Transfer pricing abuse difficult to detect

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  People queue up at a Ho Chi Minh City tax office. Tax authorities in the city undertook more than 900 investigations in 2011 in an effort to detect transfer pricing abuses, an expert says.

Transfer pricing, or the price at which divisions of a company transact with each other, is emerging as a major problem plaguing Vietnam's economy.

Matthew Facey, Tax Director at auditing and business consultancy firm Grant Thornton Vietnam, sat down with Vietweek to explore the bigger picture.

Vietweek: How do you assess the transfer pricing situation in Vietnam? Is it a serious problem for the economy?

Matthew Facey: Transfer pricing has fast become one of the most critical tax issues for taxpayers and tax authorities around the globe, and Vietnam is no exception. However, it should be recognized that having related parties and transactions with those parties is not a precursor to tax fraud or unethical business. There appears to be a common misconception in the general media that transfer pricing is synonymous with fraud.

Elsewhere in the world, there have been a number of high-profile litigation cases between taxpayers and authorities regarding transfer pricing abuses. However, the publicized cases in Vietnam have focused on a large number of taxpayers with minor adjustments. To understand why this may indicate less of an issue, one should first explore what transfer pricing is, how it can be abused, and the impact that such abuses may have.

Transfer pricing is the term used for the process by which prices should be determined and recorded for transactions taking place between related parties. Parties are generally deemed related due to ownership or the potential to control one another, such as two companies having the same board of management.

When parties are not related, the price for a transaction is generally determined by market factors, and a principle called the price elasticity of demand.

In related party transactions, the market factors and the price elasticity of demand principles may no longer be influencing price as one decision maker can control the vendor and the consumer at their sole discretion.

Accordingly, there is an opportunity for unscrupulous taxpayers to manipulate their revenue and expenses, and consequently the amount of tax they have to pay.

Signs of transfer pricing abuse can be seen at many companies. However, most of them, when detected, are only required to cut their announced losses, and are fined for their tax violations. They are not penalized for transfer pricing violations. Why?

It has been reported that tax authorities in Ho Chi Minh City undertook over 900 targeted investigations in 2011 in an effort to detect transfer pricing abuses. While there were many adjustments to the tax payable on aggregate, none of the adjusted companies were held up as being particularly at fault. This may indicate that the companies adjusted did not receive significant adjustments.

If so, this would likely be because the pricing the companies used was not substantially dissimilar to the pricing the authorities deemed to be at arm's length. Such cases may arise out of differing interpretations of the transaction, rather than attempted fraud on the part of the taxpayer.

In determining the arm's length range, taxpayers are required to consider similar transactions, and similar circumstances, and then compare the prices used in these transactions with the prices the company is intending to use.

It is generally unlikely that the taxpayer will have exactly the same transaction as another unrelated company, or that sufficiently detailed information is available to recognize the exact same transaction.

So is it difficult to detect transfer pricing fraud?                                

As we have seen, there is a relatively high degree of subjectivity, the impacts of which can be reduced through statistical means, taking an inter quartile range from the results of the economic analysis. Consulting with experienced transfer pricing experts may provide taxpayers with an additional layer of protection as analysis of the circumstances, and selection of comparable data will have been selected by an objective third party.

However, there is an inherent risk that the tax authorities' view will differ from that of the taxpayer or transfer pricing professional. But what do the authorities do to detect and tackle transfer pricing abuses?

To date, it appears that authoritative actions have been focused on investigating foreign invested entities with related party transactions with an offshore entity. The reason for this is simple, if an abuse is taking place, it will likely be to manipulate profits so that little or no profit is recognized in Vietnam, and therefore there is little or no tax payable in Vietnam.

A cross-border abuse is the most significant for Vietnam as potential tax revenue leaves the country and is unlikely to be easily recovered.

An issue here is that correctly determining an arm's length rate for certain transactions can be incredibly complex, and regular tax audit procedures may not be well suited to identify when an abuse is taking place, or the extent of that abuse.

For example, valuing intangible property and the royalty charges that would be appropriate for the use of intellectual property rights are dependent on a number of factors. It may not always be possible for taxpayers to indicate such factors, or for tax officers to assess them. Two issues arise: tax officers may not be best suited to identify and quantify abuses, and taxpayers may be adjusted in a manner which an informed party would deem unreasonable.

How do you assess Vietnam's regulations to check abuse of transfer pricing?

The government has recognized that transfer pricing abuses can be difficult to detect. As such, a plan has been released stating the intention to increase the number of transfer pricing audits subject to specific transfer pricing audit procedures, review current transfer pricing regulations, increase the level of transfer pricing disclosures, develop a specialized transfer pricing task force and generally improve technical knowledge based on international transfer pricing practices with the assistance of the OECD (the Organization for Economic Cooperation and Development) and the European Union.

What is the experience of other countries in combating transfer pricing? What is the anti-transfer pricing model that can be effectively applied in Vietnam?

Other countries have noted that low tax jurisdictions are often the destination of profits in such transactions, and as such place additional scrutiny on companies which have related parties in so-called tax havens. The Vietnamese authorities have particularly focused on foreign invested entities which declare successive losses and yet continue to expand operations as this may be indicative of transfer pricing abuses.

Several similarities can be seen between OECD guidelines and the Vietnamese regulations, and with the current European Union Commission-led project to improve international tax administration, domestic regulations and international guidelines are likely to converge.

MAP, or mutual agreement procedures, are generally reserved for large multinationals which have significant impacts on local economies, and which may act as indicators of issues within the business community at large. Currently, Vietnam does not have formal MAP procedures in place. However, clauses of double tax agreements which Vietnam has signed with over 60 countries could potentially be used to facilitate MAP procedures.

APA, or advanced pricing agreements, are mechanisms by which taxpayers can reduce the risk of adjustment by seeking the authorities' approval that proposed pricing is arm's length, before such transactions are undertaken.

Vietnam is currently in the process of preparing APA regulations with the intention of reducing the number of transfer pricing abuses. However, as APAs are generally voluntary, and only for larger taxpayers, the introduction of the system may not completely realize the desired effects. However, it serves to demonstrate the government's desire to develop the Vietnamese tax system into a sophisticated legal framework which deals with the issues of a truly global business environment.

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