With hundreds of millions of dollars in tax revenue being lost in recent years the fight against transfer pricing has become a top priority for tax authorities.
Losses of VND16,500 billion ($775 million) claimed by companies were rejected by taxation authorities following inspections from 2010 to 2013, resulting in arrears and fines totalling VND5,000 billion ($250 million). Inspections from 2007 to 2012 identified thousands of companies, including 122 foreign invested enterprises (FIEs) in 23 different provinces, conducting transfer pricing activities with related entities. Remarkably, the adjusted transfer prices according to authorities were nearly three times higher than the figures reported by some of these FIEs.
Mr Tran Quang Chieu, a member of the National Assembly’s Finance and Budgetary Committee, believes that transfer pricing is a crucial issue and serious action must be taken. “Such acts distort Vietnam’s economic landscape,” he said. “State budget funds are lost, the country’s property is stolen, people’s labour is exploited, and the faith of the genuine business community is significantly eroded.”
The author of “The Vietnam Provincial Competitiveness Index: Measuring Economic Governance for Private Sector Development”, Mr Edmund Malesky from Duke University in the US, sees transfer pricing as an “ordinary” activity of most enterprises, as their ultimate goal is maximising profits. He acknowledges, however, that when such a strategy is misused or implemented too frequently, government intervention becomes necessary.
In the first two months of this year the General Department of Taxation (GDT) completed ten enterprise inspections and increased aggregate revenue by VND3,500 million (more than $164 million) and collected in excess of VND200 billion (nearly $10 million) in tax arrears for the State budget. If all suspicious enterprises were to be inspected then arrears for tax evasion through transfer pricing would certainly be much higher.
Levelling charges of transfer pricing against any enterprise and assessing the impacts on the State budget will never be straightforward until tax authorities are able to gather comprehensive information regarding actual activities by enterprises. Experience from around the globe shows that it generally takes at least a year to collect sufficient detailed data. In Vietnam it takes authorities time to evaluate and carry out inspections to verify whether an enterprise is truly suffering losses or applying transfer pricing methods.
Ms Nguyen Thi Hanh, Deputy Head of the Modernisation & Reform Division at GDT, said that multinational corporations (MNCs) are extremely experienced and skilled in applying such strategies to evade their tax obligations, not to mention the teams of professionals and experts at leading audit and consultancy firms who advise them. “The fight against transfer pricing is extremely complex, requiring a high degree of expertise and relatively high-tech working conditions,” she said, both of which are lacking in Vietnam.
It was only in 2012 that content regarding the management of transfer pricing was placed in the drafts of the Law on Tax Administration, the Law on Corporate Income Tax (CIT), and amendments to the Law on Enterprises. Only then did fighting transfer pricing became a political mission not of only the Ministry of Finance (MoF) but also of various related sectors and localities. Before that, taxation authorities had no specialised transfer pricing management unit, with the task being carried out under a collaborative effort among several departments. Management capability was therefore limited, as these departments were insufficiently active, data and information was inadequate, and inspections were neither widespread nor intensive.
The number of FIEs claiming losses has substantially declined since strict inspections were conducted by State management agencies. Many enterprises have consequently reported earning profits rather than incurring losses, as previously, with some admitting to implementing incorporated transactions with other entities within their corporation. Nonetheless, Mr Bui Van Nam, General Director of GDT, said that Vietnam still lacks specific legislation in terms of resolving such issues. “Our existing sanctions are not strong enough to put an end to transfer pricing or tax evasion,” he said.
Having encouraged FIEs to come Vietnam it is the country’s responsibility to introduce laws and control mechanisms rather than simply hoping FIES will not engage in transfer pricing. “One of the solutions Vietnam may consider is reducing the CIT to a lower level or even eliminating it,” Mr Malesky suggested. “The government could balance its budget by increasing the personal income tax rate.” This strategy has been experimented with in Singapore and Ireland, where results fell well short of expectations. “The simplest thing Vietnam could do is to maintain a stable Law on Taxation,” Mr Malesky emphasised.
