Understanding the Various Transfer Pricing Methods

Every corporation within a business group needs to comply with the transfer pricing provisions. Each transfer pricing must fulfill the arm's length principle or commonly known as the Arms' Length Principle. 

Thus, in order to comply with the Arm's Length Principle, the transfer pricing must use an appropriate method. 

Organization for Economic Co-operation and Development (OECD) in the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations paragraph 2.1, divides transfer pricing methods into two classifications, namely the traditional method and the transactional profit method.

Traditional Methods

Essentially, traditional methods are transfer pricing methods based on transactions. These methods include:

1. Comparable Uncontrolled Price Method (CUP)
2. Resale Price Method (RPM); and
3. Cost Plus Method (C+ Method)

Traditional methods are applied by comparing related party transactions with internal or external comparables. This method is more objective in transfer pricing due to its transactional comparison. 

However, a significant challenge lies in finding truly comparable transactions, especially for products or services that are unique and specific.

Read: PMK 172 Year 2023 Reinforces Ex-Ante Provision in Transfer Pricing Regulation

Transactional Methods

On the other hand, transactional profit methods are transfer pricing methods based on profitability. These methods include:

1. Profit Split Method (PSM)
2. Transactional Net Margin Method (TNMM)

Transactional profit methods focus on the profitability of a company, which is influenced by Functions, Assets, and Risks (FAR) in the transfer pricing analysis. This method is particularly suitable for accommodating transfer pricing in more complex transactions.

Transactional methods serve as an alternative when traditional methods cannot be applied due to the absence of comparable transactions.

Transfer Pricing Methods Regulation in Indonesia

In line with the transfer pricing methods recommended by the OECD, the Indonesian government also offers several applicable methods.

This is outlined in Article 9 of the Ministry of Finance Regulation (PMK) Number 172 of 2023, which aligns with the arm's length principle and the OECD TP Guidelines 2022.

Generally, the government recognizes four primary methods, Comparable Uncontrolled Price Method (CUP), Resale Price Method (RPM), Cost Plus Method (C+ Method) and
Other methods, such as Profit Split Method (PSM), Transactional Net Margin Method (TNMM), Comparable Uncontrolled Transaction Method (CUT), tangible and intangible asset valuation method, Business valuation method

1. CUP Method
The Comparable Uncontrolled Price (CUP) Method compares the price of a transaction influenced by special relationships to that of a comparable independent transaction.

This method is appropriate for transactions affected by special relationships, in the form of commodity products and goods or services with the same or similar characteristics as independent transactions in comparable conditions.

2. RPM Method

The RPM method compares the gross profit margin of transactions affected by a special relationship with that of independent transactions.

This method is appropriate for related party transactions involving distributors or resellers who resell goods or services to independent parties or to related parties and have fulfilled the Arm's Length Principles. 

Provided that the distributor or reseller is a party that does not bear significant business risks, does not have a unique and valuable contribution to the transaction affected by the special relationship, nor does it add significant value to the goods or services transacted.

3. C+ Method

The C+ method is used by comparing the cost plus margin of transactions affected by special relationships with independent transactions. 

This method is appropriate for related party transactions involving a manufacturer or service provider that purchases raw materials and/or other production factors from an independent party or from an affiliated party at a price that meets the Arm's Length Principles. 

The manufacturer or service provider is a party that does not bear significant business risks and does not have a unique and valuable contribution to the transaction affected by the special relationship. 

4. PSM 

The PSM method is used for transactions affected by a special relationship by parties that have a unique and valuable contribution to the transaction affected by the special relationship. 

The business activities of the transacting parties are highly integrated, so the contribution of each transacting party cannot be analyzed separately. 

The parties to the transaction either share the assumption of economically significant risks or separately assume closely related risks. 

5. TNMM

The application of the Transactional Net Margin Method (TNMM) is carried out by comparing the operating net profit margin of the tested party with that of independent comparable companies.

This method can be applied as long as reliable and comparable data at the gross profit and price level are unavailable and it is suitable for the characteristics of transactions influenced by special relationships.

Furthermore, the application of TNMM can be carried out if the business characteristics of the parties involved in the transactions are as follows:

• The transactions influenced by special relationships are carried out by one or more parties that do not make unique and valuable contributions to the transactions.
• The business activities of the transacting parties are non-highly integrated; and
• The transacting parties do not share the assumption of economically significant risks or separately not assume closely related risks.

6. CUT Method 

The application of the CUT method is appropriate for the characteristics of transactions affected by special relationships that are commercially valued on a specific basis, in the form of interest rates, discounts, fees, commissions, and royalty percentages of sales or operating profit. 

7. Tangible Asset and Intangible Asset Valuation Methods

The application of tangible asset and intangible asset valuation methods is appropriate for the characteristics of transactions affected by special relationships such as: 

• Transfer transactions of tangible assets and/or intangible assets; 
• Leasing transactions of tangible assets; 
• Transactions related to the use or right to use intangible assets; 
• Transaction of transfer of financial assets; 
• Transactions of transfer of rights in connection with the exploitation of mining areas and/or other similar rights; and 
• Transaction of transfer of rights in connection with the exploitation of plantation, forestry, and/or other similar rights. 

8. Business Valuation Method 

The application of the business valuation method is appropriate for the characteristics of transactions affected by special relationships in the form of: 

• Transactions related to business restructuring, including the transfer of functions, assets, and/or risks between related parties; 
• Transactions of transfer of assets other than cash to companies, partnerships, and other entities in place of shares or equity participation; and 
• Transaction of transfer of assets other than cash to shareholders, partners, or members of the company, partnership, or other entities.