3 Critical Aspects Businesses Must Focus On When Finalizing Transfer Pricing Documentation (TP)

In today’s globalized business environment, setting prices in related-party transactions (Transfer Pricing – TP) is not only a tax compliance obligation but also a strategic tool for risk management and after-tax profit optimization. TP documentation is considered the most important legal shield for enterprises.

Based on practical experience from numerous tax audits in Vietnam, a professional TP file does not stop at merely declaring figures. Businesses must concentrate on the following three critical aspects to ensure reasonableness, compliance, and protection of their pricing position before tax authorities.

I. Aspect 1: Functional Analysis (FA) – The “Soul” of the TP File

Functional Analysis (FA) is the foundational step and is often described as the “soul” of TP documentation. The purpose of FA is to identify the Value Drivers that each related party contributes, thereby determining the level of profit that each party should earn under the Arm’s Length Principle.

1. Common Mistakes and Expert Insights

Many enterprises describe the FA in a generic and superficial manner, merely listing activities without deeply analyzing the three key elements: Functions performed, Assets employed, and Risks assumed (FAR).

• Intangibles (DEMPE): Tax authorities pay special attention to identifying which entity actually develops, enhances, maintains, protects, and exploits intangible assets (such as trademarks or proprietary technology).
   The entity performing the DEMPE functions—not simply the legal owner—has the right to earn the residual profit.

• Risk Allocation: Businesses must prove that any risk allocated to a related party is consistent with its actual ability to control that risk and its financial capacity.
   For example, a low-risk distributor cannot bear significant market risks like a full-fledged distributor, and therefore should earn only low profits.

2. The Decisive Outcome: Selecting the Tested Party

FA is the basis for determining the Tested Party—typically the entity with simpler functions and lower risks, where comparable independent companies can be found.
 Choosing the wrong Tested Party may lead to selecting an inappropriate TP method and having the results rejected by the tax authority.

II. Aspect 2: Method Selection – Practical Applicability

The selection of the TP method must follow the rule of identifying the Most Appropriate Method, as required by Decree 132/2020/ND-CP.

1. Priority and Vietnam Practice

TP methods are generally prioritized in this order:

• CUP (Comparable Uncontrolled Price)

• Resale Price Method

• Cost Plus

• TNMM (Transactional Net Margin Method)

• Profit Split Method (PSM)

In practice, due to limited availability of public comparable data, TNMM is the most commonly applied method in Vietnam.

2. The Biggest Challenge: Comparable Data

• Comparability: Enterprises must prove that the independent companies selected as comparables have functions, assets, and risks similar to the chosen Tested Party. Finding “pure” comparable companies in Vietnam is extremely difficult.

• Adjustments for Differences: Differences—such as working capital levels, inventory risks—must be adjusted to ensure accuracy and fairness. Ignoring such adjustments is a major weakness during audits.

• Arm’s Length Range: Businesses must ensure their margins fall within the 35th to 75th percentile of the market range. Falling below the 35th percentile increases the risk of tax adjustments and penalties.

III. Aspect 3: Consistency & Documentation

TP documentation does not exist in isolation—it must be consistent with the company’s overall management and accounting system. Tax authorities will compare the TP file against the following:

1. Internal Consistency of TP Documentation

Enterprises may be required to prepare the Master File and Local File.

• Master File: Provides a high-level overview of group TP policies and must match the subsidiary’s role in Vietnam.

• Local File: Must explain each related-party transaction in detail and must not contradict the Master File, especially regarding value chain descriptions and ownership of intangibles.

2. Consistency with Financial & Legal Records

• Audited Financial Statements (FS): Actual profits reported in FS must align with the market-based profit margins determined in the TP file. Large deviations from industry averages can raise red flags.

• Contracts & Agreements: Descriptions of functions, risks, and pricing terms in the TP file must match actual intercompany contracts. If a contract describes the entity as a full-fledged distributor but the FA identifies it as a low-risk distributor, this contradiction is fatal.

• Corporate Income Tax Finalization Return: All TP-related figures must be accurately reflected in the tax return and related-party disclosure forms (Form 01).

Preparing and finalizing TP documentation is a continuous and detailed process requiring both legal knowledge and deep understanding of business models. The three pillars—FA, Method Selection, Consistency—form the foundation for businesses to defend their TP position and minimize the risk of tax assessments and penalties.

Important Note: Enterprises should finalize TP documentation and perform necessary pricing adjustments before filing the annual CIT finalization return to demonstrate proactive compliance

Viet Australia
Viet Australia Auditing Company is an independent auditing organization licensed and established in 2007 in the Socialist Republic of Vietnam.