Make or break, first APA concluded
By Hoang Thuy Duong, Huynh Nhan and Tran Thi Thuy Ha of KPMG in Vietnam.
Alongside the worldwide trend of international tax reforms resulting from the OECD's recommendations in the BEPS Action plan, Vietnam has re-written its transfer pricing regulations. A government decree (No. 20/2017/ND-CP) dated February 24 2017 regarding the administration of transfer pricing matters, sets the foundation for post-BEPS regulations in the country. The Ministry of Finance's Circular No. 41/2017/TT-BTC dated April 28 2017 provides guidance on some articles of Decree 20.
Decree No. 20/2017/ND-CP and Circular 41/2017/TT-BTC – The new transfer pricing regulations, with effect after May 1 2017 is considered a major watershed for the transfer pricing state of affairs in Vietnam, providing absolute clarity of contemporaneous documentation requirements, together with the introduction of transfer pricing directives and guidance that mirror some of the key BEPS recommendations. With these actions, the Vietnamese government aims to prevent the potential loss of tax revenue and tackle abusive transfer pricing practices.
More than ever, foreign and Vietnamese multinationals should be much more diligent about their transfer pricing arrangements, by taking relevant actions to ensure consistency with mandatory filing requirements from the parent company in accordance with BEPS regulations of their country of residence and in connection with the trade agreements signed with Vietnam.
For many multinationals, this will be a significant and fundamental change from their historical transfer pricing practices and they should be prepared to extend documentation compliance efforts to review their transfer pricing policies and strategy and prepare proactive defence plans to navigate the contemporary tax framework in Vietnam.
As the decree is coming into effect, the expectation is for the Vietnamese Tax Department to enhance its capacity building accordingly and maintain interaction with relevant international organisations to enforce the decree in an efficient manner, especially in instances where income may go untaxed when dealing with foreign related parties, but should also enable businesses investing in Vietnam under non-harmful tax practices to ease the administrative burden to operate in the country.
Vietnam has established a steering committee, led by the director general of the General Department of Taxation, with a mandate to work on all BEPS actions beyond transfer pricing.
Specific developments in relation to BEPS Action 13
The new transfer pricing regulations under Decree 20 align with recommendations from the OECD's BEPS Action 13, including documentation requirements for a transfer pricing package consisting of:
i) A master file containing standardised information relevant for all multinational enterprises (MNE) group members;
ii) A local file referring specifically to related party transactions of the local taxpayer; and
iii) A country-by-country reporting (CbCR) related to the MNE's income and taxes paid together with certain indicators of the location of economic activity within the MNE group. This reporting is required in the following cases:
a) Taxpayer is the ultimate parent company of a group in Vietnam which has global consolidated revenue in the tax period exceeding VND18,000 billion (€750 million, $836 million); and
b) Where overseas ultimate parent company is required to submit a CbCR to a foreign tax authority in their respective jurisdiction, the Vietnamese taxpayer is required to submit a copy of such CbCR. Failure to do so, Vietnamese taxpayer requires to submit written explanation to the local tax authority.
Decree 20 and Circular 41 provide details and guidance for mandatory disclosure forms of related party transactions (i.e. Form 01); and the content and documents required in the local file (i.e. Form 02), master file (i.e. Form 03), and CbCR (i.e. Form 04). Forms 02 to 04 mirror the requirements under BEPS Action 13 with minor departures.
Changes to local transfer pricing legislation
The new transfer pricing regulations consider key elements provided in BEPS Actions 8 to 10, including a 'substance over form' standard; measures for the comparability of related-party transactions against independent transactions; consideration of development, enhancement, maintenance, protection and exploitation (DEMPE) functions with respect to intangibles; and guidance on tax deduction for intra-group service expenses.
With the introduction of the 'substance over form' principles, the new regulations aim to modernise the transfer pricing regime beyond the review of contractual arrangements to the analysis of business substance linked to value creation. Vietnam-based subsidiaries, as part of multinational groups will be required to revise their current transfer pricing policies with coherent, consistent and more evident alignment of substance and value creation to distinguish the entrepreneurial role of parent or holding companies, together with a solid connection with intangible ownership, risks assumed and controlled, and higher transparency to address the relevant transactions for the local file.
Similarly, an increased level of scrutiny is expected for local subsidiaries performing royalty payments related to the use of intangibles which may not be appropriate related to intermediate or semi-finished goods, and those subsidiaries with payments for management and administrative services that may lack of proper support to demonstrate the benefit received by the local entity and the methodology to calculate the fee. These transactions may be considered as harmful tax practices by the General Department of Taxation in Vietnam.
However, 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. The application of such principles will enable the tax authorities to disregard or re-characterise related-party transactions in instances when those result in reduced tax revenue.
