Understanding Decree 20 on related-party transactions: The foundation for enterprise transfer pricing management

Decree 20 on affiliate transactions is an important first step in controlling transfer pricing and tax base erosion in Vietnam. Issued to ensure that transactions between related parties comply with the independence principle, Decree 20 lays the foundation for a legal framework for determining market prices in multinational corporations. Although it has been replaced by Decree 132/2020/ND-CP, the core provisions of Decree 20 still play an important role in forming a transparent and effective tax management mechanism for related-party transactions.

Core Concepts of Affiliate Trading

To understand the new regulations on related party transactions, it is first necessary to grasp the definition:

• Related transactions (FDI): Are transactions arising between parties that have a related relationship with each other, including buying and selling, exchanging, providing services, borrowing - lending and other financial transactions.
• Arm's Length Principle: This is the legal basis. This principle requires that the price of an Related Transaction be determined as if the parties were independent, unrelated, transacting with each other under similar market conditions.

Once the concept of Related Party Transactions and the underlying principles are clearly understood, businesses need to take the first decisive step: Accurately identify the Related Party and the Scope of Transactions subject to regulation.

Scope and determination of Affiliated Parties according to Decree 132/2020/ND-CP

Correctly identifying the related party is the first and most important step in complying with the regulations. If an enterprise has a transaction that falls within the scope of the Decree on related party transactions, the obligation to declare and determine the price will arise.

Criteria for determining Affiliate Relationships

Decree 132 on related-party transactions lists specific cases to determine related-party relationships, in which the most common criteria include:

• Capital Ownership Relationship (Point a): One party directly or indirectly participates in the management, control, capital contribution or investment in the other party, accounting for at least 25% of the other party's equity capital contribution.
• Equity and Debt Relationship (Point b): Both parties have at least 25% of equity capital held directly or indirectly by a third party.
• Loan-Lending Relationship (Point c): One party lends to the other party, or guarantees a loan to the other party in any form, if the loan accounts for at least 10% of the total investment capital of the borrower and at least 50% of the total value of the medium- and long-term debts of the borrower.
• Management or Control Relationship (Points d, e): One party appoints the manager, operator or control of key positions of the other party, or both parties have more than half of the board members or key management positions held by the same person or people with direct family relationships.
• Dependent Business Relationship (Item g): One party exerts substantial control over the other party's production or business activities through the supply of raw materials, supplies, or transfer of intangible assets (IP) that affect more than 50% of the other party's total production costs or total revenue.
• Dominance Relationship (Point h): One party has the power to negotiate or control the other party's business and financial activities in practice.
• Family and Personal Relationship (Point k): Two businesses are controlled by an individual through that person holding key management positions or decision-making power in both businesses.

Correctly identifying the related party is the first and most important step in complying with the regulations. If an enterprise has a transaction that falls within the scope of the Decree on related party transactions, the obligation to declare and determine the price will arise.

Types of related transactions covered by the regulation 

Most economic transactions arising between related parties are within the scope of Decree 132 on related party transactions, including:

• Purchase and sale of goods, raw materials, finished products, fixed assets.
• Provide or receive services such as management, consulting, marketing.
• Leasing, transferring intangible assets (copyright, trademark, technological know-how).
• Financial transactions such as loans, guarantees, deposits.

Having fully identified the types of Related Transactions, the next and highly technical step is to apply independent transaction pricing methods to demonstrate the reasonableness of the prices used according to market principles.

Independent Transaction Pricing Method

This is the most technical part of complying with the Transfer Pricing Regulations. Businesses need to demonstrate that their transfer pricing is within a reasonable range of arm's length prices.

5 basic methods of determining price

Decree 132/2020/ND-CP stipulates 05 main methods to determine market price:

• Comparable Uncontrolled Prices (CUP): Compares the price of an associated transaction with the price of a comparable uncontrolled transaction. This is the preferred method if sufficiently comparable internal or external transactions can be found.
• Resale Price (RPM): Applicable to distributors. Based on the gross profit margin of independent distributors.
• Cost Plus (CPM): Applies to manufacturers or service providers. Based on the cost of production or service provision plus a reasonable gross profit margin of independent parties.
• Comparable Net Margin (TNMM): Most common method. Compares the Tested Party's net profit margin (on revenue, expenses, or assets) with the profit margins of independent companies.
• Profit Allocation (PSM): Applies to complex transactions (e.g., joint development of intangible assets). Allocate profits arising from related party transactions to related parties in proportion to their contribution.

Comparative analysis and selection of the audited party 

The selection of the audit method and auditee should be based on a detailed Function, Asset and Risk Analysis (FAR Analysis) of the business. Auditees are typically those with simpler, lower-risk functions (e.g., contract manufacturers, low-risk distributors), as comparative data for these are easier to find.

Obligation to declare and prepare Related Transaction Records

Compliance with the Decree on related-party transactions requires enterprises to fully perform their obligations on declaration and record keeping.

Form for declaring information on related transactions (Form 01/GDLK)

Form 01/GDLK must be submitted with the annual Corporate Income Tax (CIT) Finalization Declaration. This is a summary of information on related parties, types of related transactions, and pricing methods applied. Incorrect or incomplete declarations may result in administrative penalties.

Penalty for late payment: 

• Late submission or failure to submit Form 01/GDLK (considered an appendix to the corporate income tax return) is considered an act of late submission of the Tax Return.
• Enterprises will be subject to administrative penalties as prescribed in Decree 125/2020/ND-CP (regulations on administrative sanctions for violations in the tax field).
• Fines can range from several million to tens of millions of VND depending on the number of days of late payment. Specifically, if the payment is late for more than 90 days or does not pay, the fine can be up to 25,000,000 VND (for acts without aggravating or mitigating circumstances).