With the reform strategy for the taxation system in 2011 - 2020 having been passed, taxation authorities have firmer legal ground to fight transfer pricing in the long term. MoF is also now compiling circulars and decrees on valuation methods under the amended Law on Tax Administration for a pricing agreement mechanism. The Advanced Pricing Agreement (APA) mechanism will come into force from July 1 as an anti-transfer pricing method focusing on FIEs and is expected to reduce losses to the State budget while allowing enterprises to be more active in business planning and meeting their tax obligations.
The most important question, however, is whether any of the giants suspected to be engaged in transfer pricing will apply for an APA, which are strictly voluntary. In theory, an APA provides taxpayers with many benefits, including having a relatively accurate forecast of tax obligations within a certain period of time (from three to eight years), eliminating uncertainty over tax obligations, removing the need for inspections, legalising transfer pricing within a permitted quantum in accordance with the APA, and eliminating the risk of double taxation, among others.
In reality, the actual application of APAs in developed nations show that enterprises only apply for an APA voluntarily when the agreed CIT rate is lower than the CIT rate they would have to pay if tax audits were to take place. This means that an APA only works if tax inspections are carried out regularly and strictly, which is not happening because of limitations among authorities in fighting transfer pricing. APAs may also create an environment for corruption, as it would be near on impossible to ensure that tax officials don’t collude with enterprises when negotiating the agreement, especially given that the GDT is critically short of references for such negotiations. It may also be impractical to agree on an advanced price that will remain unchanged for the three-year minimum, as it may change significantly after just one year due to market fluctuations, inflation, or other factors.
MoF is committed to implementing synchronous measures to prevent transfer pricing, such as completing the guidance circular on APAs and training and enhancing the capabilities of tax officials using case studies and exercises. It is now cooperating with the delegation of the European Union in Vietnam, the Organisation for Economic Cooperation and Development (OECD), and the World Bank to implement this training programme.
Collaboration between authorities has been fostered both domestically and internationally. In Vietnam, the GDT will coordinate with the General Department of Customs to determine the value of machinery, equipment, and raw materials at import, in order to prevent enterprises from reporting higher costs. Globally, MoF is cooperating with other international organisations as well as taxation authorities in other countries to build a database of independent enterprises’ profit margins in sectors with high potential for transfer pricing, as basic reference tools for GDT analysis. Vietnam has also signed agreements on double taxation avoidance with more than 60 countries and territories to date.
The fight against transfer pricing is being executed in an aggressive manner. It must be borne in mind, however, that it is down to Vietnam to improve its policies and create a fair legal framework for both foreign and domestic investors. Benefits to the State and to investors must strike the right balance.
“The Provincial Competitiveness Index 2013 covers the opinions of 1,609 foreign-invested enterprises operating in Vietnam’s 63 cities and provinces in order to place provincial competitiveness in the broader context of Vietnam as an international investment destination. The difference between the means is 0.199 or 20 per cent, indicating that 20 per cent of respondents engaged in transfer mis-pricing in the past year. The [above] table reveals the results of this analysis. Indeed, we find that 65 per cent of extremely profitable firms (with margins greater than 20 per cent) admit to engaging in the practice. Similarly, 44 per cent of highly profitable firms, 12 per cent of moderately profitable firms, and 9 per cent of positive but low margin operations also engage in the practice. In general, loss-making firms do not employ income shifting techniques. About 30 per cent of firms with small losses (between 0 and 5 per cent) admit to the practice. This is interesting, because this most likely captures highly sophisticated firms who use transfer mis-pricing to push themselves to just below the margin of profitability that exempts them from CIT payments.
Source: Provincial Competitiveness Index 2013, administered by the Vietnam Chamber of Commerce and Industry (VCCI) with support from the US Agency for International Development (USAID)