In the context of economic integration and the rapid development of multinational corporations, transfer pricing has become a crucial issue that businesses need to pay special attention to in order to ensure compliance with tax laws and effective financial management. This article will help businesses understand what transfer pricing is, the principles for determining transfer pricing, the methods of application, the required documentation, and common tax risks according to current regulations. With an in-depth perspective on related-party transactions, the content provides practical knowledge to help businesses proactively develop appropriate pricing policies and mitigate risks during tax audits and inspections.
What is Transfer Pricing?
Transfer pricing is the process of determining the value of transactions between related parties to ensure that these transactions are conducted according to market principles. In other words, the price in transactions between related parties should be equivalent to the price that independent parties could agree on under similar conditions.
In Vietnam, the management of transfer pricing is primarily regulated by... Decree 132/2020/ND-CP Regarding tax management for businesses with related-party transactions, this regulation aims to ensure that businesses declare taxes accurately reflecting the nature of their business operations and to limit inappropriate profit shifting between countries.
Why is Transfer Pricing such an important issue for businesses?
Transfer pricing is not just a tax concept; it's directly related to how a business organizes its corporate business model.
For multinational corporations, each country has:
- Different tax rates
- Different preferential policies
- Different business conditions
Therefore, the distribution of profits among companies within the same group needs to be controlled to ensure fairness.
For example: A conglomerate has a parent company in Japan and a subsidiary in Vietnam. The parent company supplies raw materials to the Vietnamese company for the production of goods.
If the price of raw materials sold to Vietnamese companies is significantly higher than the market price:
- Costs for Vietnamese companies are increasing.
- Profits decreased.
- The amount of corporate income tax payable has decreased.
The tax authorities may consider whether this price is consistent with the arm's-length principle.
What are affiliate transactions in Transfer Pricing?
Related-party transactions are transactions that occur between related parties. This forms the basis for determining whether a business falls under the scope of Transfer Pricing regulations.
Some common affiliate transactions include:
- Buying and selling goods: For example, a parent company selling raw materials to a subsidiary, or companies within the same group distributing products to each other.
- Providing internal services: Including: Corporate management fees, technical support services, information technology services, research and development services.
- Financial transactions: Examples include loans between parent and subsidiary companies, interest expenses, and financial guarantees.
- Transfer of intangible assets: This includes the right to use trademarks, technology, software, and intellectual property rights.
When is a business considered to be related in Transfer Pricing?
In Transfer Pricing, determining whether a business has related-party transactions is the first step in assessing its reporting obligations, preparing documentation for transfer pricing, and complying with tax regulations. Not all transactions between businesses are related-party transactions; only those transactions between parties with controlling, controlling, or dependent relationships as defined by regulations fall under the scope of tax management.
According to regulations on tax management for businesses with related-party transactions, related-party relationships are usually determined based on factors such as: ownership of capital, control, management rights, financial dependence, or business operations.
Some common cases where businesses are identified as having an affiliated relationship include:
Relationships formed through ownership of capital
This is the most common scenario in FDI corporations and businesses.
A business is considered to be affiliated when one party directly or indirectly holds a sufficient percentage of capital contribution to control or dominate the operations of the other party.
For example: Company A in South Korea owns 70% of the capital of Company B in Vietnam.
In this case:
- Company A is the parent company.
- Company B is a subsidiary.
- The two sides are related parties.
If Company A sells raw materials, provides management services, or lends capital to Company B, these transactions may fall within the scope of transfer pricing regulations.
Relationships formed through control and management.
In addition to ownership percentages, related-party relationships can also arise when one business has control over or decision-making power over the key operations of another business.
For example: Company X does not own capital in Company Y but has the right to:
- Decision on core business activities
- Appointment of senior management personnel
- Operational strategy control
- Financial policy decisions
In that case, the two businesses could be considered to be related due to their controlling management.
The relationship between businesses that share the same owner.
A common scenario in practice is when businesses do not directly own each other but are all under the control of a single individual or organization.
