Effective from 1st May 2017, under Vietnam’s new revised transfer pricing regulation, including Decree No.20/2017/ND-CP (the “Decree”) and Circular No.41/2017/TT-BTC, businesses engaged in related party transactions have to pay more attention to the growing local compliance requirements. In particular, for the first time, their involvement in the Group’s operational and pricing model are now required to be transparent when the so-called transfer pricing “master file” should be maintained at the local level, and important information contained in the master file should be reported annually to Vietnam’s tax authority.
Country-by-country reports on the geographical allocation of group’s profits should also be reported, while taxpayers may have little information on how the authorities will exchange such information with their overseas counterparts.
Given the similarity between Vietnam’s new transfer pricing regulations and OECD’s guidelines, the master file and country-by-country report should theoretically have been prepared by the group, which should also ensure the local compliance for every group entity. However, under the BEPS Action 13, member countries are allowed, and in practice, did provide their taxpayer with various exemptions. Obviously, some countries have higher thresholds for exemptions than other countries and thus the group – subsidiary is now not only a set-adaptation relationship but should be more collaborative, in order to come up with the best structure for the subsidiaries’ local positions in the compilation and planning of the group’s master file and thereafter its implementation for local compliance purposes.
A typical case is that a common approach is taken in compiling the master file to tackle functional profiles of each phase within a supply chain and then to determine the arm’s length or appropriate profitability for each phase, say 5% of Operating Margin or 5% of Return on Total Operating Costs. However, it may not well suit the position of a certain associate, given its manufacturing or distribution function.
A 5% margin may not be enough to defend a potential transfer pricing challenge by the local tax authority. The performance, or profitability in other words, of each subsidiary can be varied from practice to practice depending on each country’s regulations, economic policies, infrastructure conditions, supporting industries, and so on.
When a master file fails to reflect all relevant factors in setting transfer pricing policies for identical entities attributed to a similar functional profile, it may expose certain associates of a group to potential scrutiny and transfer pricing adjustments.
To avoid such issues when compiling the master file, a group should plan carefully on various scenarios for each individual practice, for instance a 5% margin may be good enough for advanced jurisdictions while it may not be sufficient for those that are still in high inflation economies or where supporting industries are not available, or those with low-skilled labour etc. The bottom-up review process in such circumstances is very crucial in compiling a master file.
Subsidiaries can feed the ultimate parent with all of the country factors, including, but not limited to, local industry surroundings, economic conditions, regulations and restrictions, labour and social issues, to assemble a successful master file.
On the other hand, once a master file is available to subsidiaries, they are also recommended to obtain sufficient advice on how to adapt to the master file and further leverage for local filing and defending the local position.
Understanding comprehensively each area and discussion of the established master file is a solid foundation to compile successful transfer pricing documentation for local compliance purposes.