Internal or External Comparables? Some Comparative Notes on Vietnam Decree 132 and the OECD Transfer Pricing Guidelines

When a taxpayer has engaged in similar transactions with both related and unrelated parties, the use of the price or profit margin of the unrelated transaction for the related transaction is an obvious consequence of the arm’s length principle and the Comparable Uncontrolled Price method (CUP). Tax authorities in Vietnam and Cambodia, both noted manufacturing hubs, will in practice often focus quite quickly on price differences they notice on the export price of manufactured goods to the related party of the taxpayer and confront it with often minor domestic sales to a local third party purchaser at a higher price. Other local examples are found in the banking industry, as locally owned banks are often part of the business group of a local wealthy businessman, and the bank will provide loans to the other entities of the group.

In these cases, to use the conditions of the unrelated sale or loan for the related one, the key question is how comparable these transactions really are. Simply put, it frequently comes down to the taxpayer trying to prove that the third party transaction (with likely a higher price) significantly differs from the transaction at a lower price with its related party.

Can the transactions be compared?

The issue of comparability is not just a part of the discussion on comparables, but is of course fundamental to the entire arm’s length approach, also having repercussions on choice of external comparable enterprises.

Traces of the fundamental rules on factors of comparability (contractual terms, functions performed/assets used/risks assumed, characteristics of property or services, economic circumstances and business strategies) of the TPG are mostly also found, albeit heavily summarized, in Decree 132.

Decree 132: priority for internal comparables

But Decree 132 seems to provide a higher standing, a hierarchical priority for internal comparables over external comparables that is not found in de same way in the TPG. The TPG do provide that internal comparables “may have a more direct and closer relationship to the transaction under review than external comparables” and “[i]t may be unnecessary to use a commercial database if reliable information is available from other sources e.g. internal comparables”. But the TPG stops short of imposing a hierarchy. It does not provide that internal comparables trump external ones. In fact, the TPG state that:

“On the other hand, internal comparables are not always more reliable and it is not the case that any transaction between a taxpayer and an independent party can be regarded as a reliable comparable for controlled transactions by the same taxpayer.

By contrast, Decree 132 does seem to give more weight to internal comparables. In 7 (1), Decree 132 provides some kind of -qualified- hierarchy by providing that:

“In case where there are no internal uncontrolled comparables, then the selection of comparables can be conducted with reference to comparables in the same country [Vietnam] or in the region” (emphasis added).

The same theme is found in Decree 132’s provisions related to use of external databases of financial information:

“Analysis and selection of uncontrolled comparables […] must conform to the priority order in selecting comparative data as follows:
(a) internal comparables of taxpayers;
(b) Domestic comparables of the country of residence of the taxpayer [Vietnam]
(c) Comparables from countries in the region with similar economic conditions and growth”[5] (emphasis added).

Minor sales to an unrelated party

This does not mean that under Decree 132 every uncontrolled price must be used to set every controlled transaction. In Vietnam the comparability of transactions is also central to the transfer pricing determination, as is the case in the TPG, and also in the case where the tax authority wants to use an uncontrolled price for a related party transaction. Notably, Decree 132 states that:

“Selection of internal uncontrolled comparables is the selection of transactions between taxpayers and unrelated parties, while ensuring the comparability in terms of price or profit margin or profit split ratio”. (emphasis added)

But the TPG offer more assurances to taxpayers who might have a minor, higher priced local transaction which tax authorities want to use as a yardstick to reassess major related party transactions:

“Assume for instance that a taxpayer manufactures a particular project, sells a significant volume thereof to its foreign associated retailer and a marginal volume of the same product to an independent party. In such case, the difference in volumes is likely to materially affect the comparability of the two transactions. If it is not possible to make a reasonably accurate adjustment to eliminate the effects of such difference, the transaction between the taxpayer and its independent customer is unlikely to be a reliable comparable”

Conclusion

In conclusion, Decree 132 subscribes in general terms to the same comparability requirements as the TPG. This means that ultimately, also in Vietnam internal controlled transactions which are incomparable should not be used to price uncontrolled transactions. But, unlike the TPG, Decree 132 does provide (1) in an actual priority for internal over external comparables, and (2) does not offer any specific language to warn against use of minor uncontrolled sales transactions. Accordingly, taxpayers with minor but higher priced uncontrolled sales might be at a higher risk in Vietnam compared to OECD countries.