Example: Mr. A owns:
- 70% Company M
- 80% Company N
Although Company M and Company N do not jointly invest in each other, they are both controlled by the same owner.
When two companies enter into a transaction:
- Buying and selling goods
- Property rental
- Providing services
These transactions could then be considered related-party transactions.
The relationship between parent and subsidiary companies within a conglomerate.
This is a common model in multinational corporations.
For example: The global corporation has:
- Parent company in Singapore
- The company manufactures in Vietnam.
- Distribution company in Thailand
These companies may engage in various internal transactions such as:
- Buying and selling raw materials
- Trademark fees
- Management service fee
- Technical support fees
These transactions need to be evaluated according to the arm's length principle to ensure that profits are distributed appropriately among countries.
Relationships formed through financial transactions.
Internal lending transactions are also a group that is often of interest to tax authorities.
For example: The foreign parent company provided a loan to its Vietnamese subsidiary to expand the factory.
Factors to consider:
- Are the loan interest rates competitive with the market?
- Are the loan conditions similar to those of a standalone transaction?
- Does the loan actually support the business operations?
If interest rates are unusually high, businesses may be questioned about adjusting their costs.
Internal supply chain linkages
In many corporations, a business may be heavily dependent on an affiliate for:
- Raw materials
- Technology
- Output customers
- Distribution system
For example: A manufacturing company located in Vietnam:
- We only purchase raw materials from the parent company.
- Only sell products to companies within the group.
The tax authorities can then examine how the business allocates revenue, expenses, and profits throughout the value chain.
See also: Forms of related-party transactions.
Why is identifying relationships important in Transfer Pricing?
Accurately identifying the relationships between businesses helps them:
- Knowing which transactions require reporting as related-party transactions.
- Determine the obligation to prepare Transfer Pricing documentation.
- Proactively prepare explanatory documents.
- Reduce the risk of having your taxable income adjusted.
In reality, many businesses only focus on transaction prices but overlook the first step of determining whether they belong to the group of related-party businesses. This leads to omissions in tax declarations and increases the risk when tax authorities conduct audits.
The Arm's Length Principle in Transfer Pricing
One of the most important principles of Transfer Pricing is the Arm's Length Principle.
This principle requires:
“"Transactions between related parties must be defined similarly to transactions between independent parties under comparable conditions."”
For example: An independent business in the market buys raw materials for 100 million VND. Meanwhile, a subsidiary within the same group buys the same raw materials for 150 million VND.
Businesses need to demonstrate:
- Differences in quality
- Payment terms
- Quantity purchased
- Delivery conditions
Without a reasonable basis, the transaction price may be subject to adjustment.
Methods for determining price in Transfer Pricing
To demonstrate that related-party transactions conform to market standards, businesses can employ various pricing methods.
Comparable Uncontrolled Price (CUP) Method
The CUP (Comparable Uncontrolled Price) method directly compares the price of related-party transactions with transactions between independent parties.
Example: The same product:
- Sold to an affiliated company: $90
- Sold to independent customers: $100
Businesses need to explain the differences. This method is suitable when there is clear market data.
Resale Price Method (RPM)
This method is commonly applied to commercial businesses.
Recipe:
Purchase price from affiliate = Resale price – Appropriate profit margin |
For example: The company imports goods from the parent company and resells them to customers. It is necessary to determine the typical profit margin for an independent distribution business.
Cost Plus Method
Suitable for businesses:
- Manufacturing
- Simple production
Recipe:
Selling price = Production cost + Appropriate profit |
For example: Vietnamese businesses manufacture products for foreign corporations. Profits are determined based on the profit margins of similar businesses.
Profitability Comparison Method (PMM)
The profit comparison method is a commonly used method in practice.
This method compares:
- Profit margin of the business
- With comparable profit margins for independent businesses.
For example: A manufacturing company in Vietnam has a profit margin of 2%. Meanwhile, the average for independent businesses in the same industry is 6%.
