Transfer pricing of fdi enterprises in vietnam from 2011 to 2016,graduation thesis

LIST OF ABBREVIATIONS ALP Arm’s – Length Principle BCC Business co-operation contract BOT Build – operate – transfer BT Build transfer BTO Build – transfer – operate CIT Corporate In

STATE BANK OF VIETNAM BANKING ACADEMY Foreign Languages Faculty -šš&›› -

ACKNOWLEDGEMENTS

First and foremost, I wish to extend my heartiest appreciation to all my lecturers in the Banking Academy of Vietnam, who have inspired me with knowledge of English as well as Banking and Finance throughout my four-year learning process

I would like to convey my heartfelt thanks and special gratitude to my mentor, Ms

To Kim Ngoc, Assoc Prof., for her great inspiration, constant guidance and support In spite of her busy schedules, she always found time to guide me through the thesis Last but not least, I would like to express my sincere thanks to my family and friends for their unconditional love and support It is their encouragements during my process

of implementing this thesis that has played as spiritual foundation and given me the strength to fulfill this challenging task and make it such a success

Due to limited time, my graduation thesis may not be free from certain shortcomings Thus, in order to improve my thesis, I am eager to receive feedbacks from the lecturers

DECLARATION

I declare that this thesis is the product of my own work and has not been previously submitted for my degree or examination in any other university All the sources I have used have been indicated and acknowledged by means of complete references

Hanoi, May 17, 2017

Signature

Nguyen Thai Anh

LIST OF ABBREVIATIONS ALP Arm’s – Length Principle

BCC Business co-operation contract

BOT Build – operate – transfer

BT Build transfer

BTO Build – transfer – operate

CIT Corporate Income Tax

FDI Foreign Direct Investment

IMF International monetary fund

IRS Internal Revenue Service

M&A Mergers and Acquisitions

MNCs Multinational Corporations

ODA Official Development Assistance

OECD Organization for Economic Co-operation and

Development WTO World Trade Organization

LIST OF TABLES AND FIGURES

Figure 2.1: Registered FDI and Disbursed FDI from 2011 to 2015 22

Figure 2.2: Number of new projects and increased capital projects

from 2011 to 2015 22

Figure 2.3: Main investment fields from 2011 to 2015 24

Figure 2.4: Number of FDI enterprises operating in the period 2010 – 2015 27

Figure 2.5: Structure of FDI enterprises by sector in 2015 28

Table 2.1: Inspection Results of FDI Enterprises in 10 Localities in Early 2014 32

Figure 2.6: Revenue and Profit of Coca Cola Vietnam 2006 – 2014 41

TABLE OF CONTENTS ACKNOWLEDGEMENT

DECLARATION

LIST OF ABBREVIATIONS

LIST OF TABLES AND FIGURES

TABLE OF CONTENTS

INTRODUCTION 1

CHAPTER 1 4

BACKGROUND OF TRANSFER PRICING IN FDI ENTERPRISES 4

1.1 THE BASICS OF FDI ENTERPRISES 4

1.1.1 Definition and features of FDI 4

1.1.2 Forms of FDI 5

1.2 TRANSFER PRICING IN FDI ENTERPRISES 7

1.2.1 Definition and classification of transfer pricing 8

1.2.2 Motivations for transfer pricing of FDI Enterprises 10

1.2.3 Transfer pricing process of FDI Enterprises 12

1.2.4 Consequences of transfer pricing 14

1.3 INTERNATIONAL EXPERIENCES OF ANTI-TRANSFER PRICING AND LESSONS FOR VIETNAM 15

1.3.1 International experiences of anti-transfer pricing 15

1.3.2 Lessons for Vietnam 19

CHAPTER I CONCLUSION 20

CHAPTER 2 21

TRANSFER PRICING SITUATION OF FDI ENTERPRISES IN VIETNAM 21

2.1 CURRENT INVESTMENT SITUATION OF FDI ENTERPRISES IN VIETNAM 21

2.1.1 FDI legal environment in Vietnam 21

2.1.2 Current investment situation of FDI Enterprises in Vietnam 21

2.1.3 Impacts of FDI Enterprises on the economy of Vietnam 28

2.2 TRANSFER PRICING STATE OF FDI ENTERPRISES IN VIETNAM 31

2.2.1 Scope of transfer pricing in Vietnam 31

2.2.2 Types of enterprises commonly using transfer pricing 33

2.2.3 Transfer pricing methods of FDI Enterprises in Vietnam 34

2.2.4 Analysis of typical transfer pricing cases in Vietnam 37

2.3 ANTI-TRANSFER PRICING IN VIETNAM AND EVALUATION 42

2.3.1 Anti-transfer pricing policies in Vietnam 42

2.3.2 Evaluation the efficiency of the applied solutions 45

CONCLUSION OF CHAPTER 2 47

CHAPTER 3 48

POLICY RECOMMENDATIONS TO LIMIT 48

TRANSFER PRICING VIOLATIONS OF FDI ENTERPRISES IN VIETNAM48 3.1 ORIENTATIONS TOWARD ANTI-TRANSFER PRICING IN VIETNAM 48

3.2 RECOMMENDATIONS TO LIMIT TRANSFER-PRICING ACTS OF FDI ENTERPRISES IN VIETNAM 49

3.2.1 Finalizing legal documents 49

3.2.2 Reforming tax and enhancing tax disciplines 51

3.2.4 Coordinating with interstate tax authorities 54

3.2.6 Completing the information system and data on taxpayers 55

3.2.7 Other recommendations 56

CONCLUSION OF CHAPTER 3 58

CONCLUSION 59

REFERENCES 60

INTRODUCTION

1 Rationale for the Research

Formed by international economic relations, the main flows of capital in Vietnam are divided into three types including official development assistance (including official development assistance (ODA) and other forms), sources Private loans (credit from commercial banks), and foreign direct investment (FDI) Each source has its own characteristics Even though ODA is a preferential source of funding, accessing ODA is not simple and contains political as well as economic aims of other governments For private loans, political constrain is not the factor to be concerned but their strict procedures and repayment terms as well as high interest rates Therefore, FDI has been considered as the most essential fund source in Vietnam’s economic growth thanks to its great contributions Entirely regulated by objective economic laws, the development

of FDI in Vietnam under sufficient and suitable conditions has been suffering from a change in attitude – “against – accept – welcome”

