This is the second part in a series of contributions focused on analyzing Vietnam’s current key transfer pricing regulation Decree 132[1] from the perspective of the 2022 Transfer Pricing Guidelines (“TPG”) of the Organization for Economic Cooperation and Development (“OECD”).
Internal or external comparables?
When a taxpayer has engaged in similar transactions with both related and unrelated parties, the use of the price or profit margin of the unrelated transaction for the related transaction is an obvious consequence of the arm’s length principle and the Comparable Uncontrolled Price method (CUP). Tax authorities in Vietnam, a noted manufacturing hub, will in practice often focus quite quickly on price differences they notice on the export price of manufactured goods to the related party of the taxpayer and confront it with often minor domestic sales to a local third party purchaser at a higher price. Other local examples are found in the banking industry, as large Vietnam banks are often part of the business group of a local wealthy businessman, and such a bank will provide loans to the other entities of the group.
In these cases, to use the conditions of the unrelated sale or loan for the related one, the key question is how comparable these transactions really are. Simply put, it frequently comes down to the taxpayer trying to prove that his transaction with a third party (with likely a different price) significantly differs from the transaction with its related party.
The issue of comparability is not just a part of the discussion on comparables, but is of course fundamental to the entire arm’s length approach, also having repercussions on choice of external comparable enterprises.
Traces of the fundamental rules on factors of comparability (contractual terms, functions performed/assets used/risks assumed, characteristics of property or services, economic circumstances and business strategies) of the TPG are mostly also found, albeit heavily summarized, in Decree 132.
But Decree 132 seems to provide a higher standing, a hierarchical priority for internal comparables over external comparables that is not found in de same way in the TPG. The TPG do provide that internal comparables “may have a more direct and closer relationship to the transaction under review than external comparables”[2] and “[i]t may be unnecessary to use a commercial database if reliable information is available from other sources e.g. internal comparables”[3]. But the TPG stops short of imposing a hierarchy. It does not provide that internal comparables trump external ones. In fact, the TPG state that:
“On the other hand, internal comparables are not always more reliable and it is not the case that any transaction between a taxpayer and an independent party can be regarded as a reliable comparable for controlled transactions by the same taxpayer[4].
By contrast, Decree 132 does seem to give more weight to internal comparables. In 7 (1), Decree 132 provides some kind of -qualified- hierarchy by providing that:
“In case where there are no internal uncontrolled comparables, then the selection of comparables can be conducted with reference to comparables in the same country [Vietnam] or in the region” (emphasis added)[5].
The same theme is found in Decree 132’s provisions related to use of external databases of financial information:
“Analysis and selection of uncontrolled comparables […] must conform to the priority order in selecting comparative data as follows:
(a) internal comparables of taxpayers;
(b) Domestic comparables of the country of residence of the taxpayer [Vietnam]
(c) Comparables from countries in the region with similar economic conditions and growth”[6] (emphasis added).
This does not mean that under Decree 132 every uncontrolled price must be used to set every controlled transaction. In Vietnam the comparability of transactions is also central to the transfer pricing determination, as is the case in the TPG, and also in the case where the tax authority wants to use an uncontrolled price for a related party transaction. Notably, Decree 132 states that:
“Selection of internal uncontrolled comparables is the selection of transactions between taxpayers and unrelated parties, while ensuring the comparability in terms of price or profit margin or profit split ratio”[7]. (emphasis added)
The TPG offer more assurances to taxpayers who might, besides large related party sales, also have a minor, higher priced local transaction which tax authorities want to use as a yardstick to reassess its related party transactions:
“Assume for instance that a taxpayer manufactures a particular project, sells a significant volume thereof to its foreign associated retailer and a marginal volume of the same product to an independent party. In such case, the difference in volumes is likely to materially affect the comparability of the two transactions. If it is not possible to make a reasonably accurate adjustment to eliminate the effects of such difference, the transaction between the taxpayer and its independent customer is unlikely to be a reliable comparable”[8]
In conclusion, Decree 132 subscribes in general terms to the same comparability requirements as the TPG. This means that ultimately, also in Vietnam internal controlled transactions which are incomparable should not be used to price uncontrolled transactions. But, unlike the TPG, Decree 132 does provide (1) in an actual priority for internal over external comparables, and (2) does not offer any specific language to warn against use of minor uncontrolled sales transactions. Accordingly, taxpayers with minor but higher priced uncontrolled sales might be at a higher risk in Vietnam compared to OECD countries.
Internal comparables are only persuasive guidance if they are in fact comparable. A recent transfer pricing case in Spain illustrates the point that internal comparables may not always be determinative. In that case, a Spanish company resold products from an unrelated party to its Panamanian group entity with a 4% mark-up. Spanish tax authorities reassessed that 4% to 26% based on the taxpayer’s internal comparables. However, the court found that these transactions were in fact not very similar, as the third party transactions concerned sale and resale rather than agency, and because there was only one transaction at the higher profit margin[9].
