Dissecting Types of Affiliated Transactions in Transfer Pricing: From Tangible Goods Transactions to Business Restructuring

In the modern taxation ecosystem, understanding affiliated transactions (related party transactions) is fundamental for multinational companies as well as local business groups. Affiliated transactions are transactions carried out by Taxpayers with parties who have a special relationship.

Tax authorities pay special attention to these transactions due to the risk of price manipulation (transfer pricing) that does not accord with fair market principles. In Indonesia, the application of the Principle of Fairness and Business Prevalence (PKKU) or the Arm's Length Principle (ALP) is mandatory to be carried out separately for each type of transaction.

Tangible Property Transactions

This is the most common and fundamental type of affiliated transaction. These transactions cover the purchase and sale of raw materials, semi-finished goods, finished goods, to fixed assets (machinery, equipment, vehicles) between companies within one group.

In tangible goods transactions, the main focus of transfer pricing analysis is on the functions performed by the transacting parties. For example, whether the selling entity acts as a fully fledged manufacturer that bears market and inventory risks, or merely as a toll manufacturer (maklon) that only sells processing services without owning the raw materials.

Transfer pricing determination methods often used include:

• CUP (Comparable Uncontrolled Price): If the product is a commodity or general good that has an identical market price.
• RPM (Resale Price Method): Suitable for distributors who resell goods without changing their form.
• Cost Plus Method: Suitable for manufacturers of semi-finished goods or service providers.
• TNMM (Transactional Net Margin Method): Most commonly used if comparable price or gross profit data is difficult to find.

Intra-Group Services Transactions

Intra-group services refer to activities provided by one member of a business group that provide benefits to other group members. Common examples include management services, technical services, administrative services, IT support, to marketing services.

Preliminary Stage Obligations (Preliminary Test)

Unlike goods transactions, service transactions have an extra layer of testing. Before calculating the fair price, the Taxpayer must prove that the service actually occurred and was needed. The Taxpayer must prove:

1. Existence: The service has actually been rendered.
2. Economic Benefit (Benefit Test): The service provides economic or commercial value added for the service recipient.
3. Not Shareholder Activity: The activity is not an activity solely for the interest of shareholders.
4. Non-Duplication: The service does not duplicate activities already performed internally or purchased from third parties.

If this benefit test is not met, the tax authority may consider the value of the transaction to be zero, regardless of how much cost the group incurred.

Intangible Property Transactions

In the digital economy era, transactions related to intangible assets or intangibles become very crucial and often become tax disputes. These transactions usually take the form of royalty payments for the use of trademarks, technology patents, copyrights, or know-how.

Transfer pricing analysis for intangibles does not only look at who the legal owner of the asset is, but who substantially contributes to the value of the asset. This concept is known as DEMPE analysis:

Entities that only hold legal rights without performing DEMPE functions (only a cash box entity) are entitled to a lower return compared to entities that actively develop and maintain the value of the intangible.

Financial Transactions

These transactions cover intercompany loans, financial guarantees, cash pooling, and derivative transactions. The tax authority will look at two main things:

1. Is the loan real? Or is it actually a capital contribution disguised as debt? This is tested by looking at borrowing ability (debt capacity).
2. Is the interest rate fair? The interest rate must reflect the credit rating of the borrower, the term, and the currency.

Additionally, the analysis must also ensure that the transaction has a clear economic motive (economic rationale) and is not merely a scheme to erode the tax base through excessive interest payments (base erosion).

Business Restructuring

Business restructuring is defined as cross-border reorganization involving the transfer of functions, assets, and/or risks between affiliated parties. Common examples include:

• Conversion of a full distributor into a commission agent.
• Conversion of a full manufacturer into a contract manufacturer.
• Centralization of intangible asset ownership to one entity (IP Hub).

Potential Compensation (Exit Charge)

The main issue in restructuring is whether there is "profit potential" transferred from one country to another. If the transfer has significant economic value, then the party relinquishing the right is entitled to fair compensation (exit charge).

Cost Contribution Arrangements (CCA)

CCA is a contractual framework among affiliated parties to share costs and risks in developing, producing, or obtaining assets or services. Each participant must make a contribution comparable to the share of expected benefits. If not comparable, there must be a balancing payment to meet the principle of fairness.

Identifying types of affiliated transactions is a crucial first step in international tax compliance. Each type of transaction has unique risk characteristics and documentation requirements. Failure to map these transaction types can lead to errors in selecting transfer pricing methods and significant fiscal corrections.

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. Republic of Indonesia. (1983). Law Number 7 of 1983 concerning Income Tax as several times amended, most recently by Law Number 7 of 2021 concerning Harmonization of Tax Regulations.
4. 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.
5. Directorate General of Taxes. (2013). Circular of the Director General of Taxes Number SE-50/PJ/2013 concerning Technical Guidelines for Audit of Taxpayers Having a Special Relationship.
6. 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.