No sooner had FDI reached Vietnam than Vietnam’s socio-economic development started to boost up in a significantly rapid pace with more than 15,000 active FDI projects, which came along with 218.8 billion registered capital In addition, FDI also plays an important role in boosting budget revenue along with promoting Vietnam’s integration process into the world economy In case of a developing country like Vietnam, FDI can be regarded as a solution to overcome the shortage of capital, therefore contradiction between enormous demand for development and scarce financial resource can be solved Besides, following FDI are modern machines, high technologies and labor skills development However, beside the positive contributions, FDI has also been exposing various problems to the economy and therefore negatively affecting the growth’s sustainability Recently, Vietnam economy has seen a series of incidents that caused a social upheaval as well as a delay in the whole Vietnam’s development One of the most typical evidences that can be listed here is transfer-pricing issue Transfer pricing in any country is not an offense itself but it contains many illegal elements That of FDI is creating a situation called “real gain - fake loss” which led to pessimistic consequences like budget loss, unfair competition between domestic enterprises and negative impacts on the investment environment Moreover, not only

does transfer pricing falsifies tax revenue sources but it also lead to disparity in business competition Even though transfer pricing bears a wide range of risks to the economy, it

is difficult to deny the fact that transfer pricing is indispensable in an open economy because of its strong association with the growth of interest groups and the development

of economic instruments Looking for effective tools to identify those factors is a complicated issue nevertheless; it is high time to find solutions for this to ensure the integration environment as well as equal and sustainable investment As a result, investment and business consultants need to have a clear overview about how transfer pricing can be legal or illegal together with comprehensive understanding of transfer pricing methods to protect the enterprises from the risks in detail to minimize the negative impacts to the whole economy in general

In view of this problem, the research needs conducting to make objective assessments of the real situation of transfer pricing in Vietnam along with giving

personal solutions For those reasons, the topic of “Transfer pricing of FDI enterprises

in Vietnam from 2011 to 2016” has been chosen for the thesis

2 Research Objectives

The aim of this paper is to research the situation of FDI enterprises’ transfer pricing acts together with current solutions from the government to detect the

shortcomings Then the thesis will give out some suitable and effective

recommendations from personal standpoint

3 Research Subject and Scope

The study subject of this thesis is the FDI enterprises in Vietnam and their pricing phenomenon from 2011 to 2016 Within limitation scope, the thesis focus on events announced in the mass media as well as within the research limitation of

analyses and to draw reasonable conclusions The combination of these quantitative data sources made for a rich set of data, which could allow the researcher to develop a clear picture of transfer pricing in Vietnam from 2011 to 2016

For the latter, alongside the quantitative data, the thesis is based upon the information acquired via qualitative research The qualitative supplements the statistics with a flavor of views and attitudes of various writers The qualitative data consists information from monitoring and analyzing written sources

Additionally, the thesis uses mainly secondary research, which comes from prevalent information channels such as the Internet, domestic and foreign newspapers, journals, statistic reports, and annual reports The theoretical framework is abstracted from some books and public researchers All data were carefully selected, synthesized, and classified into appropriate section of this thesis Simultaneously, the thesis uses specific research methods such as general analysis, statistics, comparisons, logic, etc

5 Research Structure

In addition to the introduction and conclusion, the thesis consists of three chapters:

Chapter 1 – Background of transfer pricing in FDI Enterprises

Chapter 2 – The situations of transfer pricing in FDI Enterprises in Vietnam

Chapter 3 – Policy recommendations to limit transfer-pricing violations of FDI

Enterprises in Vietnam

CHAPTER 1 BACKGROUND OF TRANSFER PRICING IN FDI ENTERPRISES 1.1 THE BASICS OF FDI ENTERPRISES

1.1.1 Definition and features of FDI

Foreign direct investment (FDI) nowadays has become one of the most popular method of investment According to international economic organization as well as

national laws, FDI is defined as follows

World Trade Organization (WTO) defined FDI as an investment “occurs when an investor based in one country (the home country) acquires an asset in another country (the host country) with the intention to manage that asset” (World Trade Organization, 1996) WTO also considered management dimension is what makes FDI different from other financial instruments and in almost cases, both investors as well as their assets in the host country are business firms In these cases, the investors are considered as

“parent firms” and the asset as “subsidiaries” or “branches”

Besides, International monetary fund (IMF) gave another definition of FDI They took a consideration in FDI as an investment of a direct investor with the aim of obtaining a portion or all the lasting interest of an enterprise that is resident in another economy (the direct investment enterprise) The owner here needs to have 10% or more

of a company’s capital to be a direct investor In another word, the ownership must be

at least 10% of total capital to be recognized FDI

FDI has following major features

Firstly, FDI is associated with the movement of capital including cash and other assets between countries Therefore, it can increase the amount of money and assets of

the host country’s economy and vice versa

Secondly, FDI can be carried out through the establishment of new businesses (joint venture or 100% foreign-owned companies), business operation contracts, merger and

acquisition existing enterprises, purchasing share and operating transfer

Thirdly, foreign investors who wholly own or jointly own domestic enterprises with

a certain percentage of participation are able to directly manage their businesses

