In an effort to strengthen existing transfer pricing rules and enforcement, on 24 February 2017 the Government issued Decree No. 20/2017/ND-CP (Decree No. 20) regulating tax administration with respect to enterprises having transactions with related parties. Decree No. 20 will take effect on 1 May 2017 and creates a new legal framework for related-party transactions in Vietnam and provides certain changes to the current transfer pricing rules which are governed under Circular No. 66/2010/TT-BTC of the Ministry of Finance (Circular No. 66). Decree No. 20 provides detailed guidance on the determination of arm's length pricing of related party transactions, rights and obligations of taxpayers, tax authorities and other relevant authorities. We highlight below some major changes which impact taxpayers in light of this new Decree.
1. Redefining related parties
Decree No. 20 has modified the definition of related parties as follows:
a. It increases the ownership threshold and the owner capital's guarantee/loan threshold to 25% in comparison to 20% as in Circular No. 66;
b. It eliminates the following as a form of related party:
- Transactions between parties in which the volume of transactions accounts for more than 50% of one party's business capacity, including IP/intangible expenses accounting for more than 50% of the cost of goods sold; or where one party supplies the other with more than 50% of its input materials/equipment/products; or where it directly or indirectly controls more than 50% of output products; and
- Business cooperation between parties on contractual basis.
c. It adds the following as a form of related parties:
- An individual's control via capital contribution or direct management of one or more enterprises; and
- One enterprise is actually managed or controlled in decision making by another enterprise.
2. Introducing "substance over form" principle
Decree No. 20 introduces the substance over form principle, which relies on data and actual transactions of related parties for comparison with independent transactions under similar conditions regardless of the form of transactions presented in the agreements of related parties. The tax authorities' power to scrutinize related party transactions from a transfer pricing perspectives will therefore go beyond the form of contracts and agreements.
3. Expense deductibility for enterprise income tax purposes
Decree No. 20 makes the following related party transactions non-deductible for purposes of calculating corporate income tax:
a. Related party transactions that do conform with the substance of independent transactions and do not contribute to the generation of the taxpayers' revenue as described in more details below:
- The related party does not conduct any business activities related to the taxpayers' business(es);
- The related party conducts business but its assets, number of employees and business functions are not commensurate with transaction values;
- The related party does not have rights and obligations related to assets, goods or services provided to taxpayers; and
- The related party are resident of a country or territory which does not impose enterprise income tax or related party does not contribute to the generation of revenue or value added of taxpayers.
b. Services provided by related parties include:
- Services only serving to benefit or create value for other related parties;
- Services which benefit shareholders of related parties;
- The same type of service provided by many related parties, is subject to duplicate charges though is not able to determine the value added for taxpayers; and
- Services in the nature of benefits received by taxpayers due to being members of the group or additional charges by a related party for services provided by a third party through the intermediary of the related party, which does not create additional value for the services.
c. Interest expenses exceeding 20% of net profit before tax plus interest expenses and depreciation/amortization expenses (Earnings Before Interest, Taxes, Depreciation and Amortization).
4. Transfer pricing reporting forms
Taxpayers are required to prepare and file the following forms which require intensive information and must be submitted together with the annual enterprise income tax finalization return:
a. Form 01 on related parties and related party transactions;
b. Form 02 on required information and documentation in the local report;
c. Form 03 on required information and documentation in the group report; and
d. Form 04 on the declaration of transnational profit of the ultimate parent company. For taxpayers being an ultimate parent company in Vietnam, Form 04 is required when the consolidated global revenue during the tax period is from 18,000 billion VND (approx. 789.5 million USD) or more. For taxpayers having the ultimate parent company in a foreign country, taxpayers are required to provide a copy of the declaration on transnational profit of the ultimate parent company in case the ultimate parent company is required to submit this declaration to the tax authority where it is incorporated. If taxpayers cannot provide this declaration, taxpayers must explain in writing the reason, legal basis and regulations of the foreign country which do not allow taxpayers to provide this declaration.
Upon receiving a request by tax authorities during a tax audit, transfer pricing documentation must be provided within 15 working days. During the consultation period before a tax audit, this time limit is 30 working days upon receiving a request by the tax authorities and it can be extended for an additional 15 working days.
5. Exemption from transfer pricing documentation
Taxpayers are partly or fully exempt from preparing and/or maintaining transfer pricing reports or transfer pricing documentation in the following cases:
a. Related party transactions between local taxpayers which apply the same income tax rate and do not enjoy income tax incentives;
b. Total revenue in a tax period is lower than VND 50 billion and total value of related party transactions in a tax period is lower than VND 30 billion;
c. Taxpayers signed advanced pricing agreement (APA); and
d. Taxpayers perform business with simple functions with revenue of lower than VND 200 billion without generating revenue or incurring expenses related to the exploitation and usage of intangible assets and apply a net profit margin before interest and tax over revenue as follows:
- Distribution: 5% or more;
- Production: 10% or more; and
- Toll manufacturing: 15% or more
Decree No. 20 adds more reporting and documentation obligations in addition to the existing ones, which require intensive information and documentation from taxpayers. It is important that taxpayers review their business operations and related party transactions to assess issues and exposures and identify their compliance requirements.