”Transfer Pricing – The Vietnamese System in the Light of the OECD Guidelines and the Systems in certain Developed and Developing Countries”

1 Introduction

On 11 December 2009 Phat Tan Nguyen defended his doctoral thesis ”Transfer Pricing – The Vietnamese System in the Light of the OECD Guidelines and the Systems in certain Developed and Developing Countries” at the Department of Commercial Law, Jönköping International Business School. The study had been carried out within the framework of a Doctoral Scholar Award granted by the Harvard-Yenching Institute in the United States. Having been a member of the grading committee for his thesis and oral defence I will now give a presentation and evaluation of Phat Tan Nguyen’s thesis.

The review is structured in the following way: Section

2 deals with the subject of the thesis – its scope and delimitation. In Section

3 the aim and relevant questions posed by the author are presented. Section

4 is devoted to some remarks regarding the methodology chosen and the material used. In Section 5 a presentation of the structure of the thesis is given. Section 6 summarises the conclusions drawn in the thesis. The review ends with some conclusory remarks in Section 7.

2 The subject

The broader context of the subject is transfer pricing i.e. the pricing of transactions between group members. In the words of the author “transfer pricing remains the most important international tax issue multinational enterprises (MNEs) are facing”. The thesis has a clear developmental perspective. Its focus is on the transfer pricing system in Vietnam, the home country of the author. The new Vietnamese transfer pricing rules, which are currently on the brink of being tested in practice, are reviewed in the light of both the OECD Guidelines and the transfer pricing systems in four selected countries; the United States, Germany, China and Brazil. Throughout the thesis it is demonstrated that transfer pricing presents increasingly complicated problems not only to MNEs but also to tax administrations, particularly in developing countries.

Much attention is paid to the OECD Guidelines, and their approach to the application of the arm’s length principle, which governs the tax treatment of transfer prices. This has had an impact on OECD members. At the same time it is observed that important differences remain in the domestic transfer pricing rules and practices of both OECD members and other countries. Several different aspects of the OECD Transfer Pricing Guidelines and other multilateral instruments are studied, in particular how they have been incorporated in the Vietnamese transfer pricing legislation.

As mentioned above, a new transfer pricing system was recently adopted in Vietnam. The choice of Vietnam as the object for the study is thus particularly interesting since this new transfer pricing system is a challenge to the country as regards both the design and content of the regulations and their practical implementation. A crucial issue from a Vietnamese perspective is the impact the enforcement of the transfer pricing rules may have on attracting foreign direct investment (FDI) to the country, in particular so far as concerns obstacles caused by uncertainties and burdens imposed on taxpayers who have to comply with the transfer pricing rules, and there remains a clear risk that double taxation may not be prevented.

Although an MNE may be subject to several taxes, the study is limited to corporate income tax. Furthermore, regarding the two main systems applied in allocating the taxable profits of an MNE, namely the arm’s length principle (ALP) and the formula appointment principle (FA), the study largely focuses on the former. The reason given for this is that virtually all countries apply the ALP as the internationally accepted standard in this area.

3 The aim and relevant questions

The aim of the study is quite ambitious, including analyses not only of important aspects of the OECD Transfer Pricing Guidelines but also of the transfer pricing systems of selected developed and developing countries as well as other multilateral instruments. The findings in these parts of the study are then themselves used to serve as points of departure when examining how these elements have been incorporated in the Vietnamese transfer pricing legislation. The author analyses problems arising from the application of different domestic transfer pricing rules in order to suggest possible remedies from an international perspective. Since the Vietnamese transfer pricing rules are on the brink of being tested in practice through tax audits, one aim of the study is thus to indicate problems which are likely to arise in Vietnam and, where appropriate, to suggest improvements.

More precisely the study focuses on the following four selected crucial problem areas of the application of the arm’s length principle and transfer pricing rules: (1) the concept of associated enterprises, (2) the selection and application of transfer pricing methods and the arm’s length range and comparability requirements including the use of foreign and secret comparables, (3) documentation requirements, burden of proof and transfer pricing penalties, and (4) transfer pricing adjustments and dispute resolution and prevention.