Fourthly, affected strongly by the global market relations, private investment on the other hand is less influenced by political relationships between countries or governments

and the fundamental goals is always high profit

Fifthly, investors directly control and manage their own capital flows

Sixthly, FDI contains both foreign investment in a country as well as investment from that country to the others; therefore, it does include the economy’s capital inflow

and outflow

Seventhly, FDI is mainly carried out by transnational companies

1.1.2 Forms of FDI

Full foreign-owned company

This is a traditional and popular form of FDI By this way, foreign investors with the target of exploiting new business opportunities in a new environment have made a great effort in applying technological advances along with managing experiences to achieve highest efficiency This kind of FDI is much suitable for small-scale companies but foreign investors are interested in applying for large-scale projects Transnational companies have currently chosen to invest in the form of wholly foreign-owned

enterprises and they usually establish subsidiaries of the parent ones at the same time

Full foreign-owned enterprises even though are owned by foreign investors; they are still under the control of the host country’s laws As an economic entity of the host country, these enterprises need to be established, invested, and governed by the authorities Besides, foreign investors also have to take their responsibility for their business results In accordance with the Enterprise Law 2014, wholly foreign-owned enterprises can operate under the forms of limited liability companies, private

enterprises and joint stock companies etc

The host countries can benefit from this kind of enterprises because they do not have to risk their government budget to invest while they are still able to collect taxes immediately, land rental fee besides generating employment Moreover, thanks to ownership independence foreign investors are proactive in their investment by bringing new technologies as well as modern machines; therefore, the workers’ skill level is enhanced However, the host country may find it difficult to learn the managing

experiences and technology secret Concurrently, controlling foreign partners is not

simple and not profitable as well

Joint ventures between domestic and foreign investors

This is the most common form of FDI in the world and has been widely used for long time The enterprise is established in the host country based on a joint venture

agreement between domestic and foreign parties

Only in the host country must the investment be even though joint venture enterprises may share the co-owner form of legal entity The performance of these enterprises depends largely on the business environment of the host country including political, economic, and legal aspects Besides, various advantages are provided for the host countries by this form of enterprises, for example solving capital shortage, diving risks and modernizing technology together with diversifying products At the same time from investors’ point of view, joint venture form offers them the opportunities to penetrate legally and effectively international markets On the other hand, it can be inferred from the negative sides that conflicts may easily occurred in managing process due to the differences in regime, custom and law etc Simultaneously, the host countries often have to face low capital contribution rate, poor management, and labor skills

Business co-operation contract (BCC)

A business co-operation contract is an investment form signed between investors

for business cooperation to divide profits or products without establishing legal entities

This investment form is effective in fulfilling the lack of capital and technology, creating new market, concurrently, ensuring the controlling rights of the host countries’ governments However, these countries may find it hard to acquire the management experience of foreign investors or even cope with backward technology Moreover, BCC

in most cases is applied for profitable areas only like gas exploration Separate legal entity is not allowed to establish by this investment form; therefore, all BCC activities must be based on the country of origin Consequently, from the investors’ standpoint, BCC’s effectiveness is not easy to control However, this is the simplest form that does not require cumbersome legal procedures, so it is usually preferable in the early stages when developed countries start to adopt FDI policies When the quantity of wholly

owned form and joint venture ones starts to rocket, that of BCC tends to diminish

is transferred to the host country without reimbursement

BTO and BT are BOT’s derivative forms that the order of investment, exploitation,

and transfer is swapped

These types of investment contain some basic characteristics Initially, state must

be required to be one party Secondly, only infrastructure works such as roads, bridges etc can be considered to be in this investment fields Finally, foreign investors have the obligation to transfer the projects to the governments at the deadline without any

reimbursement

On the bright side, this form can support the governments to attract investment in infrastructure projects, which require long term and large amount of capital, thus reducing the pressure on the state budget At the same time, the completed infrastructure works is transferred to the host country within a certain time, creating conditions to promote other resources for economic development Adversely, these investment kinds

also bear high degree of risk, especially the policy one

Mergers and Acquisitions (M&A)

This is a cross – border M&A channel As the rapid development of stock market, Foreign Portfolio Investment channels (FPIs) are available for foreign investors to buy

shares or even buy back certain types of businesses

Conceptually, it is the boundary of equity that distinguishes FDI and FPI When foreign investors buy shares or bonds in the local stock market, they create a foreign indirect investment channel (FPI) However, if the stock ownership ratio exceeds certain limits allowing these investors the right to participate in corporate governance, they become FDI investors For Vietnam, the rate is set at 30% at present

1.2 TRANSFER PRICING IN FDI ENTERPRISES

1.2.1 Definition and classification of transfer pricing

1.2.1.1 Definition of transfer pricing

Transfer pricing is the price charged by one member of multinational organization

to another member of the same organization for the provision of goods or services or the use of a property, including intangible property in order to minimize the total tax

payable by the associate partners

According to international practice, price transfer is defined as the "implementation

of price policy" for goods and services between members of the same group internationally without complying with market prices to minimize the tax payable to

countries receiving investment

In fact, the transaction price can be detected as above due to

(1) Self – determination right in business

(2) Entities in the same corporation or group share similar interests, as a result the

price difference does not change the overall benefit

(3) Not changing the total benefit, the price changes on the other hand can change total tax liability because the tax obligation is transferred from the highly – regulated

area to the lower one and vice versa

The transfer pricing behavior can only be implemented by 100% foreign - invested enterprises or MNCs themselves To do this, the MNCs have to apply policy differences, tax incentives, tax differences across countries to formulate intra-group pricing policies