Timeline for preparation and submission of TP documentation package
The contemporaneous documentation requirement is clearer and stricter as the decree states that documentation package must be prepared before the annual corporate income tax (CIT) finalisation deadline (i.e. 90 days after fiscal year-end under Vietnam's laws).
In the event of a tax audit, the TP documentation package is required to be submitted within 15 working days from receiving formal request to provide information. If an acceptable reason is provided, the submission deadline may be extended by the tax authority only once with an additional 15 working days upon the former expiry date.
Certain thresholds are also provided for exemption from documentation rules (but submissions of Form 01 is still required) in the following cases:
i) Taxpayer having annual revenue which does not exceed VND50 billion ($2.27 million) and the total value of related-party transactions does not exceed VND30 billion ($1.36 million); or
ii) Taxpayer has concluded an APA; or
iii) Taxpayer who performs routine functions and does not generate revenue or incur expense from exploitation and use of intangibles, has annual revenue not exceeding VND200 billion and a ratio of net operating profit before interest and CIT to net sales revenue (i.e. operating margin) exceeding 5% for distributors; 10% for manufacturers; and 15% for toll manufacturers.
Hierarchy regarding the use of comparable transactions or companies
The priority order in selection of comparables transactions or companies is provided under Decree 20 (with further guidance under Circular 41), with requirements on the analysis of quantitative and qualitative comparability and material differences when selecting foreign comparable in other geographic regions. Specifically, the hierarchy order which should be followed by taxpayers is stipulated as follows:
i) Internal comparables of the taxpayers (e.g. comparable uncontrolled transactions);
ii) Comparables located in the same country, territory of the taxpayer (i.e. Vietnam); and
iii) Comparables located in the region which have similar industry condition and economic development level (e.g. South East Asia or developing countries).
The taxpayer is expected to elaborate in detail on the efforts performed to follow the above mentioned hierarchy when preparing the transfer pricing documentation package.
Use of secret comparables for risk assessment purposes
The use of secret comparables is considered to be primarily for tax risk assessments by the tax authority 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 in this regard, saying that the tax authority may use different sources of information, including commercial databases and publicly available data, including their own database and information provided by some ministerial bodies for the purposes of transfer pricing risk assessment and tax adjustment. However, in transfer pricing audit cases where taxpayers fail to submit the required disclosure forms or transfer pricing documentation package 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.
Year-end transfer pricing adjustments
Decree 20 and Circular 41 outline the use of year-end adjustment resulting from transfer pricing that increase the taxable income of the local taxpayer (i.e. upward adjustment). However, restrictions may apply to disregard downward adjustments resulting in lower taxable income for the local entity at year end, unless an advance pricing agreement (APA) is in place.
This approach may not reconcile with current practices in other countries, and therefore it should be analysed with high care by local taxpayers in conjunction with their parent company. Furthermore, Circular 41 remarks that non-adjustment leading to the shortfall of tax amount is deemed to violate the transfer pricing regulations and subject to the tax assessment.
Limit on interest deduction
A tax deduction limitation for interest expenses is also introduced in Decree 20 in consideration of BEPS Action 4, with a fixed ratio rule that caps the interest deduction to 20% of earnings before interest, taxes, depreciation and amortization (EBITDA).
Dispute resolution (including APAs)
Advance pricing agreements
APAs are available in unilateral, bilateral or multilateral forms under Circular 201/2013/TT-BTC dated December 20 2013 of the Ministry of Finance. There are now more than 10 APAs under different stages of the process, including pre-filing, evaluation, and negotiation. KPMG in Vietnam advised a client to have concluded Vietnam's first APA which is the only one ever concluded in the country.
Transfer pricing administrative appeals, judicial procedures and mutual agreement procedures (MAPs)
Technically all of these alternative dispute resolution options are available under Vietnam's laws and double tax treaties in effect. In practice, the appellation process is often lengthy with mixed results, judicial unpopular processes and MAPs not very productive.
The common effective options are to be compliant and defensive in an audit that requires taxpayers to be responsive to and cooperative with the tax authorities.
Litigation actions towards tax authorities before the court continue to be rare in Vietnam. The vast majority of audits that resulted in transfer pricing reassessments were resolved at the tax department level, however, the year 2016 marked a precedent for the first litigation case on transfer pricing that was brought to Vietnam's court with the Provincial Tax Department as the defendant.
This litigation case was ultimately resolved in favour of the taxpayer, as the judge recommended the tax authority to enter into reconciliations. During the reconciliation process, the tax authority agreed to withdraw the transfer pricing assessment decision and recalculate the tax liability using an independent benchmarking report, in which KPMG Vietnam directly assisted the taxpayer and acted as a litigation advisor, thereby defeating the tax authority's use of secret comparables on legal basis.