With these problems in mind, the author formulates the following three research questions for the thesis: (1) What are the problems and complications that may arise from the application of the ALP or different domestic transfer pricing rules and what are the approaches to the allocation of taxable profits of an MNE? What are the possible remedies for such issues? (2) What are the problems and complications that may arise from the application of the new Vietnamese transfer pricing regulations and the consequent need to comply with them? (3) What suggestions can be made to improve Vietnam’s existing transfer pricing regulations and their practical application?

4 Method and materials

As mentioned above the study is based on a comparison between the OECD Guidelines, the domestic transfer pricing laws and regulations of four selected countries, the United States, Germany, China and Brazil on the one hand, and the Vietnamese transfer pricing system, on the other. The material used also includes transfer pricing aspects of the OECD Model Tax Convention (MTC) and tax treaties concluded between different countries, the EU Arbitration Convention, the “soft law” of the Pacific Association of Tax Administrators (PATA), the Transfer Pricing Documentation Package (PATA package) and the EU Code of Conduct on transfer pricing for associated enterprises in the EU (EU TPD).

Regarding the comparative legal method applied in the thesis the author makes a distinction between “macro comparison” and “micro comparison”. For the purpose of the thesis he has chosen to use primarily the micro legal comparative method, meaning that a comparison is made between the specific regulations a number of selected countries have adopted to solve actual problems or particular conflicts of interest. To some extent the macro legal comparative method – involving a comparison of the spirit, style, methods and thoughts of the legal systems – also seems to have been applied in the sense that macroeconomic, tax, legal and judicial conditions in Vietnam are studied.

Transfer pricing and the allocation of taxable profits of an MNE are cross-border issues involving more than one jurisdiction. Considering the aim of the study, it is obvious that international practices and experiences in this area would be highly relevant and useful. Since Vietnam as a developing country is in the initial stage of applying transfer pricing rules it makes sense to compare the Vietnamese transfer pricing system and the OECD Guidelines, the selected transfer pricing systems and other multinational instruments. One could perhaps argue that the author has been too ambitious in choosing so much material for his thesis, but the general assessment is that he has successfully made use of it all.

However, on one point the sources referred to could perhaps have been more extensive, namely case law. The author repeatedly emphasises the importance of drawing conclusions based on the interpretation and practical application of existing transfer pricing systems. In this regard it is worth noting that there is a somewhat surprising lack of case law material used in the thesis. There are references to several reports and surveys carried out by professional consulting organisations, such as Ernst & Young, PricewaterhouseCoopers and Deloitte Touche Tohmatsu as well as the World Bank, illustrating different problems concerning the interpretation and application of the transfer pricing systems. But one would have expected that case law from different jurisdictions could have served as primary sources in this regard.

5 The structure

The book is divided into nine chapters. Except for the first and the last chapters, each chapter ends with a summary and concluding remarks.

Chapter 1 is the introduction to the thesis. Here, the subject and its aims and boundaries are presented. This chapter also deals with methodological issues, legal sources and the material used in the study. A special section is devoted to “the case of Vietnam”.

In Chapter 2 the economic and legal basis of the subject are reviewed and this provides the foundation for the subsequent analysis. A number of economic and legal aspects are examined, especially those that relate to cross-border trade, and investment and the business operations of MNEs. The chapter also deals with the nature and characteristics of intra-group trade, economic efficiencies and the utilisation of intra-group trade and the managerial functioning of a transfer pricing system within an MNE as well as the explanation of the existence of MNEs themselves. Finally, different areas of the legal foundation of the cross-border trade, investment and business operations of MNEs are described and examined. These include public as well as private international trade law, international investment law and of course, last but not least, international tax law.

Chapter 3 is devoted to the examination and comparison of the two theoretical approaches to allocating the taxable profits of an MNE, namely the arm’s length principle (ALP) and the formulary apportionment principle (FA). The historical background of the two approaches is examined in the light of the development of tax treaties. This is studied in both the international context as well as in to the context of the different national systems studied in the thesis.