In reality, interest groups or corporations do not necessarily have to be multinational but may be a group of companies with multiple subsidiaries in charge of doing domestic business Transfer pricing can also be carried out by independent economic entities;

however, their owners have a bonding relationship

The price charged between the parties within the corporations or groups is the basis

to analyze transfer pricing Comparing a contract price to a market price, a transaction will have a tendency to be considered as transfer pricing if the contract price is not proportionate to the market price It is very difficult, however, to identify transfer pricing because once a state loses taxes, another state gains a larger one In most cases, international transactions are evaluated more carefully than domestic ones because of the differences in the tax policies between countries Besides, transfer pricing can be

based on preferential policies as well In this case, income will shift from the less to the more privileged For countries depending on foreign investment, the more incentives are made, the better the foreign investors can make use of their tricks to gain economic

benefits from those countries

1.2.1.2 Illegal transfer pricing signals

Illegal transfer pricing is the application of price levels in non-market transactions Mediated goods and service transactions violating price law, delivery term, and quality factors are classified into unlawful group The transfer pricing acts in the article is

referred to illegal ones

In fact, analyzing if an enterprise using transfer pricing or not is not a simple decision due to the business’s complexity and the tax manager’s subject Thus, from objective standpoint, transfer-pricing phenomenon can be detected by the following

indicators

• Enterprises suffer from losses for many consecutive years while continuously expanding investment (sales are constantly growing) In some cases, businesses take the initiative to get 3-year loss, following by 1-2 years with little profit In the end, their accumulated profit is still negative To make a profit into a loss, or to set a low interest rate, FDI firms themselves cannot work alone but often co-ordinate with the same group

or a part of it These businesses negotiate prices themselves through associated deals Through these transactions, companies in the same group reduce the overall tax liability globally; therefore, increasing their after-tax profits

• The selling price is lower than the cost of goods sold

• Service payment for advertising, management and consultancy etc., or expenses attributable to companies within the associated group cannot be proved by any invoices and documents Compared with other firms in the same industry, FDI enterprises’ costs are usually higher than the average In Vietnam, businesses may take advantages of government's incentives to reduce the cost of advertising and promotion

• FDI enterprises pay for the companies in their associated group

• Payments for trademarks, copyrights, and license fees cannot be justified

• FDI enterprises pay interest above the commercial bank’s lending rate to a third part within the same credit terms To use this method, the parent company provides input

materials for their subsidiaries without taking sight payment Afterward, the subsidiaries have to pay interest for the differed loan; as a result, almost the business profit is spent

on interest payment In fact, the real gain through this interest payment is transferred to the parent company

• FDI enterprises have tendency to make transactions with companies operating in low tax countries The investors select a number of countries that offer low corporate income tax (CIT) rates to establish the investment company and make use of the tax differences between countries to evade taxes In many countries with high CIT rate such

as Vietnam with 20%, foreign investors only register their investment location in low tax rate countries along with making their subsidiaries in Vietnam sell products at original price to avoid paying tax in Vietnam After that, they resell these products to the third parties to make profit while paying low taxes in their registered countries

• Companies gradually reduce their profit after the tax incentive period

• Enterprises sell tangible assets below the cost of capital or sell intangible assets below the market value

• Enterprises’ profit margin is much smaller than other firms, which are in the same industry

• Even though the above signs are references, the probability of the transfer pricing

is dramatically high if some of above signs appear in a business

1.2.2 Motivations for transfer pricing of FDI Enterprises

1.2.2.1 External factors

Minimizing CIT

If there is a difference in tariff rates, FDIs will raise the purchase price of raw materials and goods to increase costs Afterward, they make subsidiaries located in countries with high CIT rates sell the product at low prices to reduce revenue Thus, FDI enterprises have transferred part of their profits from high CIT rate countries to lower one and their profit maximization goal has been successfully achieved

Foreign exchange regulations

For a country that has governed foreign exchange rates, although the CIT rate is not different between countries, investors cannot apply transfer-pricing methods to transfer

foreign currency abroad to eliminate the risk of foreign exchange policy In addition, hardly are their profits inspected by the tax authorities and foreign exchange agencies in the end of financial year when are they returned to the registered countries Therefore, FDI enterprises conduct transfer pricing in order to quickly recover invested capital and capture other investment opportunities In joint ventures with local partners, FDI firms experience a propensity to high value inputs purchased from the parent company to enhance capital contribution and management Moreover, MNCs may also engage with other foreign companies to distort the domestic investment

Exchange rate risks

No sooner do FDI firms expect the future value of the host countries’ currency to increase then they decide to invest Otherwise, they may immediately withdraw all capital out of these countries Besides, FDI enterprises in some cases can make early internal payments to reduce exchange rate risks based on their forecasts Debts can also

be paid earlier if their forecasts suggest that domestic currency’s value may fall On the other hand, payments are delayed if the situation reverses In short, transfer pricing is an effective way to for FDI firms to avoid exchange rate risk, or even make profits from it

Socio – economic situations

In detail, any changes in economic policy can affect the FDI’s subsidiaries profit; therefore, they often carry out transfer pricing actions to prevent them from the impacts

In other situation, if the political situation is unstable, FDI enterprises tend to withdraw their investment to reduce risk and preserve the business capital In addition, payroll pressure from the workforce as well as attention of tax authorities on foreign investors can be diminished due to transfer pricing

