Scenario: a Hai Phong plant does contract manufacturing of plastic parts for its Japanese parent: the parent supplies moulds, key materials and specs; the plant contributes labour, utilities and machine depreciation. The contract says “cost + 8%”. At audit, the authority asks two questions: is 8% an arm’s length markup, and what exactly is “cost” in the formula? Fumbling either answer collapses the entire pricing defence.
How cost plus works
Formula: arm’s length price = cost base × (1 + arm’s length markup). It fits where the tested party is the simple supplier: a contract manufacturer working to order, an intra-group service provider (IT, accounting, HR for the group) — no valuable intangibles, no market risk. Logic: an independent doing similar manufacturing/services would charge cost plus a reasonable margin — so prove your markup sits within the range of comparable independents.
What counts as “cost” — and what must be excluded?
The most disputed point. The base includes direct costs (direct labour, auxiliary materials the manufacturer buys itself) and reasonably allocated indirect costs (depreciation, shop-floor management). Exclude: abnormal, inefficient costs — idle capacity from order shortfalls, rework from poor management, above-norm costs with no business justification. Principle: no independent would pay for its supplier’s inefficiency — nor will the tax authority let it into the price base.
How is the arm’s length markup set?
Benchmark against markups of comparable independent manufacturers/service providers (commercial databases per Circular 95/2026/TT-BTC). Simple manufacturing markups on total cost typically run single-digit to low-teens by sector; for low value-adding intra-group services there is a simplified 5% markup (see EXP-2211) — but only for qualifying “low value” services, not all intra-group services. High-value services (strategy consulting, R&D) need full valuation.
Common traps
- Confusing cost plus with TNMM: cost plus marks up cost; TNMM benchmarks net margins on sales/assets. Wrong indicator = wrong method.
- Bloated cost base: stuffing parent-allocated management fees into the base and then marking up — double counting, rejected immediately.
- Frozen multi-year markups: signing “cost + 8%” in 2021 and leaving it to 2026 while markets moved — pricing policy needs periodic review, at least annually when preparing the local file.
FAQs
What markup is reasonable for parent-directed manufacturing?
No universal figure; depends on sector, complexity, assets used. It must rest on benchmarking against comparable independent manufacturers. A contract figure alone proves nothing without comparable data.
Does depreciation on parent-lent machines enter the base?
No, if the machines are not the plant’s assets. Market-rate lease costs for leased assets do count — see EXP-2215 on related-party asset leases.
Can intra-group IT services use the 5% cost plus?
Only if they meet the low value-adding definition (supportive, non-core, no intangibles). Core software development or strategic cybersecurity usually fails the test — value-based pricing required.
Does the authority accept the contracted markup?
Contracts evidence party intent but do not replace arm’s length analysis. The contracted markup must still be validated with independent comparables in the local file.
This article has been quality-reviewed by the FLAW AI Legal Council