Transfer pricing and its effect on taxation risk in Indonesia

Transfer pricing is the practice of setting prices for transactions between related parties, such as subsidiaries or affiliates of the same group. Transfer pricing can have significant implications for taxation, as it affects the allocation of income and expenses among different jurisdictions.

In Indonesia, transfer pricing is regulated by the Income Tax Law and the Minister of Finance Regulation, which adopt the arm's length principle as the basis for determining the appropriate transfer prices. The arm's length principle requires that transactions between related parties are consistent with those that would have been made by independent parties under comparable circumstances.

The Indonesian tax authority (DGT) has the authority to adjust the taxable income or deductible costs of taxpayers who do not comply with the arm's length principle, and impose penalties and interest for underpaid taxes. The DGT also requires taxpayers to prepare and maintain specific transfer pricing documentation, such as the Master File, Local File, and Country-by-Country Report, to prove the arm's length nature of their related-party transactions. The DGT may request such documentation during a tax audit, and deny deductions for payments that are not substantiated.

Transfer pricing poses a significant taxation risk for multinational enterprises (MNEs) operating in Indonesia, as they may face challenges in complying with the complex and evolving transfer pricing regulations, as well as increased scrutiny and audits from the DGT. Transfer pricing disputes may result in double taxation, litigation costs, reputational damage, and business disruption.

To mitigate this risk, MNEs should adopt a proactive and strategic approach to managing their transfer pricing policies and practices, and ensure that they are aligned with their business objectives, economic realities, and global tax planning. MNEs should also monitor the changes and developments in the transfer pricing regulations and guidance, both in Indonesia and in other relevant jurisdictions, and assess their potential impact on their existing or planned transactions.

What is TPDOC?

Transfer pricing is the process of determining the price of transactions between related parties, such as subsidiaries, affiliates, or parent companies. Transfer pricing can have significant tax implications, as different countries may have different tax rates and rules for income and expenses arising from cross-border transactions.

In Indonesia, taxpayers who engage in transactions with related parties are required to comply with the arm's length principle (ALP), which means that the conditions of the transactions should be comparable to those of transactions between independent parties. To demonstrate compliance with the ALP, taxpayers need to prepare and maintain transfer pricing documentation (TPDOC), which is a set of documents that provide information and analysis on the nature, terms, and outcomes of the transactions.

The TPDOC consists of two main components: the master file and the local file. The master file provides an overview of the business activities, organizational structure, intangible assets, financial performance, and transfer pricing policies of the group of related entities. The local file provides more detailed information and analysis on the transactions of the Indonesian taxpayer with its related parties, such as functional analysis, comparability analysis, selection and application of transfer pricing methods, and conclusion on the arm's length nature of the transactions.

The TPDOC is not required to be submitted to the tax authorities along with the annual tax return, but it must be available upon request during a tax audit or examination. The TPDOC must be prepared in Indonesian language and in Indonesian rupiah currency. The TPDOC must be prepared based on ex ante approach, which means that it should reflect the conditions and expectations at the time of entering into the transactions, not ex post or after-the-fact adjustments.

The TPDOC is an important tool to mitigate transfer pricing risk in Indonesia, as it can help taxpayers to avoid or reduce potential tax adjustments, penalties, or disputes arising from transfer pricing issues. The TPDOC can also provide evidence of good faith and cooperation with the tax authorities, and facilitate mutual agreement procedures (MAP) or advance pricing agreements (APA) if needed.

To create a TPDOC that is comprehensive and clear, taxpayers should follow these steps:

1. Identify all transactions with related parties that are subject to transfer pricing rules in Indonesia. This includes transactions involving goods, services, financial instruments, intangible assets, or cost sharing arrangements.

2. Collect and organize relevant information and documents that support the nature, terms, and outcomes of the transactions. This may include contracts, invoices, correspondence, financial statements, budgets, forecasts, market studies, industry reports, etc.

3. Conduct functional analysis to identify and compare the functions performed, assets used, and risks assumed by each party to the transactions. This will help to determine the economic contribution and value added by each party, and to select the most appropriate transfer pricing method.

4. Conduct comparability analysis to identify and compare comparable transactions or entities that are independent and operate under similar circumstances. This will help to establish an arm's length range or benchmark for evaluating the transfer prices applied by the taxpayer.

5. Select and apply the most appropriate transfer pricing method based on the nature of the transactions and the availability of reliable data. The transfer pricing methods are divided into traditional transaction methods (such as comparable uncontrolled price method, resale price method, or cost plus method) and transactional profit methods (such as profit split method or transactional net margin method).

6. Calculate and document the arm's length range or benchmark based on the selected transfer pricing method and the comparability analysis. The arm's length range or benchmark represents a reasonable interval or point of reference for evaluating whether the transfer prices applied by the taxpayer are consistent with the ALP.

7. Compare and document the actual transfer prices applied by the taxpayer with the arm's length range or benchmark. If the actual transfer prices fall within or are close to the arm's length range or benchmark, then they are considered to be compliant with the ALP. If not, then adjustments may be needed to align them with the ALP.

8. Prepare and document a conclusion on whether the transactions are consistent with the ALP based on the analysis performed in steps 3-7. The conclusion should also explain any deviations or adjustments made to achieve compliance with the ALP.

9. Compile and organize all information and documents generated in steps 1-8 into a coherent and structured TPDOC that follows the format and content requirements specified in PMK 213/2016. The TPDOC should be clear, concise, logical, and supported by relevant evidence.

How Accountant can help

Accountants can play a vital role in helping MNEs reduce their transfer pricing taxation risk in Indonesia, by providing the following services:

• Conducting transfer pricing analysis and benchmarking studies to determine the arm's length prices for various types of transactions, such as intercompany services, royalties, financing, or intangibles.

• Preparing transfer pricing documentation that meets the requirements and standards of the Indonesian tax authority, as well as other tax authorities where applicable.

• Assisting with transfer pricing audits and disputes resolution, by providing technical support, negotiation skills, and evidence-based arguments.

• Advising on transfer pricing planning and optimization strategies, such as restructuring transactions, aligning functions and risks with value creation, or applying for Advance Pricing Agreements (APAs).

• Providing training and education on transfer pricing concepts, methods, and best practices.

By engaging accountants with expertise and experience in transfer pricing matters, MNEs can enhance their compliance level, reduce their tax exposure, and improve their business performance.

References:

- OECD (2021). Transfer Pricing Country Profile: Indonesia. https://www.oecd.org/tax/transfer-pricing/transfer-pricing-country-profile-indonesia.pdf

- PwC (2022). Indonesia - Corporate - Group taxation. https://taxsummaries.pwc.com/indonesia/corporate/group-taxation

- Grant Thornton (2021). Indonesia transfer pricing. https://www.grantthornton.global/en/insights/articles/transfer-pricing-guide/transfer-pricing---Indonesia/

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