1.2.2.2 Internal factors

Avoiding tax obligation

In addition to the external incentives mentioned above, transfer pricing is also derived from the needs of the FDI in each period Transfer pricing will be able to create

a brighter financial picture of FDI enterprises’ reports even if their operations are suffering from losses The reason for this loss may come from a mistake in the business plan or in researching, managing cost, and promoting products However, transfer

pricing can help the FDI to share losses among members, thereby reducing the amount

of tax payable

Dominating market

When it comes to entering a new market, it is important to occupy the market, to gain market share in order to build the foundation for future business Therefore, in this period FDI mainly focus on the advertising activities, consequently, they may suffer from prolonged loss In business relationships, some FDI enterprises rely on their strong financial power to carry out illegal transfer pricing activities that will cause long-term loss for the aim of taking over the other firms This situation is common in developing countries such as Vietnam where the management is weak Once beating rivals and business associates out of the market, FDI firms just simply dominate the market and

raise product prices to offset the previously incurred costs Receiving the large

socio-economic privileges from the host countries, FDI parent companies only use their subsidiaries as a tool to conduct transfer pricing illegally which leads to significant consequences for the recipient country

Reducing risks

The transfer of highly specialized proprietary products and services such as information technology, biotechnology etc is also a method to conduct transfer pricing

to reduce the risks in trading process

1.2.3 Transfer pricing process of FDI Enterprises

FDI firms’ transfer pricing forms can be identified in two phases as follows

In the first stage, they increase the value of capital assets along with overblow that

of intangible assets

By raising the value of equity assets, these businesses are able to expand their capital contribution and thereby gain greater control over the capital from other joint-venture companies Moreover, foreign investors can transfer back a part of their investment to the parent companies right at the beginning of the investment In addition, raising the value of equity assets may also increase the annual depreciation as well as boost the investment cost to reimburse the fixed investment quickly and reduces the investment risk FDI can avoid the CIT payable to the recipient countries; however, these countries have to deal with budget deficit and foreign exchange imbalance Furthermore, the

overblown of cost of goods sold forces the consumers to pay a definitely higher price than the real product value Considering enterprises as a whole, higher product price

means greater profit

In addition, FDI businesses often use tricks to lift up the value of intangible assets

By conducting a joint venture, they use technology and license fee transfer as an intermediate tool to carry out transfer pricing operation These things mean that the profits of the recipient country's branches are significantly reduced, in the meanwhile

even possibly make them suffer from losses

The second stage is known as implementation phase The transfer pricing companies apply all techniques to increase the input value of the product such as importing raw materials from parent company, globally advertising at high cost and increasing administrative cost The devaluation of output along with high input costs brings many benefits to the transfer pricing enterprises Being subject to low tax rates, output products are useful in reducing CIT especially if they are distributed in the market of

FDI enterprises

In order to achieve the above-mentioned forms, the transfer pricing enterprises shall have to use fake accounting techniques including pre-accounting without spending; making provisions in contravention of regulations; increasing costs without invoice; incurring expenses not for production and business purposes; incorrectly recording

interest expense resulting in loss

Decided by dominance of assets, capital, and materials or distribution of products, the associated transactions between the parent company and its subsidiaries are varied These transactions are established as follows The parent company or associate company allocates expenses to their subsidiaries and these subsidiaries afterward record the cost for advertising, marketing, research, and expansion This operation, in fact, must be covered by the parent company The purpose of these transactions is to minimize the incurrence of taxable income in the host country In addition, parent companies or affiliates often rely on preferential policies across regions of these countries to carry out merger, dissolution, and relocation from one area to another to take advantage of CIT

incentives

Using high interest cost is another method that FDI firms frequently use At the beginning, the parent companies provide input materials and components that are not yet available in the recipient country while allowing the subsidiaries to pay principal and interest after production and distribution phases Therefore, all profits from the subsidiary's products and goods are recorded as interest expenses paid to parent companies abroad Through this interest payment, the real profit has been transferred to

the parent companies legally

Interest rates on loans from parent companies or banks within the corporation are often much higher than from other sources However, subsidiaries are willing to create

a reasonable capital structure and resources, such as using loan from parent firms to finance fixed assets or other long-term investment assets, without increasing equity capital This action has pushed up their financial expenses, resulting in reduced

profitability in the investment receiving countries

1.2.4 Consequences of transfer pricing

1.2.4.1 Causing state budget deficit

Taking advantage of the tax policy as well as the difference between the CIT and the profit remittance tax, FDI enterprises use transfer pricing as a method to minimize the amount of tax payable In particular, FDI enterprises usually invest in countries (commonly known as "tax havens"), where CIT rates are low in order to gain profit from transfer pricing However, if other countries manage transfer pricing more strictly, it

will lead to economic crisis in these "tax havens"

1.2.4.2 Causing negative impacts on capital structure

Transfer pricing causes many negative changes to the capital structure and capital flows in the host country In detail, FDI enterprises’ high valuation of inputs makes capital inflows come to other countries, reflecting a mismatch in business results and causing losses to the host countries’ economies