The tax authorities may request that the business explain the reason.
Profit allocation method
Applicable in the following cases:
- Complex value chain
- No direct comparative data is available.
Profits are allocated based on each party's actual contribution.
FAR Analysis in Transfer Pricing
FAR is a crucial element when building a Transfer Pricing profile. FAR includes:
- Function: What activities does the business perform? For example, manufacturing, distribution, marketing, research.
- Assets: Businesses use their factories, machinery, technology, and brand.
- Risk: Businesses face market risk, inventory risk, exchange rate risk, and credit risk.
The results of the FAR analysis help determine what level of profit a business should receive.
Documents that businesses need to prepare for Transfer Pricing
Businesses with related-party transactions may need to prepare a set of documents. Transfer pricing documentation.
- Local File: Includes company information, description of related-party transactions, FAR analysis, and pricing methodology.
- Master File: Typically used for multinational corporations. It details the corporate structure, value chain, and profit distribution policies.
- Country-by-Country Profit Reporting (CbCR): Applicable to certain large corporations subject to specified conditions.
Common Transfer Pricing Risks
Although transfer pricing helps businesses build a more transparent profit allocation mechanism and manage internal transactions, it is also an area with many potential tax risks if businesses do not comply with regulations. Errors in determining transfer pricing, choosing pricing methods, or preparing supporting documentation can cause difficulties for businesses during tax audits and inspections. Below are common transfer pricing risks that businesses need to be aware of in order to proactively control them and develop appropriate policies.
- Failure to prove internal services: For example, if a company pays management fees to its parent company but lacks documentation or cannot demonstrate the benefits received, the expense may be subject to tax assessment.
- Persistent losses: A business that has been operating for many years but consistently incurs losses may lead tax authorities to question its business model, internal pricing policies, and profit allocation methods.
- Non-market transaction prices: If a business cannot demonstrate that its prices are reasonable, the tax authorities may make adjustments.
Frequently Asked Questions about Transfer Pricing
No. Transfer pricing is the process of determining transaction prices between related parties. Risk only arises when a business exploits related-party transactions to improperly adjust profits in order to reduce tax obligations.
Regular selling prices are determined between independent parties, while transfer pricing involves transactions between related parties.
The regulations limiting the ceiling on interest expense are applied according to Decree 132. The total interest expense deductible when determining taxable corporate income must not exceed the net profit from business operations plus interest expense and depreciation expense for the period (EBITDA). The portion of interest expense exceeding this limit cannot be directly deducted, but the enterprise is allowed to carry it forward to the next tax period for a maximum of 5 consecutive years.
The tax authorities utilize an integrated internal data system (including tax returns from all Vietnamese businesses), customs data on imports and exports, and copyrighted international trade databases (such as Moody's Orbis, Bureau van Dijk, and Thomson Reuters). If the benchmarking data in a company's transfer pricing file is obtained from an unreliable source or intentionally selects competitors with dissimilar functions, the tax authorities have the right to reject it and apply their own benchmarking data to determine the tax liability.Is transfer pricing an illegal practice?
How does transfer pricing differ from regular selling prices?
How will interest expenses arising from related-party transactions be controlled in 2026?
What database do tax authorities use to verify and reject transfer pricing claims from businesses?
Conclude
Transfer pricing is an important aspect of corporate tax and financial management, especially for FDI companies, multinational corporations, or companies with internal transactions.
Developing an appropriate Transfer Pricing policy helps businesses:
- Comply with tax regulations.
- Minimize inspection risks.
- Effective profit management
- Transparency in business operations
In an increasingly stringent tax environment, businesses should proactively review related-party transactions, prepare complete documentation, and develop strategies that align with their actual operating model.
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Responsible for production and professional content review by: Mr. Le Hoang Tuyen – Founder & CEO of MAN – Master Accountant Network. He is a CPA Vietnam auditor with over 30 years of in-depth experience in accounting, auditing, taxation, and corporate legal consulting.