Transfer pricing burns in Vietnam

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VietnamNet English - 70 month(s) ago 13 readings

Transfer pricing burns in Vietnam

VietNamNet Bridge – “Transfer pricing,” a skill to optimize profit has been popularly used for a long time worldwide, has not got special attention in Vietnam until recently; when taxation bodies and economists rang the alarm bell over the increasingly high number of transfer pricing cases, and warned that this will cause serious consequences to the national economy. VietNamNet would like to introduce a series of stories to show the situation in Vietnam.

Part 1: Transfer pricing now head problem for taxation bodies

When did Vietnamese get acquainted with the concept of “transfer pricing?”

“Transfer pricing” is understood as the implementation of the pricing policies on goods, services and assets transferred among the subsidiaries across borders, which do not follow the market prices, aiming to minimize the sums of tax that multi-national companies (MNC) have to pay around the world.

The motive for the transfer pricing is the optimization of profits of the whole economic groups in general. B and C are the two subsidiaries of A Group. B has to pay the corporate income tax rate of 25 percent, while C, located in difficult areas, can enjoy the preferential tax rate of 10 percent. When B provides materials to C at the prices lower than the market prices, the pretax profit of B would decrease, while the profit of C would increase. It is because C only has to pay 10 percent in tax for the increased profit.

As such, in particular, B would lose money, while C gets benefit. However, in general, the total tax sums B and C have to pay would be lower than the previously thought.

In the past, “transfer pricing” was an unfamiliar concept in Vietnam, while the knowledge about transfer pricing only appeared in the textbooks compiled for economics school students.

Fifteen years ago, some economists said on some business forums that the contribution of the foreign invested enterprises (FIEs) to the national economy proved to be more modest than expected, pointing out that the transfer pricing could be one of the reasons.

After that, transfer pricing became the topic of the research works of many economists, and the topic at many conferences of taxation bodies. The participants at the conferences said that FIEs were leading in the country in terms of industrial production growth, but the contribution of the economic sector to the national economy was inappropriate.

A minor thesis prepared by a student of the HCM City Banking University under the guidance of Lecturer Nguyen Minh Sang showed that in general, products made by FIEs can be categorized into three groups: 1) intermediate products 2) finished products made to the orders by the parent groups and consumed in foreign countries, and 3) the finished products consumed domestically.

For the first group of products, FIEs act as the production bases which import main materials, make products in Vietnam and then export to foreign countries, where other production phases are carried out before the sale prices are defined. In this case, the State of Vietnam could not collect VAT from the FIEs. Meanwhile, the state also could not collect corporate income tax from the enterprises because of no profit reported.

In the second case, FIEs make profits, but the profits are modest. The Vietnamese side does not know about the profits, or it is not allowed to get involved in the profit accounting. As such, the exports do not contribute to the GDP growth.

In the third case, the products are made in Vietnam and consumed domestically, but most of the main materials are imports. Nearly 100 percent of materials needed to make seasoning powder were imported from other countries, while the proportions were 83 percent in leather products, 76 percent in sports shoes, and 56 percent in detergent.

Due to the close profit accounting mechanism followed by FIEs, though the products are consumed domestically, they could be considered as imports.

What did Vietnam find?

The report by the HCM City Taxation Department in 2009 showed that 60 percent of FIEs in the city reported losses. The proportion was 61.3 percent in 2008. Prior to that, in 2007, the year of economic prosperity of Vietnam, 70 percent of FIEs still reported loss. This meant that the city could not collect corporate income tax from the unprofitable enterprises.

In fact, incurring loss was the common problem of FIEs, not only in HCM City, but throughout the country. This can be seen in the low tax payment to the national budget (not including the tax from crude oil) of the economic sector.

In the years from 2005 to 2008, FIEs’ tax payment just accounted for 9-10 percent of the total collection to the state budget. The continued loss incurring by FIEs was described as “abnormal” thing. Though the FIEs reported loss, they still maintained their operation in Vietnam, and in many cases, they even tried to expand the production in the country.

Some experts pointed out that the reported loss was not caused by the difficulties in production and business, but because many FIEs carried out the transfer pricing to evade tax.

More and more “abnormal things” were found after that. The situation became so serious that the then Minister of Finance Vu Van Ninh said at the National Assembly’s session in October 2008 that the situation was very tough. This prompted more experts to make research on the issue in anticipation of the increasing high foreign direct investment (FDI) in Vietnam.

National Assembly’s deputies also raised the questions about the management over the transfer pricing. Pham Xuan Thuong, a National Assembly’s deputy even called the transfer pricing made by FIEs as “one of the biggest financial management loopholes nowadays.”

According to Dr Le Xuan Truong from the Finance Academy, the behavior of transferring pricing, if cannot be discovered and treated by the laws, will bring many bad consequences.

It is obvious that the behavior will lead to the decrease in state budget collection. The sums of money, which should have been paid by the FIEs, could not go to the state budget. The loss to the state budget is really considerable.

Also according to Truong, in many cases, foreign investors deliberately reported the wrong prices which were far different from the market prices at the same time.

An inspection report released by Swiss SGS Company showed that the Thang Long Hotel joint venture declared the imported equipments at 496,906 dollars, which was 190,006 dollars (40.43 percent) higher than the market price. The Hoa Binh Automobile Corporation declared the value of equipments at 5,823,818 dollars, which was found as exceeding the market price by 27.51 percent.

Besides, the behavior will create an unhealthy competition among economic subjects. Once an enterprise can get benefit from tax duties with the behavior of transferring pricing, it will get higher profit than other enterprises with the same conditions but do not carry out the transfer pricing.

It may happen that the enterprises, which benefit from the transfer pricing, will pay high to collect materials on the market. As a result, other enterprises will not have enough money to buy materials to serve their production. This would push the other enterprises to the bankruptcy.

The transfer pricing could also serve a long term plan by MNCs to penetrate new markets and compete with local companies. At first, foreign enterprises dump their products on the market to eliminate their rivals and control the market. After the rivals collapse, they will dominate the market and set rules of the games here.

Kim Chi

Part 2: Transfer pricing skills plentiful

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