Amid ongoing problems for the State budget, companies considered to be not paying their fair share of tax are obvious targets for authorities. Over the last couple of years Vietnam has significantly increased transfer pricing enforcement activities to tighten the screws on those using the practice. A series of investigations launched by the General Department of Taxation (GDT) have recently shone light on the abuse of transfer pricing by foreign-invested enterprises (FIEs). Last month the GDT released a report highlighting widespread tax violations with signs of transfer pricing by 20 FIEs. The agency reclaimed VND230 billion ($10.9 million) in taxes and fined these enterprises VND12 billion ($571,428) for their violations. Notably, all 20 FIEs accepted the penalties without appealing.

Case in point

    Keangnam Vina is renowned for developing Vietnam’s tallest skyscraper - the Landmark Tower in Hanoi. Ironically, it is also now known for tax violations. An investigation conducted by the Hanoi Department of Taxation revealed several irregularities and concluded that Keangnam Vina used transfer pricing tactics to lower its tax corporate income tax (CIT) bill. Consequently, the Ministry of Finance (MoF) has asked Keangnam Vina to adjust its revenue and profit calculations and pay $4.5 million in tax arrears.

    Since it began operating in Vietnam in 2007, Keangnam Vina has reported losses every year and was yet to pay any CIT. The Landmark Tower was opened in the first half of 2011, earning the company $250 million in revenue since but total losses of $6.7 million were reported. Tax authorities, however, took note and recalculated the costs and earnings from the company’s reported data. Among other things, one red flag was Keangnam Vina’s contract agreement with the South Korea-based Keangnam Enterprises, with which it shares the shame parent company and which was an EPC contractor on the Landmark Tower project. It’s worth mentioning that the contract stipulated that Keangnam Vina would pay the Keangnam Enterprise $871 million for these services.

    In this case, the fee Keangnam Vina paid to Keangnam Enterprises was so high that no profit could possibly be made by the former. In other words, by paying such a large amount of money to its sister company, Keangnam Vina incurred losses and subsequently avoided paying CIT as Vietnam’s tax policy absolves loss-sustaining companies from tax payments. Meanwhile, Keangnam Enterprises made a fat profit from the deal. In coming to this arrangement Keangnam Vina was successful in shifting part of its profits back to South Korea and keeping its profit out of the reach of Vietnamese tax authorities. One observer, Mr Nguyen Mai, Chairman of the Vietnam Association of Foreign Invested Enterprises, pointed out that three or four years ago Vietnam had a suspicion that some large FIEs were abusing transfer pricing tactics but the country has not been quick enough in formulating policy responses.

    In late 2012 authorities began an investigation into possible transfer pricing by Keangnam Vina through related party transactions. Investigators discovered major profits from the developer that were previously unreported and so far has identified $4.5 million in unpaid taxes.

    Tax authorities are rightly concerned that the case may be just the tip of the iceberg, as Keangnam Vina was one of 122 FIEs found to have used transfer pricing to avoid paying a total VND214 billion ($10.1 million) in taxes. In reality, authorities face a number of obstacles in attempting to combat this behaviour. “The first task is to identify which companies are more likely to be abusing transfer pricing principles and focusing investigations on them,” said Mr Tom Prescott, Manager of Tax Services at Grant Thornton Vietnam. “Automatically assuming that all FIEs are avoiding tax is unlikely to yield positive results.” Another difficulty is that tax authorities lack the experience and resources to combat tax avoidance. Many global auditing firms invest heavily to sell transfer pricing schemes but Vietnam is yet to have a specialised unit to regulate such activities, not to mention the fact that tax authorities have not been authorised to conduct audits, making it difficult for them to handle an already challenging task.

Common tactics

    For years, Vietnam has enticed foreign investors by offering relatively low tax rates and other incentives and FDI, as a result, has flooded in. With many FIEs claiming to be recording losses in Vietnam, the obvious question is why they insist on continuing to invest in the country. A number of FIEs manipulate import and export prices to avoid taxes and are overcharged for equipment and products by their parent companies, who also buy the resulting output at very low prices. In this way the Vietnamese entity reports losses and gets away with paying no tax or very little relative to the actual profits, which are shifted away from Vietnam.

    FIEs, like any other type of enterprises, try to exploit any legal loopholes and to not do so would be to put themselves at a competitive disadvantage. And the prospect of being taxed twice on the same profits makes transfer pricing attractive to FIEs but it can also be easily abused. FIEs, though, may find that success in avoiding taxes makes them unpopular with their host country and other honest taxpayers.

    Investigations by local authorities found that the most common tactic to evade tax was profit shifting. This happens when subsidiaries in different countries charge each other for goods or services sold within the parent company. “Much like what has been seen in the Keangnam Vina case, profit shifting came from manipulating transfer pricing to overstate costs when importing from subsidiaries belonging to the same company in other countries, and to then understate export values,” said Mr Vo Tri Thanh, Deputy Chairman of the Central Institute for Economic Management (CIEM). “This is particularly common among companies that have a lot of intellectual property, the value of which is extremely subjective.”

    Base erosion and profit shifting must be tackled, Mr Prescott recommended, and he also believes that there are a number of other actions that would assist reducing such abuses. “The first is to remove the incentive, such as lowering the domestic corporate tax rate, which is already in progress, to make it more closely aligned with tax rates in the region, and to allow consolidated domestic filing,” he said. Another step, he went on, would be to make compliance easier for companies, and put more severe sanctions on failure to submit transfer pricing returns, which currently carry a negligible fine. Lowering the tax rate to prevent the abuse of transfer pricing may be tempting, but Mr Thanh from CIEM feels that this is not enough. “FIEs that consider maximising profits to be the top priority will still find a way to avoid paying tax,” he said. “This is why Vietnam should be very careful with any decision to lower tax rates, as it may create an imbalance between local enterprises and FIEs.”

    Vietnam is not alone in lacking experience in handling transfer pricing issues and many developing countries are currently facing a similar situation. The recent Advance Pricing Agreement (APA) guidance is seen as a positive step towards making transfer pricing more transparent and reducing the risks of uncertain pricing positions by taxpayers. However, concerns over confidentiality of information and the costs involved in negotiating an APA are likely to restrict the number of taxpayers that are ready and willing to pursue such agreements. More detail on the format that any analysis should follow and approved information sources such as independent information databases and government statistics would also help to reduce the uncertainty taxpayers face and as a result increase compliance.

    No country, even the richest, wants its tax base to suffer because of transfer pricing. This is why transparency is widely canvassed as key to counter the practice. There seems to be a growing understanding that Vietnam should develop mechanisms that require all companies, foreign and domestic alike, to prepare transfer pricing analyses and documents on a contemporaneous basis, the nature of their business, and their related party transactions, and use appropriate data to calculate the arm’s length price. “In addition to preparing these analyses, companies should be required to submit an annual transfer pricing declaration,” said Mr Prescott. “Based on these declarations, tax authorities would be in a position to identify higher risk taxpayers and investigate accordingly.”