Note: The following provides our insights on the transfer pricing aspect of royalties following the draft of the Transfer Pricing Decree (“TP Decree”) which is published on the official website of the Ministry of Finance and the Draft Law on Amendment and Supplements to 2006 Law on Technology Transfer being published by the National Assembly (“the Law”). There may be changes in the final TP Decree so the below should be taken as a reference only.
Vietnamese language is available here.
Following the Vietnam Government’s Resolution No. 19-2016 / NQ-CP on April 28, 2016, the Ministry of Finance (“MoF”) has published a draft of the new TP Decree on its website since early September and has submitted the draft to the Prime Minister for final approval. Among several changes in the new TP decree, provision in relation to technology transfer transactions have been put into attention and focus for the first time.
At the same time, the Draft Law on Amendment and Supplements to 2006 Law on Technology Transfer have been published on the National Assembly’s website also to collect public comments. Arcticle 23 of the new Law provides that compulsory price testing needs be conducted for the transfer of technologies between related parties.
This provision marks the first time in Vietnam that a TP control provision has been included in a Law rather than Tax Law. This signals a strong message from Vietnam’s law makers that TP issues will be addressed from any possible aspects, with the joint cooperation of different government bodies.
The Draft Decree and the Draft Law together introduced a crucial legal basis for controlling TP issues in technology transfer transactions, which will materially impact the MNC’s planning, local compliance as well as provide a basis for TP adjustment during a TP audit.
Significant points covered in the Law and the Decree on technology transfer
Definition of related parties based on the royalty transactions and price testing
One of the controlled relationships under the TP Decree is that when an enterprise has royalty payables contributing more than 50% of total costs of that enterprise (in the prevailing regulation, the bases are cost of goods sold or manufacturing costs).
Similar to the relationships based on the sales and purchase transactions, this provision was initially introduced to identify transactions between taxpayers in Vietnam and a “paper company” set up in a low tax jurisdiction with no direct shareholding relationship. The change of the cost base from cost of goods sold into total costs should reduce the number of such companies caught in the transfer pricing net.
It should be noted that the above definition of related party transactions does not limit the TP assessment to legal / economic owners of the intangibles. Instead, the Decree follow the guidance of the OECD under BEPS Actions 8 -10 which expressly focus on testing the “key functions” (DEMPE – development, enhancement, maintenance, protection and exploitation) of intangibles and confirmed that who control value-creating DEMPE functions should expect arm’s length remuneration.
Benchmarking study on technology transfer transactions
The TP decree does not provide a priority among the five TP methods allowed for the testing of intangible transactions, however internal comparables would be specifically considered before external comparables.
However, the TP Decree also provided a legal base for the MoF to request information from several government bodies for transfer pricing scrutiny. In relation to the technology transfer transaction, the Ministry of Science and Technology (MOST) is in charge of developing a database related to technology transfer, trademark transfer, granting the right to use the trademark, the registration dossier on intellectual property rights, industrial property rights and the rights related to intangible assets.
Such database could be utilised by MOST to assess the validity of the technology transfer as well as the price applied. Tax authorities can also use such database for testing and TP adjustment purposes during a TP Audit.
There is no indication of whether taxpayers could be granted access to this database, however considering other “secret comparables” databases utilised by tax authorities in recent audits, we cannot expect significant transparency from the tax authorities on its contents. Taxpayers will therefore have no choice other than using commercial databases for their planning, documentation and defense purpose. In particular, taxpayers could apply the Comparable Uncontrolled Price (CUP) method using databases such as RoyaltyStat, which enables the taxpayer to compare the rate with the rate charged between unrelated parties for the identical property.
The process would include searching the database, albeit largely by subscription, for license agreements in the same or similar industry and in respect of similar property, with broadly similar terms and conditions. The search and selection criteria that would be applied to these databases would typically include the SIC codes that are considered to be representative of the tested transaction, and the use of selected keywords, followed by a qualitative assessment of the potentially comparable license agreements.
The TP Decree provides principle criteria for the searching of comparable technology transfer agreements relating to an intangible, which include :
- Legal ownership;
- Potential benefits from intangibles;
- Geographical scope;
- exclusivity and non- exclusivity with respect to rights transferred;
- involvement of the transferee in the development of intangibles and actual functions performed, ability to exert control over risks of each related party based on the whole process of development, enhancement, maintenance, protection and exploitation of intangibles.
