Internal TNMM, A Cheap and Easy Way to Avoid Transfer Pricing Correction

In the spectrum of transfer pricing methods, the Cost Plus Method (CPM) holds a vital role, especially for companies operating in the manufacturing and service sectors. As one of the "Traditional Transaction Methods", CPM is considered more direct in reflecting the relationship between production costs and expected profit compared to transactional profit-based methods (such as TNMM).

However, CPM application is often deceptive; appearing simple on the surface (cost plus profit), yet harboring high complexity regarding accounting consistency.

Definition and Basic Concept of CPM

The Cost Plus Method (CPM) is a transfer pricing determination method carried out by adding a fair gross profit mark-up obtained by a comparable manufacturer or service provider to the cost of goods sold (cost base) of the goods or services.

Philosophy of CPM

CPM looks at transaction fairness from the perspective of the goods or service provider (seller). The logic is that in an independent transaction, a producer or service provider expects to cover all its production costs (direct and indirect costs) and obtain an additional profit (mark-up) that is fair as compensation for the functions performed and risks assumed.

Based on MoF Regulation (PMK) 172 of 2023, CPM is defined as a method carried out by adding a fair gross profit level for a manufacturer or service provider to the cost of goods sold of the goods or services.

When is CPM Mandatory?

Not all transactions are suitable for using CPM. Based on the The Most Appropriate Method principle, CPM is ideally used for:

1. Semi-finished Goods: Transactions of semi-finished goods sales between affiliated parties.
2. Contract/Toll Manufacturers: The Taxpayer acts as a manufacturer producing goods based on orders, where market risk is assumed by the principal.
3. Long-term Buy-and-Supply: Transactions with long-term purchase guarantees.
4. Provision of Services: Intra-group service provision transactions that are routine in nature.

CPM is less appropriate if it involves unique intangible assets or if the producer assumes full market risk (fully fledged manufacturer).

Calculation Mechanism: Cost Base and Mark-up

The core of CPM is the determination of the Cost Base (Cost Base) and Gross Profit Mark-up (Gross Profit Mark-up).

A. Cost Base (Cost Base)

The calculation basis is usually production cost (direct + indirect production costs), excluding operating expenses (SG&A).

• Direct Costs: Raw materials, direct labor.
• Indirect Costs: Machine depreciation, factory electricity, supervisor salaries.

B. Gross Profit Mark-up

This mark-up is obtained from:

• Internal Comparable: Mark-up when selling to independent parties.
• External Comparable: Mark-up of comparable independent manufacturers.

Accounting Consistency

The biggest challenge of CPM is ensuring accounting consistency. Differences in how costs are recorded can significantly distort analysis results. OECD TPG 2022 and UN Manual 2021 emphasize the importance of uniformity in cost classification between COGS and Operating Expenses.

Comparability Analysis in CPM

In CPM, functional comparability is prioritized over product comparability. Two different products can be compared provided the production process and functional complexity are comparable. However, efficiency differences must not be ignored; manufacturers that are more efficient are entitled to a higher mark-up.

Application Case Study

The Cost Plus Method (CPM) is a powerful tool for manufacturing and services, provided it is used with high discipline regarding accounting details. The key to success lies in the accurate identification of the cost base, consistency of cost treatment, and understanding of functions/risks. If detailed comparable cost data is difficult to access, consider other methods such as TNMM with the Net Cost-Plus Mark-up indicator.

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). Circular Letter of the Director General of Taxes Number SE-50/PJ/2013 concerning Technical Guidelines for Audit of Taxpayers Having a Special Relationship.