Internal prices in related-party transactions have become the “focus” of inspection because they pose many potential risks regarding taxes, legality and business reputation. If the principle of independent market prices is not followed, businesses may face tax arrears, administrative penalties and loss of investor confidence. This article analyzes in detail the risks of using internal prices in related-party transactions and suggests solutions to help businesses prevent and manage them effectively.
What is internal price in related party transaction?
Internal price in affiliate transactions is the price that related parties (e.g. parent company - subsidiary, businesses in the same group) apply when transferring goods, services, assets or rights to use assets to each other. Unlike independent transactions in the market, internal prices are often set based on profit allocation strategies, tax optimization or cash flow regulation within the same group.
According to the provisions of Decree 132/2020/ND-CP According to the Vietnamese Government and international standards issued by the OECD, internal prices must comply with the Arm's Length Principle, which means that the price must be similar to the price that independent parties would apply under similar conditions. Compliance with this principle not only helps businesses be transparent in declaring corporate income tax (CIT), but also minimizes the risk of being reimbursed, fined or having international disputes by tax authorities.
Internal prices in related party transactions, if properly determined, will help businesses optimize resources and allocate costs and profits fairly among units in the group. On the contrary, if abused or incorrectly determined, businesses may face huge legal, financial and reputational risks in the market.
The importance of correctly determining internal prices in related party transactions according to tax and OECD standards.
Correctly determining internal prices in related-party transactions is an important factor in tax management and legal compliance. It is the basis for businesses to make their financial activities transparent and minimize tax risks.
Legal regulations on internal prices in related party transactions
- According to Decree 132/2020/ND-CP and OECD standards, enterprises must comply with the Arm's Length Principle.
- Internal prices in related-party transactions should reflect the actual economic value, similar to the prices that independent parties in the market would apply.
Benefits of compliance
- Avoid the risk of being charged with additional taxes, assessed taxes or administrative penalties by tax authorities.
- Strengthening prestige and trust from investors, shareholders and international partners.
Consequences of applying internal price deviations in related party transactions
- Prone to suspicion of “transfer pricing” and distortion of financial statements.
- Cross-border tax disputes may arise, affecting the operations of the entire group.
Determining the correct internal price in related-party transactions is not only a mandatory requirement to ensure compliance with tax laws, but also the foundation for sustainable business development. After clearly recognizing the importance of internal prices in related-party transactions, let's next explore the practical role of internal prices in related-party transactions in corporate governance, from profit allocation, cost optimization to cash flow regulation in the group.
What role does internal pricing play in related party transactions?
To see the impact clearly, let's analyze the important roles of internal prices in related-party transactions for businesses, specifically:
Transparent profit distribution
- Helps determine the profit share corresponding to the actual contribution of each member company.
- Ensure financial statements accurately reflect economic value across the value chain.
- Avoid the situation of unreasonably concentrating profits in one unit to reduce tax obligations.
Optimize operating costs
- Properly control internal management, production and service costs.
- Help businesses limit the risk of having unreasonable expenses excluded when settling corporate income tax.
- Increase management efficiency and improve competitiveness thanks to a transparent cost structure.
Regulating internal cash flow
- Support financial balance between member units in the group.
- Help a subsidiary with capital difficulties to maintain operations through appropriate internal pricing.
- Ensure general liquidity, contributing to stabilizing the business system.
Tax compliance and risk management
- By correctly applying the principle of independent market prices, businesses minimize the risk of being taxed, reimbursed or penalized.
- Build trust with tax authorities, investors and partners, especially in the international business environment.
From the analysis of the importance and role, it can be seen that internal prices in related-party transactions are both a useful tool in financial management and a mandatory requirement to ensure tax compliance. However, if the determination of internal prices is not carried out in accordance with the principles of independent market prices and legal regulations, enterprises will face a series of consequences. This is the reason why it is necessary to analyze in depth the risks when using internal prices in related-party transactions so that enterprises have a comprehensive view and proactively prevent them.
Risks of using internal prices in related party transactions
According to Decree 87/2024/ND-CP prescribes the subjects of application and the level of penalties for the act of declaring the purchase, sale, and exchange prices of goods and services within enterprises inaccurately, inconsistently with regulations, or unclearly, causing distortion of price reporting information to competent authorities.
Applicable objects
The subjects of application according to Decree 87/2024/ND-CP are stipulated as follows:
- Economic organizations established under the provisions of the Law on Enterprises, including: private enterprises, joint stock companies, limited liability companies, partnerships, and dependent units of enterprises such as branches, representative offices...
- Cooperatives, cooperative unions
- Organizations established under the provisions of the Investment Law and the Commercial Law, including: domestic investors, foreign investors (excluding individual investors), economic organizations with foreign investment capital; representative offices and branches of foreign traders in Vietnam; and representative offices of foreign trade promotion organizations in Vietnam.
- Social organization, socio-political organization, socio-political-professional organization, socio-professional organization;
- Public service unit;
- State agencies commit violations that are not part of their assigned state management tasks.