Structure of the Pricing Profile 

Pricing documents have 03 levels according to international standards:

• Local File: Focuses on the transaction details of the unit in Vietnam. This is the most important document for tax authorities to check.
• Master File: Overview of the Group's global business operations, strategy and general pricing policies.
• Country-by-Country Reporting (CbCR): Only applicable to multinational corporations with total consolidated revenue over VND 18,000 billion.

While it is a standard obligation to fully document these levels, Decree 132/2020/ND-CP has set out clear criteria to reduce the compliance burden for certain groups of businesses. These are the cases that are exempted from the obligation to prepare a Transfer Pricing Document.

Cases of Exemption from the Obligation to Prepare Valuation Documents 

Decree 132 on related-party transactions clearly stipulates cases where enterprises are exempted from the obligation to prepare a Pricing Document (Local File, Master File), although they still have to declare Form 01/GDLK. Understanding these criteria according to Article 16 is very important for small and medium-sized enterprises (SMEs):

Exemptions based on transaction size and turnover

This case applies to businesses that simultaneously meet both of the following criteria regarding scale:

• Total revenue generated during the tax period is less than 50 billion VND
• Total value of all related transactions arising in the tax period is under 30 billion VND.

Simple functional exemption and profit margin

To be considered for this exemption, an enterprise must simultaneously satisfy all of the following conditions regarding scale and operational efficiency:

• Total revenue generated during the tax period is less than 200 billion VND;
• Only perform simple functions, do not generate revenue or expenses from the exploitation and use of intangible assets;
• Do not conduct affiliate transactions outside of Vietnam; and
• Achieve the minimum pre-tax net profit margin on revenue (Net Profit Margin - NPM) for each industry as specified in Decree 132/2020/ND-CP (Specifically: Distribution 5%, Production 6%, Processing 7%).

Exemption for purely domestic transactions

To be exempted, domestic related party transactions must simultaneously satisfy strict conditions on taxpayer and tax rate as follows:

• Enterprises only have related party transactions with related parties that are subject to corporate income tax in Vietnam.
• Associated parties apply the same corporate income tax rate.
• One of the parties has declared and determined that the taxable income is not lower than the prescribed level.

Enterprises should note that, even if exempted from preparing a Transfer Pricing Document, enterprises must still declare information on related transactions on Form 01/GDLK attached to the annual Corporate Income Tax Finalization Declaration.

Interest Expense Limit Regulations: The Biggest Change

This is a core adjustment of Decree 132/2020/ND-CP compared to the previous Decree 20 on related-party transactions, and is the latest regulation on related-party transactions that businesses must pay special attention to.

Limit on Net Interest Expense Deductibility

Decree 132/2020/ND-CP stipulates that net interest expense (after deducting deposit interest and loan interest) deductible when determining taxable income for corporate income tax must not exceed 30% of the total Net profit from business activities plus Interest Expense and Depreciation Expense (EBITDA).

• Important new point: The portion of non-deductible interest expense due to exceeding the 30% EBITDA threshold can be carried forward to the next tax period (up to 5 years) if all conditions are met. This is a major change, overcoming the limitations of the previous Decree 20.

Complying with complex regulations on pricing and interest rate limits poses many challenges, increasing the risk of errors. Therefore, it is necessary to understand the common risks below to proactively avoid them when the tax authorities conduct inspections.

Common risks of non-compliance

Many businesses make mistakes due to lack of practical experience in complying with Decree 132 on related-party transactions, leading to inspection risks:

• Insufficient identification: Omission of related parties identified through lending relationships or indirect control.
• Lack of comparison data: Unable to find or using inappropriate comparison data (Benchmark).
• Untimely valuation records: Valuation records are usually prepared after the financial year ends, but must be fully prepared. before when requested by the tax authorities.

Enterprises will face administrative penalties and corporate income tax arrears, specifically as follows:

Forms of administrative sanctions

Non-compliance with transfer pricing regulations can lead to two main sets of financial consequences:

Administrative penalties for tax procedure violations (according to Decree 125/2020/ND-CP)

Applicable to late submission or failure to submit the GDLK Declaration (Form 01/GDLK) and violations of the deadline for submitting documents.

• Late submission of the GDLK Declaration: The fine ranges from VND 2,000,000 to VND 25,000,000, depending on the number of days late. Specifically, late submission of more than 61 days or failure to submit the Declaration may result in a maximum fine of VND 25,000,000.
• Failure to provide complete TP File (Local File/Master File) when requested: This behavior often leads to the tax authority moving to the tax assessment step.

Tax Collection and Late Payment Penalties

This is the most serious consequence, which occurs when the tax authority rejects the enterprise's pricing method and re-determines the independent transaction price.

• Corporate Income Tax Collection: Enterprises must pay back the corporate income tax owed due to increased adjusted profits.
• Late payment penalty: Calculated on the amount of corporate income tax to be collected, at the rate of 0.03%/day on the amount of tax overdue. This amount can be very large if the collection period lasts for many years.

Conclude 

Full compliance with regulations from Decree 20 on related party transactions to Decree 132/2020/ND-CP not only helps businesses minimize tax risks but also demonstrates transparency and professionalism in financial management. In the context of tax authorities increasingly tightening control over transfer pricing, proactively reviewing, documenting and developing a standard related party transaction strategy is necessary.

If your business needs expert advice or assistance in complying with Decree 132 on related party transactions, please contact us. MAN – Master Accountant Network for specific guidance, ensuring safety and optimization in financial activities.

Contact information MAN – Master Accountant Network

• Address: 19A, Street 43, Tan Thuan Ward, Ho Chi Minh City.
• Mobile/ Zalo: +84 (0) 903 428 622 (Ms. Ngan)
• E-mail: nguyenthikimngan@man.net.vn

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