection or consultation.
Failure to comply with these requirements may lead to transfer pricing and tax adjustment, and penalty imposition.
Decree 132 does not make material changes to transfer pricing compliance and transfer pricing inspection principles but addresses certain controversial points in former transfer pricing regulations.
However, some key challenges under the transfer pricing regulations remain and require close attention and careful consideration.
Timeline for transfer pricing compliance and submission
Decree 132 requires that taxpayers in Vietnam complete the transfer pricing documentation before the lodgment of the transfer pricing declaration form.
The regulated deadline for the transfer pricing declaration form lodgment is three months from the end of the taxpayer’s fiscal year. The reason for this requirement is that taxpayers have an opportunity to evidence that their related party transactions are arm’s length or, alternatively, make a self-adjustment based on the transfer pricing study.
Notably, the transfer pricing self-adjustment, if any, under Vietnam’s tax administration rules is only allowed if it results in an increase in the taxpayer’s net taxable income.
This regulated, limited timeline makes it challenging for most Vietnamese taxpayers to complete the transfer pricing documentation in time.
This regulated, limited timeline makes it challenging for most Vietnamese taxpayers to complete the transfer pricing documentation in time
Most taxpayers apply the transactional net margin method (TNMM) in their transfer pricing documentation, which requires benchmarking operating profit based on their audited financial statements.
As audited financial statements are normally available one to two months after the end of the fiscal year, this cuts short the time taxpayers have to undertake the comparison, discuss with related parties, and decide whether a self-adjustment should be made.
Decree 132 also shortens the timeline to submit transfer pricing documentation during the inspection.
Under the previous transfer pricing regulations, the deadline for submission was 15 days from receipt of the request (this was already shortened from the 30-60-day time frame in prior regulations). Decree 132 refers to the Law on Inspection for the information submission timeline, which only provides that enterprises need to follow the timeline set by the inspectors.
According to General Tax’s Decision No. 746 on Tax Inspection, the deadline for taxpayers to provide documentation is 10 days from the request.
In practice, tax inspectors may request that taxpayers submit transfer pricing documentation on the first day of the inspector’s visit at the taxpayer’s premises.
Timing issue in conducting benchmarking study using TNMM
In applying the TNMM, Decrees 132 requires a comparison of the tested entity’s yearly net profit with the profit range of comparable companies for the same year.
This is a departure from regional and international transfer pricing practice in which weighted average data is applied to smooth the yearly fluctuation of enterprises’ business results.
Commercial databases used in transfer pricing studies normally do not have updated financial data of comparable companies for the corresponding year within this 3-month timeframe. This leaves taxpayers little room to prepare documentation using financial data of comparables for the relevant year.
Decree 132 allows the comparison of the tested entity’s profit for a year with the comparables’ profits of the prior year but with strict conditions and adjustment for differences, if any.
However, there is no guidance provided on what comparability adjustment is considered acceptable from the tax authorities’ perspective.
Due to this timing issue and the uncertainty of when the financial data of comparable companies corresponding to the reviewed year is available, there is always a risk of transfer pricing administration burden and underdeclared tax. In particular, tax authorities may require taxpayers to reassess their transfer pricing position and tax declaration (plus additional tax payable and late payment interest) upon the availability of the financial data for the corresponding year.
The use of commercial databases in transfer pricing study
Even though the use of a commercial database in transfer pricing studies has been accepted since 2017, Decree 132 has provided a clearer definition of an acceptable commercial database from the Vietnamese tax authorities’ perspective.
According to Decree 132, “a commercial database contains financial and economic information and data that data businesses acquire, collect, standardize, archive, update and provide via their access support software, manage using tools and applications which are readily programmed, provide utilities supporting users in searching, accessing and using financial and economic data of foreign and domestic enterprises operating in Vietnam, and arranged according to business industries and sectors, geographical regions or search criteria meeting other demands to serve the purposes of comparison and determination of comparable in the process of declaration and management of transfer prices.”
This is an important update of former transfer pricing regulations.
The former transfer pricing regulations either provide no official option for the use of a commercial database in transfer pricing studies (2006-2016), or require that data from commercial databases must be able to be verified by tax inspectors using public sources (2017-2019).
Further, for the first time in transfer pricing regulations in Vietnam, Decree 132 provides that a commercial database can be used as a source of information for authorities to assess the arm’s length nature of related party transactions.
Further, for the first time in transfer pricing regulations in Vietnam, Decree 132 provides that a commercial database can be used as a source of information for authorities to assess the arm’s length nature of related party transactions.
According to Vietnam’s Law No. 38 on Tax administration, tax agencies in Vietnam will have the budget to subscribe to commercial databases for the purpose of tax administration and APA from 1 July 2020.