Chapter 4 is the first of four chapters in which the above mentioned four selected problem areas of the application of the ALP and different transfer pricing rules are analysed from an international perspective. Here the focus is on a comparative analysis of the scope of the notion of associated enterprises and its significance under the OECD MTC and domestic transfer pricing rules of the four selected countries.

The second selected problem area is dealt with in Chapter 5, where a comparative analysis is made of the various existing methods of establishing arm’s length prices in theory and practice. The analysis covers the use of foreign and secret comparables under the recommendations of the OECD Guidelines and the domestic transfer pricing laws and regulations of the four selected countries as well as the EU TPD.

Chapter 6 compares and analysis the transfer pricing documentation requirements, burden of proof and transfer pricing penalties under the recommendations of the OECD Guidelines, the domestic transfer pricing laws of the four selected countries and the EU TPD. Problems in the application of and the compliance with these rules are also dealt with.

The fourth and last problem area is dealt with in Chapter 7. Here the focus is on examining transfer pricing adjustments and dispute resolution under the OECD MTC, selected tax treaties and the EU Arbitration Convention. Special attention is paid to the problem of whether the current systems protect MNEs from the risk of double taxation and how more precisely to prevent transfer pricing disputes, double taxation and transfer-pricing related risks.

In Chapter 8 the focus is on Vietnam and how the four problem areas relate to the recently introduced Vietnamese transfer pricing rules. The chapter examines the Vietnamese transfer pricing rules in detail by way of comparison with the OECD Guidelines and the transfer pricing systems of the four selected countries, the PATA package and the EU TPD. This is one of the core chapters of the thesis. It analyses the potential problems in this field of tax law in the light of Vietnam’s situation as a developing country and relevant aspects of the national economy, the benefits of FDI, the tax environment, Vietnamese tax treaties, the legal culture, the functioning of the judicial system and so on.

The final conclusions drawn from the study are presented in Chapter 9, where answers are given to the three research questions mentioned above. Various problems arising from the application of the ALP and different domestic transfer pricing rules are discussed and possible remedies from an international perspective are suggested. Hereafter, the focus is on Vietnam and the potential problems and complications facing the country. Against this backdrop certain improvements of the Vietnamese transfer pricing system are proposed. A summary of these proposals is presented below.

6 Conclusions drawn

In the final chapter the author sets out the conclusions drawn from this comprehensive study. First some points relating to the international context are presented and thereafter the author proceeds to the case of Vietnam.

The author comes to the somewhat obvious conclusion that in order to provide certainty for associated enterprises it is necessary that countries apply similar transfer pricing systems and rules with respect to the selection of transfer pricing methods and the arm’s length range and that these rules are applied in similar ways. The findings of the study show, however that this does not seem to be the case. The author finds here a striking difference between transfer pricing law and, for example, international private trade law. In the latter case, as a result of international agreements, commercial judgements and arbitral awards which have legal effect in one contracting state are generally recognised and enforced in its jurisdiction by the other contracting state. No such recognition can however be taken for granted when it comes to the field of transfer pricing law. Due to the fact that tax authorities in different tax jurisdictions may differ in their opinion on the selected method, arm’s length range etc. an MNE may, for the same controlled cross-border transaction, have to select and apply two different methods to meet the transfer pricing rules in the two countries. This in turn may result in double taxation. Since the author recognises that a worldwide multilateral treaty on the application of the ALP does not seem feasible, he proposes that countries instead harmonise their domestic transfer pricing rules with respect to the selection and application of transfer pricing methods, the arm’s length range and the use of comparables by adhering as closely as possible to the recommendations of the existing OECD Guidelines.