The benchmarking study of royalty rates could apply the above criteria in its search and screening and come up with a list of license agreements (ideally at least 5 agreements) which are relatively appropriate for comparison purpose. The royalty rate information for the license agreements identified from this search and selection process can be used to create a range of arm’s length results, and if there are enough of them, an inter-quartile range (excluding the bottom 25% and top 25% of the results or observations) can be produced to increase the reliability of the results.
If the royalty applied in the technology transfer agreement falls within the inter-quartile range, there would be basis to be prove that the related party transactions would be considered arm’s length from Vietnam TP perspectives.
Annual TP reporting requirement on technology transfer
Several declaration and documentation will be required for the technology transfer under the Law and the Decree, which could be summarised below:
- According to the law, enterprises who are subject to tax and customs incentive due to the technology received need to report in their annual tax declaration details of the technology transferred such as the name, type, nature and price of the transfer.
- In addition, tax payers are also required to declare the transactions in the new annual declaration form (Form 01/NĐ-GCN), which at minimum would include the related party information, type and value of the transaction and the TP method applied. The new TP declaration form must be submitted together with the annual corporate income tax, and the local TP documentation (with the royalty benchmarking study) should be completed before the submission deadline of the TP declaration form. The local TP documentation must be submitted within 15 days upon receipt of the request from TP auditors.
- In addition to the above, the TP decree also requires taxpayers to file and submit upon request the following information among other in the Master File in relation to the technology transfer agreement with related parties:
- Description of the Group’s strategy on development, ownership and exploitation of intangibles,
- List of key intangibles of the Group
- List of key agreements among the Group entities regarding the intangibles
- Group’s TP policy on the R&D and intangibles
- Description on the transfer of intangibles including parties involved, countries, and payments.
It should be noted that several additional supporting documents not listed above are also normally required by TP auditors during recent local TP audits depending on the approach of the audit team. These documents would include agreements, meeting notes, training materials, technical documents…etc.
TP issues in Intangibles transactions are well focused by several similar jurisdictions with Vietnam such as China and India.
In China and India, ruling and audit cases have demonstrated that functions such as setting up sales channels, controlling client networks, promotion of group names and brands could be considered significantly contributing to the value of intangibles. Further, tax administrations in these countries also emphasize that the learning curve of the technology transferee should also be taken into account and the royalty payment for a technology transfer dated back several years would not be a reasonable basis for comparison.
The TP issue in technology transfer has not been paid proper attention by Vietnamese entity. In several cases, the Vietnamese entity is not aware of who is actually the legal owner, not to mention who controls the “DEMPE function”. It is not uncommon that the accounting departments in many Vietnamese factories are making annual royalty payment overseas without knowing whether such technology is really still applied in the manufacturing process or whether a royalty benchmarking study is in place to support the rate charged.
Vietnam has become a very active jurisdiction in respect of transfer pricing enforcement, audits and adjustments. Among others, countries worldwide have been focusing on technology transfer agreements in particular and intangibles in general, supported by the OECD’s official release of BEPS Actions 8-10, with the emphasis on DEMPE analysis. The Draft TP Decree and the Law on technology transfer have signalled that Vietnam will follow this global trend. More stringent control will be applied for technology transfer agreements between Vietnamese entities and their group affiliates to not only manage both the technology transferred to Vietnam but also the TP issues.
What should taxpayers do now?
Groups which have subsidiaries in Vietnam and Vietnamese enterprises should:
- Closely follow updates on the development of the draft TP Decree and the Law to understand key changes which are applicable to both the local entity and the Group.
- Conduct a thorough review on the intangibles transactions, especially the substance of current business arrangements as well as TP documentation to identify changes / room for improvement following changes in the TP Regulations.
- Perform royalty benchmarking for any intangibles transactions which will happen or will trigger expenses within the upcoming years.
- Prepare additional supporting package/ addendums to the existing TP documentation referring to the intangibles transactions.
Tu Ha – Senior Manager (Vietnam)
T: +84 919 25 0086
Steven Carey – Managing Director (Asia)
T: +852 9516 2830
*The information provided is for information purposes only, and is not intended to constitute legal advice. Legal advice should be obtained from qualified legal counsel for all specific situations.