Together with Law No. 38, Decree 132 creates a legal basis for taxpayers and tax inspectors to reach an agreement during a transfer pricing audit given the same commercial database could be used for discussion and conclusion of a tax inspection.
However, Decree 132 still allows tax inspectors to use their secret database if they are not satisfied with the transfer pricing study provided by the taxpayer.
A new definition of arm’s length range
From 2006-2019, the arm’s length range (or interquartile range) is consistently defined under prevailing transfer pricing regulations as a range from percentile 25 to percentile 75 (or quartile 1 to quartile 3) of the data.
Decree 132 provides a new definition of the arm’s length range, which ranges from percentile 35 to percentile 75 of the computed data from the benchmarking study.
The “inter-quartile range” is no longer acceptable. The key difference from former transfer pricing regulations is the lowest value in the arm’s length range (percentile 35, instead of percentile 25 (or 1st quartile).
According to Decree 132, if an enterprise’s margin is below the arm’s length range, then the enterprise is required to make a self-adjustment in its tax return, using one of the values in the arm’s length range.
This places more pressure on taxpayers to self-adjust for tax purposes compared to years prior to 2020.
Deductibility cap on interest expenses
The cap on the deductibility of interest expense has been a controversial point in Vietnamese transfer pricing regulations.
According to Decree 20, introduced in 2017, the total interest expense (either from the related party loans or independent loans) is limited to 20% of EBITDA.
After more than two years of application, the government relaxed this restriction in mid-2020 by issuing Decree No. 68.
According to Decree No. 68. net interest expense (interest expenses less interest income) will be limited to 30% of EBITDA, and this has retrospective application to 2017 and 2018 (with certain conditions discussed below).
Further, the amount of interest expense that is not deductible in a particular year can be carried forward to be utilized in future years for a period of up to five years.
Decree 132 formalizes this deductibility cap and requires that taxpayers file the revised declaration forms for years 2017 and 2018 before 1/1/2021.
Decree 132 limits the retrospective application for the 2017 and 2018 years.
In particular, the retrospective application for years 2017 and 2018 is only applied if there is an overpaid tax in 2017 and 2018 due to the change in regulated interest expense cap.
In practice, tax overpayment is not always the case. For example, if an enterprise reports a loss (in particular negative EBIT) in those years, then according to the limitation under Decree 132, all interest expenses for 2017 and 2018 will not be considered deductible, and there will also be no carried forward of nondeductible interest expense.
Country-by-country reports
Decree 132 provides that taxpayers are obliged to inform or submit reports if their overseas ultimate parent company is subject to country-by-country reporting compliance requirements in the ultimate parent company’s jurisdiction.
According to Decree 132, Vietnamese tax authorities accept the automatic exchange of information mechanism for country-by-country reporting if a multilateral competent authority agreement between Vietnam and the ultimate parent company’s jurisdiction is effective and automatic exchange of information is available.
However, as of 31 December 2020, Vietnam has not signed any competent authority agreements and Vietnam has not yet set any date for first year of automatic exchange of information commitment according to the November report of OECD’s Global Forum on Transparency and Exchange of Information for Tax Purposes.
Local taxpayers will have to submit a different notification on information of the ultimate parent company or the reporting entity depending on whether the ultimate parent company chooses to submit the country-by-country reporting via a local subsidiary or a reporting entity.
From the Vietnam tax authorities’ perspective, a qualified reporting entity should firstly be an overseas entity incorporated in a jurisdiction in which country-by-country reporting is required. Secondly, there must be an effective competent authority agreement between Vietnam and the reporting entity’s jurisdiction, and the automatic exchange of information is available. Apparently, the ultimate parent company must officially appoint either a local subsidiary or a reporting entity to submit the country-by-country reporting on its behalf.
The appointment and the notification must be submitted by the end of the ultimate parent company’s fiscal year, and then the country-by-country reporting must be submitted within one year from the end of the ultimate parent company’s fiscal year.
New considerations and challenges
Overall, the shorter timeline for transfer pricing documentation, the official use of commercial databases by tax authorities, the timing issue in conducting TNMM benchmarking studies, the new definition of arm’s length range, the change in the interest deductibility cap, and the new country-by-country reporting requirements trigger the need for a review of taxpayers’ approach to transfer pricing compliance in Vietnam.
Decree 132 brings the transfer pricing administration in Vietnam somewhat closer to the overall global transfer pricing practice, but there remain several uncertainties and challenges for Vietnamese taxpayers in practice.
Steven Carey, Transfer Pricing Managing Director, Duff & Phelps, Hong Kong, and George Condoleon, Transfer Pricing Director, Duff & Phelps, Sydney, contributed to this report.
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