1.2.4.3 Distorting total FDI disbursement

By augmenting input price and devaluating the output price, FDI enterprises create

a fake loss and a virtual value for the fixed assets This action also leads to a rise in depreciation rate of real fixed assets, thus changing the structure of FDI Due to this

mechanism, the production and consumption market are forced to accept unreasonably high price It is worth mentioning that the high input price has eliminated the price advantage from import activities, boosting the price to be artificially high Transfer pricing also adjust the price of many goods and services in Vietnam to be contradictorily

high, concurrently, limit the competitiveness of Vietnamese enterprises

1.2.4.4 Posing negative impacts on the environment competition

Transfer pricing indirectly creates an unfair market competition between businesses Due to the abundant capital investment, MNCs can easily take over the domestic companies through mass advertising and promoting campaigns Domestic companies, which do not have enough financial resources to compete, are gradually weakening not

to mention bankruptcy MNCs, on the other hand can manipulate the domestic market The inevitable consequence of this unhealthy competition to the national macroeconomic recovery is extraordinarily serious The macroeconomic policy-making process meets various difficulty while the domestic industries grow slowly Besides, it also causes damage to the economy of the investment receiving countries that gradually

depend on other ones

1.3 INTERNATIONAL EXPERIENCES OF ANTI-TRANSFER PRICING AND LESSONS FOR VIETNAM

1.3.1 International experiences of anti-transfer pricing

1.3.1.1 Experience from United States of America

In January 1992, the Internal Revenue Service (IRS) issued a new set of three valuation rules, all based on collation of transaction results In January 1993, the IRS issued a provisional regulation On July 1, 1994, the regulation was enacted and it has been effective from July 8, 1994, to present The United States of America is very concerned about the transfer pricing control of MNCs This can be expressed in the

following sense

Firstly, the United States is concerned about the regulatory framework for transfer pricing within the enterprises This is reflected in the US Internal Revenue Code and the Inland Revenue Department's guiding documents that are typically referred to as "White Paper" Based on the profit method, the "White Paper” does point out basic methods to

detect transfer pricing This approach considers the net profit margin in relation to the

price, sales, and profitability that taxpayers make from controlled transfer

Secondly, in line with the legal framework, the IRS has also recognized subjects to apply transfer pricing adjustment which are firms engaging in international business Some kinds of these firms can be listed as follows: (i) US businesses that directly and indirectly control a business overseas; (ii) US businesses under the direct or indirect control of a foreign enterprise; (iii) Enterprises that are jointly controlled by a foreign enterprise or corporation By this identification, the business zones can be limited during investigation process while US government can use this remedy against enterprises’ tax

avoidance through transfer pricing violation

Thirdly, IRS uses a variety of methods to adjust the transfer pricing operation, which are (i) Free market price comparison; (ii) Selling price basis; (iii) Profit distribution;

(IV) Profit comparison

Fourthly, US government requires mandatory presentation of supporting documents with promulgation of rules regulating the professional activities of affiliates during implementation process Thereby, the firms need to produce the necessary supporting

documentation to determine the results of the transfer operations between the associates

Fifthly, they show strong concern for handling measures if any evidence of violation When the tax office can prove that there is a violation in the valuation of the transfer for tax evasion purposes, it shall be entitled to readjust the income of the

taxpayer and apply a fine of 20-40% of the total tax amount

1.3.1.2 Experience from China

In terms of current transfer pricing adjustment, China is applying the CIT Law (2007) and Guoshuifa Circular No 2 (2009) By using these laws, State Administration

of Taxation (SAT) is provided the basis to adjust the taxable income of taxpayers when they conduct transactions with affiliated parties that do not comply with the principle of market prices The CIT law also requires taxpayers involved in transactions with affiliated parties to submit a clear statement of the transaction along with their annual tax return Moreover, relevant documentations for transactions such as price and cost method of calculation as well as explanation are also compulsory According to CIT

Law, clarifying documents is required for enterprises whose tangible asset value more

than 200 million Yuan or transactions valued at least 40 million Yuan

China’s Anti Transfer Pricing regulations are also based on guidelines of the Organization for Economic Co-operation and Development (OECD) However, China's

Anti-Pricing Law has some fundamental differences

(i) China's obligation to pay taxes is not consolidated Branches of a group in

different provinces are subject to multiple anti transfer pricing tax;

(ii) Even though a tax issue is accepted by one provincial tax office, it is not certain

that the tax office of another locality also pass;

(iii) If a company is detected with any sign of transfer pricing, the transfer pricing adjustments issued by the Chinese tax authority will be imposed on all related taxes such

as taxes CIT, VAT, import and export taxes;

China also passed specific regulations of penalty for transfer pricing actions Serious

offenses such as tax evasion or fraud may be prosecuted for criminal liability

1.3.1.3 Experience from ASEAN

In South East Asia, some countries have developed as well as implemented the Transfer Pricing Law for many years Generally, these laws, which are applied to both domestic and foreign companies, followed the provisions of the Organization for

Anti-Economic Co-operation and Development (OECD)

In Malaysia, government has legislated transfer-pricing issue by passing two specific transfer-pricing declarations for domestic firms and foreign businesses These two statements are distributed to selected taxpayers who, after full disclosure, have to file the return to the Malaysian Tax Authority Afterward, the National Tax Department considers whether to inspect this business The highlight of this regulation is that the Malaysian Taxation Office is able to investigate through the declaration the structure of the corporation and its payable costs such as royalties as well as management costs Malaysian Tax Authorities can use these declarations for tax inspection and transfer

pricing detection purpose

In addition, to determine whether the firms carry out transfer pricing or not Malaysian Authorities use various methodologies such as free market price comparison

method, price-based method and method of profit distribution etc Simultaneously,

illegal transfer pricing businesses’ identities are also published widely

In Thailand, Anti Transfer Pricing Law has been promulgated and implemented for more than 10 years Accordingly, the national tax authorities have established a comprehensive database, which can easily be traced to businesses that follow or not follow market prices In response to the transfer-pricing phenomenon, Thailand has set

up a database of information about companies that are targeted to conduct audits and investigations Especially, companies have "high risk" indicators such as continuous losses over 2 years; total negative profit; cannot pay tax in one period; having significant

transactions of the same group involved and low profitability compared to competitors

