Comparability Analysis: The Heart of Applying the Arms Length Principle in Transfer Pricing

In the application of the Principle of Fairness and Business Prevalence (PKKU) or the Arm's Length Principle (ALP), many Taxpayers get trapped in merely selecting a method or searching for comparable data in commercial databases. Whereas, the validity of such methods and data relies heavily on one fundamental process: Comparability Analysis.

Without reliable comparability analysis, the comparison between affiliated transactions and independent transactions becomes invalid ("apple to orange"), which can lead to significant fiscal corrections by tax authorities.

The Nature of Comparability Analysis

By definition, comparability analysis is the process of comparing conditions and price indicators (price, gross profit, or net profit) of transactions influenced by a special relationship (affiliated transactions) with independent transactions.

The main principle is that two transactions are considered comparable if they meet one of the following two conditions:

1. There are no material differences in conditions that could significantly affect the price or profit; or
2. If there are differences, reasonably accurate adjustments (reasonably accurate adjustment) can be made to eliminate the impact of those differences.

In Indonesian regulations, MoF Regulation (PMK) 172 of 2023 affirms that comparability analysis is not merely a supplement, but a mandatory stage that determines whether the transfer price meets the fairness principle.

Five Comparability Factors (Comparability Factors)

To determine whether two transactions are comparable, Taxpayers are required to analyze five main factors recognized globally (OECD) and domestically.

A. Characteristics of Products or Services

Physical differences, quality, and availability of goods or services significantly affect price.

• Tangible Goods: Physical features, quality, durability, availability, and supply volume.
• Services: Nature and scope of services.
• Intangible Property: Form of transaction (license/sale), type of asset (patent/brand), duration, and level of legal protection.
• Relevance: This factor is crucial if using the CUP method.

B. Functional Analysis (Functions, Assets, and Risks/FAR)

This is the factor most often the determinant in profit-based methods (such as TNMM). This analysis compares:

• Functions: Who performs design, manufacturing, distribution, marketing, or logistics?
• Assets: What assets are used (machinery, intangibles, working capital)?
• Risks: Who bears market risk, inventory risk, or foreign exchange risk?
• Principle: The party performing more complex functions is entitled to a higher reward (profit).

C. Contractual Terms

This analysis dissects the division of responsibilities, risks, and benefits. Tax authorities will look at written contracts, but if they differ from actual behavior (conduct of parties), then actual behavior will be the guide (substance over form).

D. Economic Circumstances

Market prices are influenced by the economic conditions where the transaction occurs:

• Geographic location, consumer purchasing power, level of competition, and local production costs.

E. Business Strategies

Corporate strategies such as market penetration or innovation can affect prices temporarily. This must be taken into account when comparing with stable conditions.

Stages and Analysis Process

Based on Article 8 of PMK 172/2023, comparability analysis must be carried out through systematic stages:

1. Understanding the Affiliated Transaction: Identifying the relationship based on FAR analysis.
2. Determining the Tested Party: Choose the party that possesses the simplest functions and risks so that it is easier to find comparables.
3. Identification of Comparables: Internal Comparables (Taxpayer's transactions with independent parties) must be prioritized over external data.
4. Comparability Adjustment: If there are material differences, adjustments must be made (example: working capital adjustment).

Case Studies of Comparability Analysis Application

Comparability analysis is a dynamic process demanding a deep understanding of business reality. The key to its success lies in the accuracy of transaction delineation (ensuring contracts match facts) and the courage to make data adjustments. Ignoring factors such as risk differences or working capital will cause the Transfer Pricing Document (TP Doc) to be considered unreliable by tax authorities.

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. United Nations. (2021). Practical Manual on Transfer Pricing for Developing Countries (2021).
4. 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.