The final settlement at court not only alleviated financial liabilities for the taxpayer, but more importantly set good precedence on use of commercial database in transfer pricing audits.
Time for readiness in Vietnam
The unveiling of Decree 20 is expected to result in higher level of transparency between taxpayers and tax authorities beyond the boundaries of Vietnam, given that for the first time tax authorities will have, via the master file and CbCR, a clearer view of where value is created, and in which tax jurisdictions multinationals make profits and pay taxes.
Navigating the proliferation of BEPS-driven requirements will require careful risk based approach to reduce the likelihood of challenges, limit potential double taxation, and align tax goals with business objectives, particularly since new rules always raise interpretation issues.
Taxpayers should consider conducting a comprehensive risk assessment and readiness analysis for the regulatory change to understand their particular impact, and adherences or differences of their current transfer pricing policies with the new regulations and ensure full compliance in Vietnam.
Hoang Thuy Duong
KPMG in Vietnam
46th Floor, Keangnam Hanoi Landmark Tower, 72 Building, Plot E6, Pham Hung Street, Me Tri, Tu Liem Hanoi
Tel: +84 4 3946 1600 (ext 6406)
Duong has been with KPMG for close to 17 years, including 15 months at KPMG Australia's Global Transfer Pricing Services and Corporate Tax practices.
Duong has advised multinationals on tax, customs and transfer pricing planning, compliance and dispute resolution, supply chain tax planning and business restructuring. He has provided tax due diligence and structuring advice for corporate transactions in various sectors, including industrials, automotive, FMCGs, financial services, infrastructure, IT, and the Japanese market.
Duong was the engagement partner of several dozens of transfer pricing audit and dispute resolution engagements, and many of these cases were resolved successfully either in the audit, appellation or in one court case (the only court case on TP adjustment in Vietnam so far). Duong was invited to speak to the central and provincial fiscal and non-fiscal authorities on international best practice of transfer pricing audits and local practical issues. Having been the engagement partner for a transfer pricing capacity building project with the General Department of Taxation (GDT), Duong advised on the conclusion of Vietnam's first advance pricing agreement (APA), which is the only APA concluded so far. Duong has provided advice to the General Department of Taxation and Ministry of Finance in relation to the Decree 20/2017/ND-CP on transfer pricing management in line with BEPS Action 13, including the consideration of practical issues in local transfer pricing audits of multinational corporations operating in Vietnam.
KPMG in Vietnam
10th Floor, Sun Wah Tower
115 Nguyen Hue Street
District 1, Ho Chi Minh City
Tel: +84 8 3821 9266 (ext 8909)
Nhan specialises in tax and customs advisory services, particularly in tax and duty planning and restructuring, tax efficient supply chain management, and tax dispute resolution and controversy services.
Nhan is responsible for providing regular tax and customs consulting services to many local and international clients. He has assisted many multinational companies on their investment structuring, corporate formation and reorganisation, mergers and acquisitions, tax and customs planning and compliance.
Nhan has extensive hands-on experience in representing clients and dealing with local authorities on customs and taxation issues.
He has been invited to speak at forums and seminars on Vietnam's inbound investment, customs and taxation.
Nhan holds his bachelors from the University of Melbourne, Australia.
Nhan speaks, reads, and writes English and Vietnamese fluently.
Tran Thi Thuy Ha
KPMG in Vietnam
46th Floor, Keangnam Hanoi Landmark Tower
72 Building, Plot E6, Pham Hung Street
Me Tri, Tu Liem, Hanoi
Tel: +84 4 3946 1600 (ext 6516)email@example.com
Ha is a tax and transfer pricing director in KPMG's Global Transfer Pricing Services, Trade & Customs and Value Chain Management advisory team in Hanoi.
Ha has been with KPMG for nine years, including with KPMG Australia, Sydney Global Transfer Pricing Services group under an international assignment.
Ha has advised a wide range of multinationals from Australia, Europe, the US, and Asia-Pacific region in diverse industries including consumer/industrial goods, media and entertainment, financial services, electronics, forwarding and logistics, and IT, on tax, customs, and transfer pricing compliance and planning, and inbound investment.
Ha's sector experience includes transfer pricing, taxation, trade and customs.
Ha was the engagement director of several dozens of transfer pricing audit and dispute resolution engagements where many of the cases were resolved successfully either in the audit or appellation. She was initiated to speak to the central and provincial tax authorities on international best practice of transfer pricing audits and local practical issues.
Ha is directly involved in consultation with the General Department of Taxation and Ministry of Finance in relation to the Decree 20/2017/ND-CP on transfer pricing, including the consideration of practical issues in local transfer pricing audits of multinational corporations operating in Vietnam.