Related-party transactions at risk of tax inspection

Related-party transactions at risk of tax inspection

1. Royalty Fees 

Royalty fees refer to payments made by the licensee to the licensor for the right to use the brand, formula, business model, operating procedures, etc.

Key transfer pricing risks associated with royalty fees:

• Unreasonable pricing: Royalties charged are higher than market norms, with no benchmarking against independent parties.
• Lack of economic substance: Royalties are paid despite the trademark or brand not being genuinely used by the taxpayer.
• Profit shifting risks: The Vietnamese entity generates profit, but high royalty fees paid to the foreign parent reduce taxable income in Vietnam.
• Complex transaction structure: Royalty fees often involve intangible assets, which are more difficult to value and compare, leading to disputes or further information requests from tax authorities.

Risk mitigation measures:

• Clear legal contracts with full regulatory registration.
• Preparation of complete transfer pricing documentation, with benchmarking against independent parties.
• Retention of sufficient evidence showing the actual value received from the transaction.
• Coordination between Audit, Tax, and Legal departments to assess fee appropriateness. 

2. Management Fees from Parent Company

Management fees refer to charges paid by subsidiaries or related parties to the parent company or group for centralized management, support, or technical services.

Key transfer pricing risks:

• Lack of substance: The subsidiary recognizes management fees without clear evidence that services were actually rendered.
• Unjustified pricing: High fees are charged without third-party or internal benchmarking.
• Service duplication: The parent company charges for services that the subsidiary already performed internally or outsourced.
• Unreasonable allocation: Management fees are allocated without a clear, consistent allocation basis.

Risk mitigation measures:

• Execution of specific service agreements outlining scope and fee calculation methods.
• Retention of documentation and evidence of services rendered.
• Use of consistent and reasonable allocation methods.
• Preparation of complete transfer pricing documentation with market-based comparables. 

3. Allocation of Global Advertising and Marketing Costs by Parent Company

These are costs incurred by the parent company for global or regional branding, marketing, and media campaigns, which are subsequently allocated to subsidiaries based on a certain criterion.

Transfer pricing risks associated with such allocations:

• No clear business purpose for the local entity: The Vietnamese subsidiary derives no direct benefit from global advertising.
• Lack of documentation: No evidence or breakdown of cost allocation methodology or specific advertising channels benefiting the Vietnamese market.
• Lack of arm’s length comparability: No substantiation that the allocated cost is reasonable compared to what independent parties would pay.
• Duplication with local spending: The Vietnamese subsidiary already incurred domestic advertising expenses but is still charged additional global campaign costs.

Risk mitigation measures:

• Clear contractual agreements and allocation terms.
• Retention of detailed supporting documents for the transaction.
• Preparation of complete transfer pricing documentation with appropriate market benchmarks

4. Conclusion and Recommendations

Transactions involving royalty fees, management fees, and globally allocated advertising costs are classified as high-risk in transfer pricing assessments. To mitigate potential risks, Vietnamese enterprises should:

• Periodically review and identify related-party transactions.
• Prepare transfer pricing documentation in accordance with Decree 132/2020/NĐ-CP.
• Retain adequate evidence to demonstrate that the transactions are genuine and reasonable.
• Conduct market-based comparability analyses with independent parties.