Segregation and Aggregation Approaches in Transfer Pricing Analysis

One of the most crucial decisions—yet often overlooked—in transfer pricing analysis is determining the "unit of analysis". Before selecting a method or searching for comparables, Taxpayers must answer a fundamental question: Should every affiliated transaction be tested one by one separately (segregation), or can several transactions be combined and tested as a whole (aggregation)?

The choice between segregation and aggregation is not merely a technical preference, but a legal foundation determining whether the final analysis result is considered reliable by tax authorities. Errors in determining this approach can lead to the rejection of the entire Transfer Pricing Document (TP Doc).

Priority on Segregation (Separate Evaluation)

Theoretically and regulatorily, the gold standard in transfer pricing is the Segregation approach or transaction-by-transaction evaluation.

Based on Article 4 paragraph (2) of PMK 172 of 2023, the Indonesian Government explicitly mandates that the application of the Principle of Fairness and Business Prevalence (PKKU) must be carried out separately for each type of Transaction Influenced by a Special Relationship.

Why do tax authorities prefer segregation?

1. Mixing different transactions (e.g., manufacturing and distribution) can obscure the fact that one transaction might not be fair.
2. Aggregation is often used to hide inefficiencies or losses in one product line by covering them up using super profits in another product line (cross-subsidization).
3. The Comparable Uncontrolled Price (CUP) method, which is the most direct method, almost always requires transaction-by-transaction data.

In line with PMK 172, OECD TPG 2022 Paragraph 3.9 and UN TP Manual 2021 Paragraph 3.3.3.2 state that ideally, to achieve the most precise approximation of arm's length conditions, the fairness principle should be applied on a transaction-by-transaction basis.

When Is Aggregation Allowed?

Although segregation is the main rule, the business world is often too complex to separate every activity clinically. Therefore, regulations allow Aggregation (combining transactions) in very specific conditions.

Referring to Article 4 paragraph (3) of PMK 172/2023, combining can be done if:

• The transactions are interlinked; and
• Influence each other in transfer price determination;
• So that separate analysis cannot be performed reliably and accurately.

OECD TPG 2022 provides more detailed guidance on when aggregation is considered appropriate:

• Closely Linked Transactions: For example, long-term contracts for the provision of goods and services.
• Continuous Transactions: For example, the continuous supply of vital components to an affiliate assembly plant.
• Routing: Transactions routed through an intermediary company (intermediary).

Common Business Scenarios for Aggregation

A. Portfolio Approach (Portfolio Approach)

This strategy involves selling various products where the Taxpayer might set a low price on one product to create demand for another high-profit product. Classic Example: Sale of printers (low margin/loss) and ink cartridges (high margin). Separately, printer sales would appear unfair, but in aggregate, total profit might be very fair.

B. Package Deals (Package Deals)

MNEs often sell packages consisting of various elements (patent licenses, trademarks, technical services) at a single price. OECD states it might not be feasible to evaluate each element separately.

C. Manufacturing and Distribution Integration

If a Taxpayer produces semi-finished goods and sells them to an affiliate for further processing, separating manufacturing and distribution functions might not yield a reliable analysis. The Profit Split method is often the solution here.

Intentional Set-offs (Loss Compensation)

This occurs when one party provides a benefit to another party and in return receives another benefit. Taxpayers must prove that after accounting for such set-off, the overall transaction conditions remain fair and must be disclosed transparently.

Challenges and Risks in Aggregation

1. Rejection by Auditors: If auditors prove transactions can be separated, they will break down the aggregation. This often results in positive corrections on one side without negative correction compensation (cherry-picking).
2. Loss of Detail: If indirect cost allocation (such as overhead) into segments is inaccurate, analysis results will be distorted.
3. Comparability Non-equivalence: Third-party data is often aggregated data, making it difficult to ensure the comparator product mix is truly the same.

Conclusion and Compliance Strategy

In compiling the Master File and Local File according to PMK 172/2023, follow this hierarchy:

1. Always attempt Segregation analysis first (Safe Default Position).
2. Use Aggregation only if segregation is impossible, include strong written justification.
3. Apply the approach consistently from year to year.

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).