Local or foreign comparables?
Searching for comparable companies on a regional or even global basis is common in transfer pricing benchmark efforts, including when using the Transactional Net Margin Method (“TNMM”). The more well-known transfer pricing tools have long included financial information from more than one country. In fact, most providers of financial information databases only offer packages per region and not per country.
The OECD recommends tax authorities to be open to the use of non-domestic financial data:
“Non-domestic comparables should not be automatically rejected just because they are not domestic”[10].
Instead, the OECD believes that it all depends on the situation. If a case can be made that foreign data is appropriate, then it should be used even it is foreign:
“A determination of whether non-domestic comparables are reliable has to be made on a case by case basis”[11].
The Vietnam position is, at least in theory somewhat less flexible. As already mentioned, Decree 132 sets forth a hierarchy of data to be used:
“Analysis and selection of uncontrolled comparables […] must conform to the priority order in selecting comparative data as follows:
(a) internal comparables of taxpayers;
(b) Domestic comparables of the country of residence of the taxpayer [Vietnam]
(c) Comparables from countries in the region with similar economic conditions and growth”[12] (emphasis added).
Thus, in Vietnam’s approach, the taxpayer will in his analysis and documentation need to, lacking internal comparables, first search for data in Vietnam (or, if the foreign company is the tested party, that company’s country of residence) before expanding the search to countries outside of Vietnam.
It is noteworthy in this context that private companies in Vietnam have a fairly well implemented obligation to lodge their financial statements with the commercial regulator. Although this data is not publicly available at no cost, there are several subscription-based and “per use” solutions offered by commercial publishers for this Vietnam data. The financial statements of public companies at one of Vietnam’s stock exchanges are public and free. For comparison, although business enterprises in Cambodia have the obligation to prepare financial statements and lodge them with tax and commercial authorities, and many must be audited externally, none of this data is available to the public or to commercial publishers[13].
Assigning a priority rank to local data by the GDT can be seen in the context of the easy availability to taxpayers and officials of Vietnam financial data. In that light, Vietnam has chosen not to eliminate the use of foreign data, but to make it subsidiary to the use of local data.
Transfer pricing practitioners have often wondered which foreign countries would be deemed “comparable” enough to their own market, as is required by Decree 132. The TPG do not offer any set rules on how to determine if a foreign country is comparable, although it does recognize that a geographic market is an economic circumstance that may have an impact on comparability[14]. The OECD’s special note on data comparability for developing countries sets out the example of the rather small economy of New Zealand, where parties often resort to data from Australia and the United Kingdom as “the same or similar markets”[15].
Vietnam’s Decree 132 is less flexible in this regard. Even if use of another country’s data is permitted under the priority order cited above, certain criteria must be respected notably: “where the sector’s economic conditions and economic growth levels are comparable”[16]. Although it is reasonable for the GDT to require that the economy of the foreign data source is in some respects comparable to that of Vietnam, it is also true that this condition will actually complicate the analysis.
First of all, any kind of absolute condition related to the country itself rather than to the transaction or the company is somewhat difficult to justify from a conceptual standpoint. As the OECD states, the economic comparability should be the priority, not the “nationality” of the data. Furthermore, from a practical standpoint, there is the problem of availability[17]. Finally, a bias against foreign data exposes the taxpayer to an additional level of risk and scrutiny, one might argue as kind of a penalty, for using foreign country data. There is always a chance not everybody agrees that one or another foreign source is “not sufficiently comparable”. This risk is not present if one sticks to Vietnam data./
[1] Decree 132/2020/ND-CP Prescribing Tax Administration for Enterprises with Related Part Transactions dated 5 November 2020.
[2] OECD TPG 2022, 3.27
[3] OECD TPG 2022, 3.32
[4][4] OECD TPG 2022, 3.28
[5] Decree 132, art. 7 (1)
[6] Decree 132, art. 17 (3)
[7] Decree 132, art 7 (1)
[8] OECD TPG 2022, 3.28
[9] Spain vs Tomas Bodero, S.A., July 2023, Tribunal Superior de Justicia, Case No STSJ CL 3218/2023
[10] OECD TPG 2022, 3.35
[11] OECD TPG 2022, 3.35
[12] Decree 132, art. 17 (3)
[13] See also a ruling by the Vietnam tax authorities dated 29 March 2022 on acceptable foreign databases.
[14] OECD TPG 2022, 1.132. The OECD considers that the “relevant market” of the product or service may or may not coincide with a geographical market.
[15] OECD, Transfer Pricing Comparability and Developing Countries, 2014, par. 20.
[16] Decree 132, 17 (3) (c)
[17] Think about operations service of a nuclear plant, construction of artificial islands, developing artificial intelligence or laboratories for DNA research services.
