Newsletter No. 93 (EN)
Synopsis on Transfer Pricing in Hong Kong,
Thailand and Vietnam
Transfer Pricing becomes highly important as soon as a business entity decides to expand its operations across international borders. Transfer Pricing deals with structuring the price of transactions between related parties within a group of companies.
Every Multi National Enterprise (“MNE”) wishes to minimise its tax obligations in order to maximise its overall profits. In principal, multi-corporate businesses have to pay tax in their host countries, based on the profit share which arises in (or is allotted to) the respective business in such host country (e.g. Thailand, Hong Kong or Vietnam). These host countries can differ in various respects, e.g. tax systems, customs duties, currency exchange rates, legislation etc. As a result, Transfer Pricing also affects revenue and customs authorities, investors, creditors and the like.
The obligation to comply with national and international tax regulations regularly conflicts with the goal of a tax-efficient allocation of profits within MNEs. This is primarily because while the enterprise will take a global perspective, the respective tax legislation is usually nationally focused.
Thus, anticipatory business and corporate tax planning which takes both concerns into consideration is vital.
II. Different Methods of Price Calculation
In most countries, Transfer Pricing regulations are built around the core concept of the Arm’s Length Principle. According to this principle, the transaction (or transfer) price charged between affiliated companies must be the same as the price which would have been charged to an independent company.
There are six generally accepted methods by which to compute the transfer price so that it accords with the Arm’s Length Principle. These six methods can be separated into two categories:
- Traditional methods (Transaction Methods) focus on the facts of the actual transaction in question in order to compute an appropriate transfer price (bottom-up method).
- Other methods (Profit-based Methods) utilise the profit generated by comparable companies when undertaking similar transactions in order to determine the price of the intercompany transaction in question (top-down method).
Transaction Methods are generally considered to be more accurate and appropriate.
- Transaction Methods (TM)
a) Comparable Uncontrolled Price Method (CUP) and Comparable Uncontrolled Transaction Method (CUT)
Both CUP and CUT compare the price of the intercompany transaction with the price of an identical or sufficiently similar independent transaction (e.g. the price charged in transactions between independent parties).
b) Cost Plus Method
This method summarises all the original costs of the unfinished product and then adds the customary net profit for such transactions for calculating the applicable transfer price.
c) Resale Minus Method
Under this method, the transfer price is computed by deducting the customary profit margin from the respective resale price. The customary profit margin is calculated on a partial cost basis.
Profit-based Methods (PBM)a) Comparable Profit Method (CPM)
This method is based on the operating profit gained from the intercompany transaction and the allocation of this profit to the respective business segment which is then defined and subdivided as precisely as possible. In order to compare these profits, the profit margins of comparable independent businesses are used for each business segment. A target operating result can be computed by applying this method to the total profit of the multi-national organisation. By comparing this result with the individual entities’ actual financial statements, it can be assessed whether the correct transfer price was used.
b) Profit Split Method (PSM)
PSM is based on the total profit an MNE gains from an intercompany transaction. This profit is divided according to the functions and risks which each related party adopted, just as it would be in the case of a transaction between non-related parties.
c) Transactional Net Margin Method (TNMM)
The net profit gained from the intercompany transaction is analysed in relation to an appropriate basis (cost, turnover, assets etc.) and the resulting profit margin is checked against comparable independent transactions. (This method is similar to Resale Minus or Cost Plus, thus strictly-speaking it is a bottom-up method as well.)
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