Advance pricing agreements: A solution to alleviate transfer pricing challenges

Advance pricing agreements (APA) can help prevent violations of transfer pricing and create more favorable conditions for businesses, writes Huong Vu, general director of EY Consulting Vietnam.

The determination of transfer pricing has posed significant challenges for the Vietnamese tax authority over the years. In many instances, the lack of consensus on transfer pricing valuation has led to prolonged disputes, wasting time and resources for both the government and businesses, while also negatively impacting the investment environment and posing risks of tax revenue loss. The advance pricing agreement (APA), a measure adopted by many countries worldwide, could serve as an effective solution to this issue.

Most commonly identified violations in transfer pricing practices

The typical operational model of FDI enterprises in Vietnam currently relies heavily on inputs provided by parent companies, such as technology licenses and technical services. The parent company also supplies the majority, or even 100%, of the primary raw materials needed for production. The subsidiary purchases a small portion of raw materials, auxiliary materials, or packaging from independent suppliers in Vietnam.

On the output side, the subsidiary sells most, or 100%, of its finished products to affiliated companies abroad for further production and distribution in the market.

Due to operations in multiple countries, businesses utilize transfer pricing (defined as the prices in business transactions such as buying, selling, leasing, and transferring goods, services, and assets between affiliated parties) as a tool to allocate income among companies within the same group.

This allows them to shift internal group transactions by transferring revenue and costs to countries with more favorable tax rates, referencing the transfer pricing regulations of each respective country.

Based on years of consulting experience in the tax field, the author identifies several typical manifestations of transfer pricing violations, including:

Firstly, reporting losses while simultaneously expanding business operations and continuously increasing investment capital in Vietnam. Secondly, reporting losses after tax incentives expire.

Thirdly, parent companies selling assets to subsidiaries at prices above market value to increase profits abroad and raise depreciation costs in Vietnam. Next is FDI companies recording service costs such as royalties, management fees, and consulting fees to affiliated parties, without actual transactions or evidence that these services support the company's operations in Vietnam.

Last but not least, maintaining low profit levels and paying minimal taxes to avoid attracting the attention of tax authorities.

The challenge for state management agencies in these cases is to eliminate factors influenced by affiliated relationships to determine transfer prices equivalent to market prices. Some measures commonly applied by tax authorities include setting profit margins based on independent transaction value ranges to reduce losses and increase taxable income for businesses; adjusting the purchase price of assets, leading to reduced depreciation value of fixed assets; or completely or partially excluding service costs from reasonable and valid expenses when calculating corporate income tax.

Challenges in implementing current regulations

To safeguard state interests and combat tax revenue loss, Vietnamese authorities have issued numerous regulations related to transfer pricing. The tax authorities have also had to invest significant resources in terms of time and personnel to combat transfer pricing.

According to a report from the Ministry of Finance, in 2022, tax authorities conducted 1,380 tax inspections at companies with affiliated transactions, recovering nearly VND914 billion ($35.28 million), reducing losses by nearly VND18.1 trillion, and increasing taxable income by over VND3.7 trillion. In 2023, although the number of inspections decreased to 1,250, the increase in taxable income rose to over VND5.43 trillion ($209.6 million).

However, during the implementation of policies, many prolonged disputes have arisen, negatively affecting the investment environment. For instance, disagreements between a company and the tax authority regarding the application of the comparable uncontrolled price method for determining transfer prices.

In other cases, differing expectations regarding the application of specific prices within the independent transaction value range have emerged. In some instances, the application of Decree 132/2020/ND-CP on transfer pricing has also been inconsistent, leading to complaints and wasting time and resources. The necessity for numerous inspections and the lengthy inspection process have also impacted companies' production and business plans, reducing Vietnam's investment attractiveness.

APA as a solution

So, what is the solution to both prevent violations of transfer pricing and create more favorable conditions for businesses? Currently, several countries in the region are implementing APAs, a practice that has shown significant benefits. An APA is a written agreement between the tax authority and the taxpayer, or between the tax authority and the taxpayer and the tax authorities of countries or territories with which Vietnam has signed Double Taxation Avoidance Agreements, aimed at preventing tax evasion for a specified period. It specifically defines the tax bases, methods for determining taxable prices, or market-based taxable prices.

This method has notable advantages, including reducing uncertainty and tax risks, helping businesses predict their future tax obligations, and minimizing risks of audits and subsequent tax adjustments. When an APA is issued to a business, they are exempt from preparing transfer pricing documentation, leading to reduced administrative procedure times and compliance costs.

Secondly, APAs are often conducted between the tax authorities of two or more countries, helping to avoid double taxation on the same income of a business. Additionally, APAs help minimize legal costs and time associated with tax audits and disputes. The implementation of APAs will create a stable and predictable business environment, fostering healthy and cooperative relationships between businesses and tax authorities, as well as among tax authorities of different countries.

APAs have been adopted by many developed countries worldwide. The United States is one of the first countries to implement APAs and has a relatively detailed legal framework for their execution. EY's summary shows that the number of APAs conducted by the U.S. tax authority in 2023 nearly doubled compared to 2022, increasing from 77 to 156. The U.S. conducts both bilateral and multilateral APAs, with multilateral APAs making up the majority. The most common APAs from the U.S. tax authority are with partners from Japan, India, and Italy.

Japan is also one of the countries that issued and applied APA regulations early, starting in 1987. The number of APA applications submitted by Japanese taxpayers from July 2022 to June 2023 reached 243.

In Singapore, the number of APA applications increased from 10 in 2017 to 22 in 2022.

In Vietnam, APAs are not an unfamiliar solution. The legal framework for APAs has been established since 2013 under Circular 201/2013/TT-BTC of the Ministry of Finance and was later replaced by Circular 45/2021/TT-BTC, which made significant progress. However, the implementation of these regulations remains limited, with over 30 APA applications submitted but none approved.

In this context, the author believes that now is an opportune time for Vietnam to develop a decree on APAs to enhance the legal framework for practical implementation. The development of this decree also presents an opportunity to amend regulations to better align with international practices and strengthen accountability mechanisms. Many countries are willing to cooperate with Vietnam to implement this method, such as Japan. If realized, the decree would be a significant step forward in the broader application of APAs, helping to alleviate bottlenecks in transfer pricing determination.

* This article reflects the author's views and does not necessarily represent the views of the global EY organization or its member firms.