The most interesting parts of the thesis, including the final conclusions, are those dealing with the case of Vietnam. The author points out several severe shortcomings of the Vietnamese tax system, which according to a World Bank survey is among the top five tax systems in the world having the most complicated procedural rules of tax compliance. Vietnamese taxpayers’ costs of tax compliance are therefore higher than in other countries. Furthermore the author points out that currently there exist tax officials who are overly bureaucratic and who make use of their position to apply tax laws and regulations incorrectly. It goes without saying that this is not an optimal environment for the introduction of a sophisticated and complicated transfer pricing system. The Vietnamese tax authorities’ lack of practical experience with transfer pricing assessments coupled with the fact that, according to the author, they have broad authority in the interpretation and application of the tax laws and regulations seems to make the situation even more problematic.

The author has identified 15 complications and problems with the Vietnamese system: these include both highly specific and more general issues. The problems identified relate to shortcomings in regard to clarity, transparency, consistency and uniformity of the rules and their application. The improvements suggested would serve to provide legal certainty and confidence for MNEs seeking to conduct long-term business in Vietnam and would assist the country in maintaining and attracting FDI.

7 Concluding remarks

The subject of transfer pricing has already been studied from many different angles of approach and much research has been published in this particular field of tax law. The use of a development perspective is, however, a new, interesting and challenging way to proceed. This is no doubt the main contribution of Phat Tan Nguyen’s thesis.

The thesis is apparently one of the first in depth academic studies on the allocation of taxable profits to associated enterprises in Vietnam and according to the author there have only been one or two academic articles published on this topic in Vietnam. This research into the potential problems and complications that may arise from the application of the new transfer pricing regulations, and the comparison with the relevant legal materials, is a welcome contribution to the existing academic literature in the area of transfer pricing in the international as well as in the Vietnamese context.

However, on two points one could have wished that the thesis had been taken a little further.

The first issue concerns the Vietnamese transfer pricing rules and the taxpayers’ right to justice. In his thesis (p. 382) the author makes the following statement.

“Because of the very limited functioning of the Vietnamese judicial system in interpreting and applying tax laws and resolving tax disputes, the tax authorities have discretionary powers in many aspects of tax administration.”

From a tax payer’s perspective this seems like a somewhat alarming state of affairs. What about judicial independence in this regard? It would have been interesting to get a more in depth analysis of how the Vietnamese system does or does not protect the rights of the tax payers when it comes to the transfer pricing rules. The thesis could have studied the right to appeal a decision of the tax authorities and the judicial independence of the Vietnamese courts.

The second issue that could preferably have been given more attention is that of conflicts that might arise when determining a fair value for a cross border transaction. Here opposing interests and stakeholders could be identified and the same party might play different roles in different contexts. For instance, both customs valuations and transfer pricing rules set standards for determining the “arm’s length price” or the “fair value” of transactions. There are customs valuation rules included in the WTO Agreement – GATT Art VII and an additional separate Agreement on Valuation – that are very similar but not identical to the rules contained in the OECD Transfer Pricing Guidelines.

This might cause problems and tensions in international transactions and their taxation. Customs authorities and tax authorities within the same country often have conflicting interests. On a given import transaction, the customs authorities might be tempted to try to increase the value declared by the importers in order to collect more duties, while the tax authorities’ natural inclination would be to decrease the value declared in order to limit the deductible amount. Looking at it from an MNE perspective, the enterprise might want to declare as low an import value as possible for customs purposes, while it might be interested in higher transfer prices for income tax purposes if they can generate greater deductions. This illustrates an additional complexity when determining a fair value for a cross border transaction and it would have been interesting to learn more about how such situations are handled in the different jurisdictions studied in the thesis, including that of Vietnam.

But these are, as should be clear, only marginal comments. Phat Tan Nguyen has written a very fine thesis indeed. It is the result of a comprehensive and impressive work of research which will be a most valuable tool for any future researcher in this field of law.

It is impossible to do justice to the above-mentioned complex problems within the framework of a short review. The bottom line is that the thesis constitutes an important and valuable contribution to the understanding of the laws of transfer pricing in different contexts, both from a theoretical and a practical point of view. It will no doubt assist those academics, governments and practitioners concerned with international tax law and transfer pricing.

Christina Moëll is Professor of Fiscal Law, Faculty of Law, Lund University.