Although it brings many benefits in profit allocation, cost optimization and cash flow regulation, internal prices in related-party transactions also pose many risks if businesses apply them incorrectly. In fact, many FDI enterprises in Vietnam have been subject to tax collection or heavy fines for violating the principle of independent market prices, leading to serious consequences both financially and in terms of reputation. Therefore, early identification of risks when using internal prices in related-party transactions is an important step for businesses to proactively develop compliance strategies and minimize losses.
Tax and legal risks
If internal prices in related-party transactions are not based on the Arm's Length Principle, tax authorities have the right to determine taxes based on comparative data from independent transactions. In that case, enterprises may be subject to corporate income tax (CIT) arrears for many years, along with fines and late payment interest, causing great financial losses. In serious cases of fraud, authorities may even consider criminal prosecution according to the law. Currently, the maximum fine under the current Decree is VND 150 million for individuals and VND 300 million for organizations. In addition, enterprises are also at risk of being forced to stop production and business activities or having to return all the money obtained from the incorrect use of internal prices in related-party transactions in particular and other transactions in general.
Financial risks
Inaccuracies in setting internal prices in related-party transactions can cause businesses to record unreasonable costs or fictitious profits, making financial reports lack transparency. This situation also creates cash flow imbalances between subsidiaries in the group: some units have to bear high costs, while others enjoy disproportionate profits. In particular, when tax authorities make adjustments, businesses will have to face unplanned costs, directly affecting their investment, expansion and long-term growth strategies.
Risks to reputation and corporate image
Cases involving internal pricing in related-party transactions often attract public and media attention. Once violations are discovered, businesses can easily lose the trust of shareholders, investors, and strategic partners. In addition, tax authorities can put businesses on special monitoring lists, leading to more frequent inspections and audits, increasing administrative burdens and consuming more resources.
Risks of compliance with international standards
For multinational corporations, misapplication of internal prices in related-party transactions can cause conflicts with international standards, especially the OECD guidelines on anti-transfer pricing. As a result, businesses are at risk of falling into a situation of double taxation, when two countries have different views on reasonable internal prices. This not only increases tax costs, but also directly affects the ability to expand the market, reducing the competitiveness and global development potential of businesses.
Reasons why businesses often make mistakes when applying internal prices in related party transactions
Enterprises often do not have enough information about similar transactions in the independent market to determine prices. When the principle of independent transaction price is not compared, the application of internal prices in related-party transactions can easily lead to errors, giving tax authorities grounds to suspect transfer pricing behavior.
Building internal pricing policies is not clear and transparent
Many businesses still apply internal prices according to agreements between member companies, lacking explanatory documents or standard pricing policies. This makes it impossible for businesses to prove reasonableness when being inspected, thereby creating legal risks..
Focus on short-term benefits
Many businesses only focus on short-term benefits by using internal prices in related-party transactions to reduce tax obligations. However, this approach can easily lead to long-term consequences such as tax arrears, administrative fines, reputational damage and loss of investor confidence.
Lack of updates on tax regulations and international standards
Vietnam is increasingly integrating, participating in many tax treaties and OECD commitments, causing regulations on internal price management in related-party transactions to constantly change. Enterprises do not keep up to date or lack legal expertise, leading to errors in declaration and preparation of price determination documents.
Solutions to minimize risks when using internal prices in related-party transactions
To minimize the negative impact of the analyzed risks, businesses need to build an appropriate management strategy from the beginning. Applying internal prices in related-party transactions is not only a legal compliance requirement, but also a key factor to ensure transparency and maintain trust with management agencies and partners. Below are solutions to prevent risks.
Adhere to the Arm's Length Principle
- Enterprises need to determine internal prices based on similar market conditions, ensuring that they are not unreasonably low or high compared to independent transaction prices.
- The principle of independent market price has been clearly stipulated in Decree 132/2020/ND-CP and the guidance of OECD Transfer Pricing Guidelines 2022. This is an important legal basis to avoid the risk of tax imposition.
Establish transparent transfer pricing documentation
- Valuation Profile (Local file, Master file, CbCR) is a tool to demonstrate business compliance, reducing the risk of inspection and collection.
- Enterprises should prepare documents including: corporate information, functional analysis - risk - assets, comparative analysis and related financial reports. Full preparation helps minimize risks during tax inspections and audits.
Advice from experts in the field
- Enterprises should proactively cooperate with tax experts and auditors experienced in the field of related-party transactions.
- Experts will support businesses in explaining the mechanism of internal price formation in related-party transactions, and updating the latest regulations from the Ministry of Finance and OECD.
- This is a way to ensure that businesses not only comply with Vietnamese law but also conform to international standards, avoiding legal risks.
Conclude
Internal pricing in related-party transactions is a necessary management tool but also contains many risks if not strictly controlled. From tax, legal to brand reputation, any mistake can make businesses pay dearly. Therefore, compliance with the principle of independent market price, creating transparent records and regularly reviewing internal pricing policies are indispensable steps in the context of increasingly tightening tax management.
In fact, many businesses have limited risks by proactively consulting experts and promptly updating new regulations. This is also a safe direction for each business to ensure compliance and maintain sustainable development. If your business is considering reviewing internal pricing policies in related-party transactions, this is the right time to start.
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