Transfer Pricing - Predicament of the Economy

Parent groups reported a loss but subsidiary companies enjoyed a profit. Vietnam National Petroleum Corporation (Petrolimex) was suspected of transfer pricing when it deducted good commissions to agents although its loss amounted to trillions of Vietnamese dong. According to the regulations of the Ministry of Finance, a full commission for a kilo or a litre of petroleum products is VND600, but Petrolimex was found to give up to VND1,100 - 1,200 to its agents from time to time. The country’s largest petroleum trader paid a commission of VND860. The difference in commission rates led to a loss of VND516 billion. Petrolimex has 4,000 agents nationwide, including 2,100 for first-grade agents which are under its direct administration. The loss in couple with the higher-than-regulated commission aroused the suspicion of transfer pricing - the parent company makes a loss to transfer the profit to subsidiary units. The Ministry of Finance confirmed that if Petrolimex had been compliant with regulations on commissions, profit norm and business expenses, it would have made a profit. There is much suspicion about transfer pricing in this case. However, the authorities have not made any conclusion about whether Petrolimex breached transfer pricing or not.

 

Not only domestic enterprises, but foreign companies are also suspected of transfer pricing.

 

According to the General Department of Taxation, up to 90 percent of investigated FDI enterprises were found to commit various forms of violations. But, the investigation was carried out in huge, continuous loss-making companies. Many companies with losses in excess of the owner’s equity still expand operations. The number of checked companies is very small in relation to the total of about 8,800 FDI enterprises with tax payments. If more companies are probed, the number may be larger.

Companies have used many different ways of transfer pricing. The most common violation uncovered is to falsify production and business costs, salaries, depreciations, provision extraction, unrecorded expenses, and overspending.

 

Many FDI enterprises still receive investment incentives from the Government of Vietnam and they are expanding production scale, although they continuously report losses. More strangely, the larger scales they have, the more losses they suffer. The causes for loss are defended in different ways. This is one of their explanations: To manufacture a product, they import materials at very high price rates from their parent companies in foreign countries but export finished products to their parent companies at lower prices than those of materials. “Undervalued” products will be labelled before being sold on the market.

 

According to the review report of the General Department of Taxation in 2011, anti-transfer pricing inspection and examination were increased in both quantity and efficiency and caught public opinion throughout the country. Specifically, the general department planned to inspect 1,276 enterprises (a 10 fold increase from 2010) but actually investigated 856 enterprises, or 67 percent of the plan. Losses were reduced by VND4,400 billion (more than 2.5 times over 2010), tax arrears and fines reached VND1,650 billion (an increase of 4 times over 2010.)

 

Speaking of the Petrolimex case, Dr Le Dang Doanh, a senior economist, said: “I first suggest splitting Petrolimex into 3 different independent companies (wholesaling - retailing - importing). The authorities must have serious attitude towards controlling prices, losses and profits in petroleum business to protect consumers."

 

Dr Doanh said: "Petrolimex’s violation in commission mechanism has been found by the Ministry of Finance, but it did not intend to deal with such violation but wanted to use it to gradually increase the transparency of the petroleum market. Then, authorities consider raising the rate of business expenses and commission rates for petroleum agents. Actually, it is very difficult for consumers to enjoy their legitimate rights if we do not have real reform in petroleum business."

 

In spite of knowing that 90 percent of loss-making FDI enterprises have signs of transfer pricing, the authorities are unable to make exact conclusions regarding their behaviour. Mr Do Nhat Hoang, Director of Foreign Investment Agency under the Ministry of Planning and Investment, said: Inspectors have collated lists of material and equipment prices declared to tax authorities by FDI enterprises with prices of materials and equipment in parent companies in foreign countries, but no evidence has been found.

 

Tax agencies and Foreign Investment Agency only use the phrase “signs of transfer pricing” in writing and no case has been proven with violations of transfer pricing thus far. Mr Hoang said: To fight against transfer pricing, after consultation with relevant ministries, the Ministry of Planning and Investment has established the Working Group on Transfer Pricing Affairs. We are coordinating closely with other ministries, particularly the Ministry of Finance, to take action against transfer pricing. In addition, the Working Group is responsible for studying forms and modes of transfer pricing as well as proposing measures to deal with companies which committed transfer pricing.”

Mr Hoang explained: “Although there are signs, we have no database, evidence, arguments, and instruments to identify whether the acts are violation or not. We very much want to find a case of violation to send a warning to other businesses. However, we do not find any evidence of violations. I only use the phrase ‘signs of transfer pricing’ because the information must be accurate and leave no impact on the investment climate.”

 

He also pointed out that apart from insufficient data and a short survey period, Vietnam lacks coordination from tax authorities and financial agencies in other countries. “Possibly, foreign authorities will protect their companies because the act of transfer pricing is beneficiary to their countries," he added. “For example, a pharmaceutical company in the United States transferred prices of medicines and this act caused a damage of US$2 billion, but it was found after some years. In the United States, regulations are much more stringent than those in Vietnam but they face a lot of difficulties in determining transfer prices. In Vietnam, the lack of policies, instruments, especially information and management, makes the task more difficult.”

 

The head of the Foreign Investment Agency said the determination of transfer pricing is difficult right from the stage of valuation. For example, a chip production costs only US$10 but the producer can declare the import price of US$12. However, the chip is monopolistically produced. “If this is the case, we cannot continue with it.”

 

Ms Nguyen Thi Cuc, former Deputy General Director of the General Department of Taxation, said: “Small auditor force, intersection of enforcement agencies, and overlapping of legal regulations and policies are also difficulties of determining transfer prices.

 

If transfer pricing persists, companies declare falsified prices and transfer tax payables in Vietnam to foreign countries, Vietnam will continue to lose taxes. Thus, determining transfer pricing cannot be done if regulations are not effective and strong enough.