Minister of Finance Sri Mulyani Indrawati re-emphasized the importance of the Arm's Length Principle (ALP) in determining the price of transactions between affiliated parties (transfer pricing).
The ALP serves as guidelines for implementing the Advance Pricing Agreement (APA) and Mutual Agreement Procedure (MAP), which are closely related to the mitigation and handling of cross-jurisdictional tax disputes.
The latest legal basis for ALP is the Minister of Finance Regulation (PMK) Number 22/PMK.03/2020 on Procedures for the Implementation of Advance Pricing Agreement, effective as of 18 March 2020.
Transfer Pricing Method
The implementation of ALP in transfer pricing will depend entirely on the use of the transfer pricing methods that have been valid and recognized so far. In general, the transfer pricing methods are divided into two major groups, namely the traditional transaction method and the transactional profit method.
Traditional transaction methods include the Comparable Uncontrolled Price (CUP) method, the Resale Price Method (RPM), and the Cost Plus Method (CPM). While the transactional profit method category includes the Transactional Net Margin Method (TNMM) and the Profit Split Method (PSM). Apart from that, there are also other transfer pricing methods whose application in Indonesia is adjusted from time to time.
PMK Number 22/PMK.03/2020 also regulates more detail of the application of transfer pricing methods in Indonesia. For example, the CUP and the Comparable Uncontrolled Transaction (CUT) methods, which both compare price levels but different in objects of pricing. The CUP method focuses on determining transfer prices for tangible asset transactions. Meanwhile, the CUT method is a transfer pricing method for transactions other than tangible assets and based on certain bases, including interest rates, discounts, provision, commissions, and percentage of royalties to sales or operating profit.
Interestingly, PMK Number 22/PMK.03/2020 provides an alternative method of transfer pricing related to a business restructuring scheme, namely business valuation. Previously, this method had not been regulated in Indonesia's transfer pricing provisions. This regulation also sets the priority scale in selecting the transfer pricing method. If the CUP method or any other method can be used and has equal reliability, the CUP method takes precedence over others. Also, if the RPM, the CPM, the PSM, and the TNMM can be used and have equivalent reliability, the RPM and the CPM take precedence over the PSM and the TNMM.
So, when and how to determine the most appropriate and reliable transfer pricing method? There are many factors to consider in determining the transfer pricing method. Concerning the implementation of PMK Number 22/PMK.03/2020, here are several things that Taxpayers should pay attention to:
- the suitability of the method with the characteristics of the transactions affected by special relationships and the business characteristics of the parties to the transaction;
- the advantages and disadvantages of each applicable method;
- the availability of reliable comparable independent transactions;
- the level of comparability between transactions affected by special relationships and comparable independent transactions; and
- the accuracy of adjustments in case of differences in conditions between the transactions affected by special relationships and the comparable independent transactions.
Arm’s Length Range
In the context of ALP, a Taxpayer must compare the conditions and price indicators for affiliated transactions with those of independent transactions. Price indicators can be transaction prices, gross profit, or net operating profit based on absolute values or certain ratio values. An arm’s length affiliate transaction price indicator can be either in a single transaction price indicator or in the form of an arm's length range (ALR) of price/profit.
PMK Number 22/PMK.03/2020 also regulates the application of ALP for special transactions, such as the service transaction, the use or rights to use of intangible assets, borrowing costs, transfer of assets, business restructuring, and fee contribution agreements. Several provisions have been changed or added.
Loan Cost Transactions
There is an additional explanation regarding the stages of implementing ALP for loan cost transactions related to intragroup financing. The explanation provides a perspective on the terms and conditions of the loan that reflects the ALP.
Intangible Asset Transactions
Related to intangible asset transactions, PMK Number 22/PMK.03/2020 includes a clause for disclosing information on parties contributing to and conducting development, improvement, maintenance, protection, and exploitation activities of intangible assets. This is in accordance with the recommendations of the BEPS Action Plan and the 2017 OECD Transfer Pricing Guidelines, which emphasize the importance of information regarding the roles, functions, assets, and risks of each member of the business group—in addition to information related to legal and economic ownership. This clause aims at providing compensation or remuneration for contributions in these activities according to the remuneration that meets the ALP.
Other Special Transactions
Besides, the scope of PMK - 22 has also been expanded to special transactions that are not specifically regulated in other transfer pricing regulations. Among other things, regarding the transfer of assets and business restructuring transactions. The evidentiary provisions for both transactions include:
- motives, objectives, and economic reasons for the transaction
- transactions under the actual substance and circumstances
- expected benefits of the transaction
- that the transaction is the best choice out of various other options available
Arm’s Length Principle General Guidelines
In general, Taxpayers must uphold the ALP in exercising their rights and fulfilling their obligations in the field of taxation, especially those related to transactions affected by special relationships. The obligation requires several conditionals as expressed in PMK Number 22/PMK.03/2020 as follows:
1. Taxpayers do not apply ALP by comparing conditions and indicators of transaction prices affected by a special relationship with those of comparable independent transaction prices;
2. Application of the Arm's Length Principles that are not carried out:
- based on the actual circumstances;
- at the time of determining the transfer price and/or at the occurrence of the transaction affected by a special relationship; and
- according to the stages of ALP implementation, including the preliminary stages for certain affiliated transactions as previously explained.
3. The transfer price specified by the Taxpayer does not meet the ALP in case of the value of the transfer price indicator is equal to that of the comparable independent transaction price.
Based on these conditions, the DGT has the authority to determine the transfer price according to the ALP. In essence, the ALP is not only mandatory in the APA and MAP processes, but also for general affiliate transactions. However, PMK Number 22/PMK.03/2020 still does not provide certainty for the implementation of ALP, as long as the previous regulations are not revoked. This is because the current ALP provisions are still at risk of multi-interpretation and potentially lead to different practices in reality.