Transfer pricing focus in store for overseas-invested groups

Transfer pricing focus in store for overseas-invested groups

All FIEs is highly recommended to prepare well for possible tax audit 2020, especially regarding
transfer pricing requirements.

The extent of economic restraints caused by the COVID-19 now cannot be known, but also the Vietnamese economy
will not grow as estimated until recently. This will also make it necessary to reduce the estimation regarding the tax
revenue from normal tax declarations. It can be assumed, that this re-estimation will further increase the expectation
of the Government of Vietnam, that the Vietnamese tax authorities will increase the additional revenue from tax audits.

Doing business and investing in Vietnam is not always easy, but regulations have been becoming more streamlined over
the years. One important point is that especially foreign-invested enterprises (FIEs) must be increasingly more aware of
tax issues, in particular regarding transfer pricing. Compliance with legal requirements on transfer pricing is becoming
more important.

The tax authorities have already been instructed to increase revenue by enforcing an increase in compliance of taxpayers.
For the Tax Audits 2018, the General Department of Taxation instructed the tax authorities to focus on implementing a
software-based risk analysis system and especially target FIEs.

The basic principles stated for the audits 2018 are to be applied also in the following years. For 2019, the Ministry of
Finance (MOF) instructed the tax authorities to additionally focus on evasion and fraud. This year, the MOF instructed
them to focus on value-added tax, transfer pricing, anti-smuggling and trade fraud. Besides that, all three regulations are
establishing a systematic approach to tax audits. The intention is to reduce the importance of the special relationship of
the taxpayer to the local tax officer, which in the past was very crucial.

Regulations Tightened

Details of transfer pricing are complex, but the basic idea is simple. Different countries cooperate on putting an end to
tax avoidance strategies which exploit the difference in the national tax systems. By means of many different instruments,
countries try to secure a fair share of tax for the respective country. Contracts between companies within the same group
are checked whether they are having the same terms and conditions which would have been agreed between non-related
entities for comparable transactions.

Until now, transfer pricing issues of FIEs in Vietnam in many cases have not been taken very seriously. The current regulation
became effective with May 1, 2017. It is expected, that tax authorities will identify within the audits in 2020 some cases of
non-compliance.

The transfer pricing documentations must be available at the deadline of the Corporate Income Tax (CIT) finalization
submission at the 90^th day of the following the financial year. The transfer pricing documents must consist of local master
file and should be prepared in Vietnamese. Upon request of tax authorities, the transfer pricing documents be filed within
15 working days.

No transfer pricing documents must be prepared by companies with the total revenue below VND50 billion ($2.2 million),
related party transactions below VND30 billion ($1.3 million); signed an Advance Pricing Agreement (APA) and a submitted
annual report as far as the transactions are covered by the APA.

A business will not have to prepare transfer pricing documents if the company has only simple function or no revenue or
expensesfrom exploitation or use of intangibles, a total revenue of less than VND200 billion ($8.6 million) and the following
pre-loan interest and pre-CIT net profit over turnover ratios, including the distribution, at 5 per cent or more, as well as for
production 10 per cent or more and processing 15 per cent or more.

All FIEs is highly recommended to prepare well for possible tax audit 2020, especially regarding transfer pricing requirements.
For companies who set the calendar year as financial year, the transfer pricing documentation must be ready before end of
March 2020. It must be submitted to tax authorities within 15 working days upon request of tax authorities.

Prime target for these audits will be companies with high risk signals on tax and transfer pricing, such as not being audited for a
longer time; having a high revenue, loss or unusually low profit, tax incentives and allegedly illegal invoices.

Moreover, companies in real estate, oil & gas, electricity, and finance as well as franchises and enterprises with new and special
business lines; will most likely be targeted. Especially scrutinized will be the production cost and all high value transactions such
as interest, royalties and service fees of all kinds.

On 01 July 2020 the new law on tax administration will come into force. Some important principles are not new, but now formulated
more clearly. One of the crucial principles is the rule of substance over form. This means that a certain business transaction is taxed
according to the economic content.

It is applicable for the matter of taxation regardless whether the used form as such is legal or not. If using certain forms is not
following economic reasons except for reducing taxation, this form might be ignored for calculating the tax.

The tax environment in Vietnam is changing rapidly, and the country’s regulations are mostly clear. Some requirements regarding
accounting and taxation are more bureaucratic than in other countries. In the past, the pressure for tax compliance was not very
high. However, because the tax authority is increasingly using electronic tools for tax audits, the transparency within their system
is dramatically increasing.

Because the targets for the additional tax revenue generated by the audits are clear and high, and the state must generate more
revenue,the pressure on companies with a not fully compliant regime on managing internal contracts, accounting and taxation
will become very high. Such pressure already exists in most highly developed countries for many years.

The Dutch Sandwich

Multination corporations are combining the benefits of the tax laws of many countries by allocating profits where they are not taxed
or taxed at a low rate. This requires a sophisticated system of agreements between the national legal entities of the same group.

Each of these contracts is compliant with the relevant national laws, if not considering regulations on transfer pricing. But the
combination of these contracts lets the multinationals achieve the desired result of avoiding income tax. One of these systems is
called the Dutch Sandwich.  It was developed with this intention for groups with intellectual property of considerable value.
A company in a Country A, with a normal tax rate on corporate income, is paying royalties to a company in the Netherlands for
using its intellectual property. Country A is not imposing any withholding tax on these payments on royalties.

The receiving company in the Netherlands is not making any or only a minor profit because it is paying royalties itself to a company
registered, for example, in Bermuda. Also, the Netherlands is not imposing a withholding tax on these payments on royalties.
The company on the Bermuda is owner of the intellectual property and is collecting the royalties free of corporate income tax.

Now, the Netherlands intends to impose a withholding tax on paid royalties. New tax avoidance models are built to circumvent
any new legislation. The higher the profit is, the more efforts a group may make to avoid taxation of this profit. Because the cost of
developing and implementing these systems is high, they are only used by large corporations.

In less sophisticated models, profit-making companies are paying overrated prices for services provided by the headquarter or
affiliated companies.

Wolfram Gruenkorn
Chairman of the Members Council