A man carries boxes of Coca-Cola at a soft drink shop in Ho Chi Minh City. The media reported last month beverage giant Coca-Cola is under suspicion of avoiding taxes in Vietnam. The beverage giant has reported losses every year since entering the Vietnamese market in 1994, but is still seeking to expand further in the country. Photo: Dao Ngoc Thach
A cut in corporate income tax may not stop abuse of transfer pricing, since other countries could have even lower taxes. To deter frauds, authorities should ensure they are detected and resultant penalties should be stringent, Tom Prescott, transfer pricing specialist at auditing firm Grant Thornton Vietnam, tells Vietweek in an exclusive interview.
Vietweek: Some major foreign companies in Vietnam like Metro Cash & Carry, Adidas, and Coca- Cola are suspected of transfer pricing abuse. There is a view that auditing and consulting companies help them do it. Do you agree?
Tom Prescott: Often taxpayers seek assistance from accounting or advisory firms in analyzing their company and data for comparable transactions, as most taxpayers lack the resources and expertise to do this internally.
The media often wrongly associates transfer pricing with tax abuse – readers should be clear that transfer pricing refers to the study and application of prices used in transactions between related parties, and should not be used as a term synonymous with tax abuse.
It should also be noted here that taxpayers are not required to follow the advice offered by their accountants or advisors, and can choose to conduct transactions at prices other than those suggested.
It is very difficult for local tax agencies to assess actual input costs of firms, which is the basis of tax assessment. What should Vietnam do to deal with the issue?
There are a number of global and regional databases that transfer pricing professionals use to populate datasets for comparison of tested entities – such databases may also be of use to the tax authorities in determining general benchmark figures for a number of industries, and extrapolating or interpolating data for a particular business in Vietnam, taking into account the size of the company and other specific circumstances.
Greater cooperation between the tax authorities and customs may also be useful in preventing potential double-taxation and ensuring that both the customs and corporate tax revenues from associated with imported materials are consistent.
Ultimately, if companies are willing to collude in order to overstate the expenses of the Vietnamese entity, such as preparing invoices and supporting documents for services which were not actually received, there is little that the Vietnamese tax authorities would be able to do to detect the fraud; as such, authorities often pay particular attention to management fees charged by offshore parent companies to their Vietnamese subsidiaries, and may deem them non-deductible if sufficient evidence cannot be provided to prove the services were really provided.
Tax authorities need to […] distinguish between losses which are occurring for commercial purposes and those which are artificially incurred purely for […] minimizing tax liabilities.
Can authorities’ inspections make foreign firms pay more taxes or simply cleverer at evading tax?
As noted above, if transfer pricing principles are ignored, taxpayers may understate their profit, resulting in lower taxes paid. Understated profit is caused by either paying too much for expenses, or charging too little for goods and services, resulting in lower income.
The issue arises if the related parties are not subject to the same tax rate. For domestic companies, tax holidays, incentive rates and accumulated tax losses may give an incentive to manipulate profits so that most profit is recognized in the entity which has a lower tax rate, resulting in a lower overall tax rate for the group. For multinationals, there could be incentive to manipulate profits to recognize lower profits in Vietnam and higher profits in other countries with lower tax rates.
Vietnamese transfer pricing authorities allow taxpayers to select from five options. The methods are designed to allow for comparability in a number of circumstances, such as direct comparison between goods, comparison of profit margins on a given activity, comparison of profit margins for the whole company, and comparison of how profit is split from collaborative projects. Unfortunately, all of the methods are subject to the subjectivity mentioned above.
Taxpayers are generally required to conduct transfer pricing studies, undertake their transactions, file annual returns, and then wait to be audited to find out whether or not the tax authorities consider their pricing appropriate. Due to the subjectivity of selecting comparable data, it may be that the authorities select different data, and arrive at a different arm’s length rate, which could mean an adjustment for the taxpayer.
Other countries also face transfer pricing issues. How do they deal with it? And how can their experience be useful for Vietnam?
Many countries have regulations based on the guidance offered by the OECD and UN. Generally, regulations are similar from country to country with just slight differences.
The most important factor in avoiding tax abuses will be training transfer pricing task forces and developing transfer pricing-specific investigation procedures. However, a number of steps could be taken to ease the administrative burden on taxpayers wishing to comply with the regulations, such as more detailed guidance for following existing regulations, and publicizing approved data sources so that some of the subjectivity is removed when taxpayers and tax authorities select potentially comparable data.
A centralized transfer pricing unit under the General Department of Taxation would also likely assist in attaining a higher degree of consistency in the assessments undertaken by the tax authorities – as currently, the assessment of one local tax office may differ significantly from that of another.
Currently, Vietnam’s transfer pricing regulations focus on potential lost revenues from corporate income tax, with taxpayers only required to adjust their prices if the adjustment would result in paying more corporate income tax in Vietnam. Though potentially difficult to implement, Vietnam could consider following an approach similar to other countries in which total lost tax revenue is considered, such as the impact which inappropriate pricing has on value-added tax and foreign-contractor income tax in addition to the corporate income tax.
Many foreign companies do not pay income tax, claiming they are suffering losses. However, they still expand their business, saying the market has potential. Is their argument logical?
Loss leading is a common business strategy by which one product or service is offered by a company at a very low price, sometimes at a loss-per-unit, to attract more customers, with the intention of increasing the customer base for associated products which are sold at higher margins, or to gain market share which will provide a strong return when the price of the product increases over time.
If considered as an independent business unit, a Vietnamese company continuously trading at a loss may be considered unsustainable. However, when considered as part of a larger group, the losses incurred by the Vietnamese entity may be a key factor in the group’s strategy for securing a large market share in Vietnam to capitalize on later, or to secure regional contracts – such as agreeing to service a client at a loss in one country to secure the client in other countries where a profit can be made which exceeds the loss.
As such, continued losses may be logical from a group perspective in some circumstances. Tax authorities need to ensure they are able to distinguish between losses which are occurring for commercial purposes and those which are artificially incurred purely for the purposes of minimizing tax liabilities.
Foreign-contractor withholding taxes are a useful way of limiting lost tax revenues when funds are remitted offshore. It is important to strike a balance between minimizing leakage from tax evasion to ensure that tax revenues are generated in the short term, and allowing businesses the freedom to operate effectively so that they can continue to generate tax revenues over the long term.
Should Vietnam reduce corporate tax to stop transfer pricing fraud?
From a transfer pricing perspective, a lower corporate income tax rate would likely reduce the incentive for taxpayers to commit tax abuses. However, many offshore locations used in profit-stripping structures result in zero, or very low taxation, so a partial reduction in corporate income tax may not see a significant reduction in the number of abuses.
Likewise, an increase in corporate income tax would not likely see an increase in the number of abuses, but may have an impact on the ability of Vietnam to attract foreign investment. Taxpayers who choose to follow the transfer pricing regulations will do so regardless of the corporate income tax rate. To reduce the likelihood of a taxpayer deciding not to follow the regulations, the authorities should increase the likelihood of the abuse being detected, and ensure that penalties will have a significant impact.
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By Bao Van, Thanh Nien News (The story can be found in the January 4th issue of our printed edition, Vietweek)