In order to prevent and handle transfer pricing situations, Thailand's tax authorities focus on accurate price evidence, all of which need be reasonable to demonstrate transparency, up-to-date documentation to indicate the structure and the relationship company group, including the nature of each business, its budget, its business plan as well as its financial strategies Along with that is the document explaining the company's sales, results of operations, international transactions with affiliated business organizations There are also the pricing policies, profitability of each product and market information, the profitability of each party receiving functional functions, the assets used and the risks All of them must be included in the calculation and be used for a thorough investigation The more developed economies are, the easier transfer pricing problems become Simultaneously, difficulty in investigating the transfer pricing

is also growing, the way the investigation proceeds to arrive at a satisfactory conclusion

requires careful preparation and close cooperation among nations

In particular, the tax authorities in Thailand scrutinize thoroughly the internal costs

of the corporation such as management costs, copyright costs They not only see the company has a contract serious or valid invoice, but also look at the nature of the transaction whether the transaction took place or not, or for the costs of general management, whether they are actual or divided up to those who hold the contract On the other hand, the Thai Taxation Bureau often reviews tax incentives and compares the profits of these companies to companies without tax incentives, see if the profits of these

two groups of companies are the same and carry out the next inspection

1.3.2 Lessons for Vietnam

By examining the price control experience of some Asian countries and the transfer pricing practices of some of the world's major companies, it can be drawn some lessons

for Vietnam as followings

Firstly, Vietnam should consider the lessons from other countries to build and perfect the economic law in general and transfer pricing law in particular Ergo, Vietnam could be ready for the receipt of foreign investment capital This is also a prerequisite

to good control transfer pricing behavior The United States, China, and other Asian countries are interested in clearly defining the subject-applied regulations in tax law on transfer pricing methods and procedures to control transfer pricing In addition, it is necessary to improve the coordination mechanism between relevant authorities with tax authorities in anti-price transfer activities, especially the coordination of Vietnamese

diplomatic missions abroad

Secondly, experiences of China which is close to Vietnam are effective to apply in Vietnam in various cases, hence to finalize tax policies in line with the domestic situation while meeting the integration requirements and common tendency of the world Tax difference between countries is the main reason impedes the transfer pricing acts of FDI enterprises; therefore, tax incentives are necessary From the lessons of ASEAN’s counterparts, it is also essential to consider other ways of regulating economic issues Hardly do other incentive forms provide benefit when tax incentives should be

applied in order to attract FDI

Thirdly, in regulating transfer pricing, special regulations on disclosure of information relating to associated enterprises along with their presentation of supporting documents should be given special attention In detail, enterprises must declare information relating to transactions with their affiliates Besides, tax information system need to be upgraded and updated frequently while to broadening the information sources

by professional activities of tax intelligence department

Finally, the E-government developing process should be speed up, simultaneously ensuring the connection and exchange of information automatically between tax authorities and other state agencies

CHAPTER I CONCLUSION

Chapter 1 gives an overview of the transfer pricing’s basic contents in FDI enterprises including its motivation, common methods, and negative impacts on the economy These contents are the basis to analyze the current transfer pricing status of FDI enterprises in Vietnam

CHAPTER 2 TRANSFER PRICING SITUATION OF FDI ENTERPRISES IN VIETNAM 2.1 CURRENT INVESTMENT SITUATION OF FDI ENTERPRISES IN

VIETNAM

2.1.1 FDI legal environment in Vietnam

Amended several times from 1987, Foreign Investment Law was the first legal document mentioning about FDI By 1996, a new Foreign Investment Law, which replaced the 1987 one, was promulgated by National Assembly of Vietnam and had also been amended several times until 2000 Simultaneously, investment activities untaken

by domestic investors were governed by the Corporate Law along with 1990 Private Enterprise Law which was later replaced by 1999 version and 1994 Domestic Investment Promotion Law Within the integrating process to the world economy, it is necessary for the government to uniform a law that is able to regulate both domestic and foreign investment Thus, Enterprise Law and Investment Law were released in 2005 by National Assembly before coming into effect on July 1 2006 In short, these laws are in

charge of replacing the former Laws

Currently, the Investment Law of 2014 replaces the previous version and be

considered as the most important legal document to regulate foreign investment

Broadening rights, creating favorable conditions and narrowing the differences between foreign and domestic investment are general trend of policy change in Vietnam Through these changes, the government’s effort to improve as well as create an attracting investment environment was clearly demonstrated in line with Vietnam’s

integration trend

2.1.2 Current investment situation of FDI Enterprises in Vietnam

The five-year socio-economic development plan (2011-2016) was approved by the National Assembly on November 8th 2011, which clearly identified one of the government’s goals to develop Vietnam’s economy with fast and sustainable growth rate on the basis of economic restructuring, quality improving as well as world integrating Relating to this goal, the policy to attract foreign investment has become one of the most important motivation for socio-economic development It can be

indicated from the past that FDI in Vietnam increased under the aspects of both quality

and quantity

Figure 2.1: Registered FDI and Disbursed FDI from 2011 to 2015

Unit: Billion USD

Source: Ministry of Plan and Investment

2.1.2.1 Investment certificate licensing situation

Ø FDI status

Figure 2.2: Number of new projects and increased capital projects

from 2011 to 2015

Unit: Billion USD

Source: Ministry of Plan and Investment

05.000

Although the country only had 1091 new projects licensed investment certificate in

2011, it had up to 2120 ones in 2015 The amount of new and increased FDI inflows in

2015 reached the peak at 24.1 billion USD, increased by nearly 2.2 billion or 10% compared to that in 2014 (21.9 billion USD), increased by 56.5% compared to that in

