Dissecting the Arm's Length Range and Adjustment Points in Transfer Pricing Analysis

In the world of international taxation, transfer pricing is not an exact science. Often, there is no single absolute correct price for a complex affiliated transaction. Instead, what is often found is a series of figures reflecting various fair market possibilities. This concept is known as the Arm's Length Range.

For Taxpayers and tax authorities, understanding how this range is formed and which point is used to make fiscal corrections is crucial to mitigate tax disputes. In Indonesia, provisions regarding the arm's length range are specifically regulated in MoF Regulation (PMK) 172 of 2023 Article 12. This regulation affirms that the independent transaction price indicator value can be an arm's length point (arm’s length point) or a point within the arm's length range (arm’s length range).

The Nature of the Arm's Length Range

By definition, the Arm's Length Range is a range of price indicator figures (can be unit price, gross profit margin, or net profit margin) acceptable to establish whether affiliated transaction terms are in accordance with the fairness principle.

Why is this range necessary? OECD Transfer Pricing Guidelines 2022 explains that the application of the arm's length principle generally only produces an approximation of conditions that would occur in the open market, not absolute certainty. Furthermore, minor differences between compared transactions that cannot be fully adjusted also cause price variations. Therefore, the use of a range is considered more reliable than a single figure.

Range Formation Mechanism: Ex-Ante Principle

Not all data sets can be immediately called an arm's length range. There are statistical and qualitative rules that must be met.

A. Single Year Comparable Data and Ex-Ante Concept

Based on Article 12 paragraphs (2) and (4) of PMK 172/2023, the formation of price or fair profit indicators ideally uses single year comparable data. What is meant by single year data is data that is available and closest to the time the transfer pricing determination is made (ex-ante or price-setting approach).

B. Multiple Year Data

Although single year is prioritized, multiple year data (multiple year) is allowed if proven to increase comparability, for example, to smooth the impact of business cycles or fluctuating product life cycles.

C. Statistical Methods: Full Range vs Interquartile

Based on Article 12 paragraph (6) of PMK 172/2023, the method of forming the range depends on the number of comparables:

• Full Range: Used if there are only two comparables. This range extends from the minimum value to the maximum value.
• Interquartile Range: Used if there are three or more comparables. This range extends from Quartile 1 (Q1) to Quartile 3 (Q3). This method is used to eliminate outliers (outliers) or extremes that may have comparability defects.

Testing Transfer Price Compliance

The next step is to test the position of the Taxpayer's price indicator against the formed range:

• Safe Scenario (Inside Range): If the Taxpayer's price indicator falls between Q1 and Q3, then the transfer price is considered to have met the fairness principle. Tax authorities are not permitted to make corrections.
• Risk Scenario (Outside Range): If it falls outside the range (e.g., profit 2%, range 4%-8%), then the price is considered not to meet the fairness principle. This is where the DGT's authority arises.

Determination of Adjustment Point

If the Taxpayer's price is outside the range, to what figure must the price be pulled (corrected)? PMK 172/2023 Article 12 paragraph 7 regulates the hierarchy for determining the adjustment point:

1. Priority 1: Arm's Length Point: If a specific figure from a very identical comparable is available (usually internal CUP).
2. Priority 2: Most Appropriate Point Within the Range: If it can be proven there is a certain point (e.g., Q1 or Q3) that has the highest degree of comparability.
3. Priority 3: Median: If it cannot be proven which point is most appropriate.

In practice in Indonesia, corrections are almost always made to the Median. This aligns with the guidance of OECD TPG 2022 Paragraph 3.62 to minimize the risk of errors due to remaining comparability defects.

Secondary Adjustment

This correction also impacts profit distribution indirectly (constructive dividend). The difference resulting from the correction will be considered a dividend paid to the affiliate, thus subject to Income Tax Article 26 (Dividend Tax) according to the applicable rate.

Proper understanding of the ex-ante principle in the use of comparable data is key to the validity of the transfer pricing document (TP Doc). Taxpayers must use data available at the time of price determination, not current year data that only appears after book closing. Errors in data selection can cause the TP Doc to be considered unreliable, giving tax authorities the authority to make corrections to the Median value which is often burdensome.

References

1. Ministry of Finance of the Republic of Indonesia. (2023). Regulation of the Minister of Finance of the Republic of Indonesia Number 172 of 2023 concerning the Application of the Principle of Fairness and Business Prevalence in Transactions Influenced by a Special Relationship.
2. OECD. (2022). OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022. OECD Publishing, Paris.
3. Directorate General of Taxes. (2013). Regulation of the Director General of Taxes Number PER-22/PJ/2013 concerning Guidelines for Audit of Taxpayers Having a Special Relationship.
4. OECD. (2025). Transfer Pricing Country Profile: Indonesia.