Choosing the Right Measuring Tool: A Comprehensive Guide to Profit Level Indicators (PLI) in Transfer Pricing

In the application of Transfer Pricing methods, specifically the Transactional Net Margin Method (TNMM), the selection of the profit level indicator or Profit Level Indicator (PLI) is the most crucial step. PLI is a ratio measuring the relationship between profit (usually operating profit) and a relevant denominator such as sales, costs, or assets.

Incorrect PLI selection can distort fairness analysis results, even if the selected comparable data is already very accurate. This article will dissect the types of PLIs, selection criteria, and nuances of their application across various jurisdictions.

Basic Concepts and Importance of PLI

PLI functions as a measuring tool to compare the profitability of the "Tested Party" (Tested Party) with comparable independent companies. The main principle is that in a perfect competition market, companies with similar functions, assets, and risks should yield similar returns relative to the economic basis they use.

According to OECD Guidelines, the PLI selected must consider:

1. The strengths and weaknesses of the indicator.
2. The appropriateness of the indicator given the nature of the transaction and the functions of the tested party.
3. The availability and reliability of data.
4. The level of comparability between affiliated and independent transactions.

In Indonesia, MoF Regulation (PMK) 172 of 2023 Article 10 paragraph (5) affirms that the application of the TNMM method is carried out by comparing the net operating profit level of the tested party with the net operating profit level of comparables.

Main Types of PLI

Generally, there are three main categories of PLI recognized internationally (OECD & UN) and regionally (Singapore & Malaysia):

A. Return on Sales / Operating Margin (ROS/OM)

Definition: Ratio of operating profit to net sales. Usage: Most frequently used for distribution and marketing activities. Economic Logic: Distributors purchasing products for resale are usually measured by performance based on how much profit they can set aside from every unit of sales.

• OECD: ROS is used to determine the fair price of purchases from affiliates for resale.
• Malaysia: Suggests operating margin for distribution activities.
• Singapore: Recognizes operating profit margin as a common indicator.

B. Full Cost Mark-up (FCMU) / Net Cost Plus

Definition: Ratio of operating profit to total costs (COGS + Operating Expenses). Usage: Very suitable for service providers and manufacturers. Economic Logic: Cost is the main indicator of the value of functions performed. The greater the effort (cost) expended, the greater the profit expectation.

• OECD: Fully loaded costs are often used as the basis.
• UN Manual: Mentions Return on Total Costs (ROTC) as a common PLI.

C. Return on Assets (ROA) / ROCE

Usage: Industries that are capital-intensive such as heavy manufacturing or utilities. Economic Logic: Companies with large asset investments expect returns commensurate with the capital invested.

D. Berry Ratio

Definition: Ratio of gross profit to operating costs. Strict Berry Ratio Criteria:

• Value of functions is proportional to operating costs.
• Not influenced by the value of distributed products.
• Does not perform manufacturing functions.

Challenges and Technical Issues in PLI Application

A. Denominator Determination

The denominator in the PLI ratio must be independent of the affiliated transaction being tested. For example, do not use COGS as a denominator if that COGS contains the purchase price from the affiliate being tested.

B. Pass-Through Costs

Third-party costs without value added (such as third-party shipping) should be passed through without mark-up, or excluded from the FCMU cost basis to maintain consistency.

Application Nuances in Southeast Asia

This region has specific preferences that Taxpayers must observe:

• Indonesia (PMK 172/2023): Emphasizes "Profit level indicators". TNMM often becomes the primary choice if comparable data for other methods is difficult to find.
• Malaysia: Mandates consistent accounting practices. If the comparable uses Full Cost, then the tested party is required to use the same basis.
• Singapore: IRAS emphasizes the importance of adjustments if there are differences in working capital risk profiles between the tested party and comparables.

PLI selection is not merely a mathematical exercise, but a reflection of the economic substance of the transaction. Use FCMU for services/manufacturing, ROS for distributors, ROA for capital intensive, and Berry Ratio only for pure intermediaries. The key to success is the Taxpayer's ability to explain why that PLI most appropriately describes the company's value creation compared to other options.

References

1. OECD. (2022). OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022. OECD Publishing, Paris.
2. United Nations. (2021). Practical Manual on Transfer Pricing for Developing Countries (2021).
3. 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.
4. Inland Revenue Board of Malaysia. (2024). Malaysia Transfer Pricing Guidelines 2024.
5. Inland Revenue Authority of Singapore. (2025). IRAS Transfer Pricing Guidelines (Eighth Edition) (2025).