Transfer Pricing Audit, Stages, and Documentation Used

In the era of global trade, transactions between parties with a special relationship (affiliated transactions) become a major focus of tax authorities. To ensure that these transactions are not utilized as a mode of tax avoidance through profit shifting, the Directorate General of Taxes (DGT) conducts testing known as a Transfer Pricing Audit.

This audit is essentially a test on the application of the Principle of Fairness and Business Prevalence (PKKU) or Arm’s Length Principle (ALP).

Preparation Stages of Audit

The first stage is preparation. Although procedurally this stage follows the general audit procedures applicable, in the context of transfer pricing, there are specific specifications.

The main focus of the tax auditor at this stage is the collection and review of initial data regarding the Taxpayer and its affiliates. The auditor must study Taxpayer data related to special relationships with transaction counterparties. This includes identifying business group structures, share ownership (both direct and indirect minimum 25%), or control relationships through management and technology.

The goal is to map tax avoidance risks before the field audit or office audit is actually executed.

Execution Stages of Audit

This is the core of the transfer pricing audit process. Based on PER-22/PJ/2013, the execution stage is divided into three crucial steps that are interrelated:

1. Determining Taxpayer Business Characteristics

This step aims to accurately understand how the Taxpayer runs its business. Without this understanding, the selection of comparable data will not be valid.

• Identification of Affiliated Transactions: The auditor will examine industry conditions, competition situations, and economic factors affecting the business. This also covers the analysis of terms of agreement (terms of agreement), business strategies, and supply chain (supply chain).
• Function Analysis (FAR): This is an analysis of Functions performed, Assets used, and Risks assumed. By knowing the FAR profile, the auditor can estimate the level of remuneration or profit that the Taxpayer should earn.
• Financial Ratio Analysis: The auditor conducts initial research on financial performance using ratios such as Gross Margin, Operating Margin, Return on Assets (ROA), up to the Berry Ratio to detect anomalies.

2. Selecting Transfer Pricing Method

After business characteristics are understood, the next step is to select the most appropriate transfer pricing method (the most appropriate method). Method selection is based on suitability with transaction characteristics, availability of reliable comparable data, and level of comparability.

Methods that can be chosen include:

• Comparable Uncontrolled Price Method (CUP): Comparing the price of goods/services directly.
• Resale Price Method: Using the gross margin of resale price minus fair gross profit.
• Cost-Plus Method: Adding a fair mark-up to production costs.
• Transactional Net Margin Method (TNMM): Comparing net operating profit ratio against a specific base.
• Profit Split Method: Used for highly integrated transactions or unique intangible assets.

3. Applying the Principle of Fairness and Business Prevalence (ALP)

The final stage of execution is number testing. The auditor compares affiliated transactions with independent transactions (comparables).

• Comparability Analysis: Transactions are considered comparable if differences do not have a material influence or if accurate adjustments can be made.
• Search for Comparables: Using internal or external databases through a systematic searching strategy and manual review.
• Adjustment: If a difference is found, a correction is made:
  • Primary Adjustment: Correction on taxable income.
  • Secondary Adjustment: Subsequent correction (e.g., considered as dividend/loan implying other taxes).

Reporting Stages of Audit

The results of the analysis—including the selected method, comparables, and corrections—will be poured into the Audit Report (LHP) which becomes the basis for the issuance of the tax assessment letter.

Details of Forms and Letters in Audit

To guarantee standardization, PER-22/PJ/2013 establishes specific document formats (Attachment II):

1. Request Letter for Information or Evidence: Formal request for data related to special relationships.
2. Statement Letter: Taxpayer's official statement that the data submitted is correct.
3. Form of Transactions in Special Relationship: Detailing types, partners, values, and methods.
4. Segmented Financial Statements: Separating performance between affiliated and independent transactions.
5. Supply Chain Management Analysis: Entity functions within the global group supply chain.
6. Function, Asset, and Risk (FAR) Analysis: Checklist of who performs functions and assumes risks.
7. Business Characteristics Form: Declaration of business type (e.g., Limited Risk Distributor).
8. Comparability Analysis: Head-to-head comparison table based on 5 comparability factors.
9. Summons to Provide Information: Summons for presentation or direct explanation.
10. Minutes of Providing Information: Legal record of interviews or information provision.

Conclusion

A transfer pricing audit is not merely a number check, but an in-depth analysis of economic functions and business substance. The key for Taxpayers to face this audit is documentation preparation consistent with the "Blue Side" principle, as well as a deep understanding of the stages regulated in the regulation.