2011 (15.4 billion USD) and increased by 9.6% compared to plan set for 2015 (22 billion USD) In which, the total new registered capital in 2015 was 16.34 billion USD, apart from 918 adjusted capital projects with increased registered capital of 7.77 billion USD, increased by 43.5% compared to that of the same period in 2014 Overall, the amount

of registered capital at this stage had high growth at an average rate of 12.8% per annum

If accumulating the number of projects valid until 31/12/2015, the whole country had 20.069 projects with total registered capital of 281.88 billion USD

§ Based on investment field

During this period, the manufacturing sector has always attracted the attention of foreign investors with FDI registered proportion ranging from 48.5% in 2011 to 76.7%

in 2013 In addition, electricity distribution, construction and real estate sections etc attracted the majority of foreign investment Particularly in 2015, the processing and manufacturing industry gained 1012 new investment projects including 16.4 billion USD of both new and added capital accounting for 68.1% of the total registered capital Power and water distribution that ranked second within 10 newly registered investment projects accounted for 11.6% of total initial capital Third place was the real estate business with the total newly registered and added capital of 2.39 billion USD, accounting for 9.9% of the total registered capital

Figure 2.3: Main investment fields from 2011 to 2015

Unit: Billion USD

Source: Ministry of Plan and Investment

Estimating valid projects until December 31, 2015, the real estate, manufacture, and trading sectors are the leading ones with total registered investment of 162.77 billion

USD, 50.9 billion USD, and 12.57 billion USD respectively

§ Based on investment partner

Korea has continued to invest strongly in Vietnam over recent years In particular, South Korea did overtake Japan to be the largest investment partner, beside traditional ones such as Singapore, Taiwan, Hong Kong, and Malaysia Among 62 countries and territories that invest in Vietnam in 2015, South Korea held the first position with total newly registered capital and additional capital of 6.98 billion USD, accounting for 28.9% of total investment in Vietnam Malaysia ranked second with 2.47 billion USD, accounting for 10.2% of total investment, followed by Japan and Taiwan with 7.4% and 6% respectively

In addition, considering the cumulative projected until 31/12/2015, Korea, Japan, and Singapore are the three largest investment partners of Vietnam with total investment capital of 45.19 billion USD, 38.97 billion and 35.15 billion correspondingly

§ Based on the investment area

In the 5 years from 2011 to 2015, Ho Chi Minh City attracted the largest amount of investment capital with nearly 13.5 billion USD in new and additional capital, accounting for 13.5% of the total registered capital during the period Other provinces such as Binh Duong, Bac Ninh, Thai Nguyen, Hai Phong and Dong Nai are also attracting a large amount of foreign investment Regarding the region, the Southeast region and Red River Delta are attractive destination for foreign investment; meanwhile, Tay Nguyen is the least attractive area for FDI in the period Particularly in 2015, excluding offshore oil and gas, foreign investors invested in 52 nationwide provinces and cities In which, the leading foreign investment area is Ho Chi Minh City with 4.1 billion USD in new capital and additional capital, accounting for 17% of the country’s total investment capital Bac Ninh ranked second with total newly registered capital and additional capital of 3.66 billion USD, accounting for 15.1% of the country’s total investment capital Binh Duong ranked third with 3.12 billion USD in newly registered capital and increased capital

Accumulated projects valid until 31/12/2015, Ho Chi Minh City, Ba Ria - Vung Tau and Hanoi are the top provinces with the total investment capital of 42.37 billion USD, 27.77 billion USD and 25.49 billion USD correspondingly

§ Newly licensed investment scale

In general, the number of large-scale projects in this period was small, most of which were small-scale projects under 1 million USD Only in 2015, the country attracted 4 projects capitalized at over 1 billion USD, 32 projects worth over 100 million USD, 74 projects worth over 50 million USD, and 363 projects worth over 10 million USD The remaining projects are under 10 million USD (accounting for 80% of total projects in 2015) The average capital size of foreign investment projects in 2015 was about 7.9 million USD

Ø The quantity of FDI enterprises

In the whole country, the total number of enterprises in 2011 legally existed was 12.312 enterprises By the time 15/10/2015, this number increased to 14.026 enterprises, higher 13.9% than that in 2011

2.1.2.2 Operation status

Ø Disbursed capital

In general, the amount of disbursed capital has been increasing at an average rate of 7.4% per year In 2015, although the economy was facing many difficulties, disbursed capital of FDI sector still increased and exceeded the set plan FDI disbursement in Vietnam in 2015 is estimated to reach 14.5 billion USD, higher 31.8% than that in 2011, 16% over 2014 and 11.5% over the plan in 2015 Disbursement of FDI projects gets these results thanks to the supporting and promoting the disbursement of the projects paid more attention In the interim, the policy dialogue with investors operating in Vietnam to remove their difficulties and obstacles are promoted, partially helping investors to deploy operation more effectively

Ø Number of FDI enterprises in operation

§ General data

While there are 7,248 FDI enterprises operating in the country in 2010, this figure was 10,864 enterprises on nationwide basis in 2015, accounting for 77.4% of total enterprises, increased by 50% compared with 2010 The average growth rate of the period 2010-2015 was approximately 8.5% per annum

Research by type shows that 100% foreign - owned enterprises in 2010 were 5,989 but by 2015 was 9,156 (accounting for 84% of all FDI enterprises), higher 52.9% compared to 2010 Besides, joint venture enterprises in 2010 were 1,259 and by 2015 were 1,758 (accounting for 16% of FDI enterprises), higher 35.7% compared to 2010