Indonesian Transfer Pricing

In today's interconnected global economy, transactions between related parties within a business group (affiliated transactions) have become standard practice. However, these practices carry the risk of profit shifting to lower-tax jurisdictions. To safeguard fiscal sovereignty, Indonesia implements rigorous Transfer Pricing rules. With the issuance of Minister of Finance Regulation (PMK) Number 172 of 2023, the government has codified and simplified previous technical rules into a single legal framework to provide greater legal certainty for taxpayers while strengthening supervision of affiliated transactions.

1. Definition and the Arm’s Length Principle (ALP)

Transfer Pricing is simply the pricing set in transactions between parties that have a "special relationship." The core of Indonesian regulation is the application of the Arm’s Length Principle (ALP), known locally as Prinsip Kewajaran dan Kelaziman Usaha (PKKU).

The ALP requires that prices or profits in affiliated transactions must be equal to or within the range of prices or profits that would occur in transactions between independent parties under comparable conditions. PMK 172/2023 emphasizes that failure to apply the ALP may trigger fiscal corrections by the Directorate General of Taxes (DGT).

2. Special Relationships: Determining Parameters

A special relationship is deemed to exist if one of the following three criteria is met according to the Income Tax Law:

• Ownership or Capital Participation: Direct or indirect capital participation of at least 25%.
• Control: Through management, use of technology, or effective control even without majority shareholding.
• Family Relationship: Either biological or through marriage in a direct lineage and/or one degree of collateral lineage.

3. Hierarchy of Transfer Pricing Methods

PMK 172/2023 provides flexibility but prioritizes accuracy in method selection. Applicable methods include:

4. Transfer Pricing Documentation (TP Doc): Three Main Pillars

Indonesia adopts the international standards of BEPS Action 13. Taxpayers meeting certain thresholds must maintain:

• Local File: Detailed information regarding specific affiliated transactions in Indonesia.
• Master File: Information regarding the global business group, including organizational structure, business lines, and intangible assets.
• Country-by-Country Report (CbCR): Allocation of income, taxes paid, and indicators of economic activity of the group in each country.

5. Thresholds for TP Doc Obligations

Under the latest regulation, the obligation to maintain a Local File and Master File applies to Taxpayers who:

1. Have a gross turnover in the previous tax year exceeding IDR 50 billion.
2. Have affiliated transaction values in the previous tax year:
   • Exceeding IDR 20 billion for tangible goods.
   • Exceeding IDR 5 billion for each category of services, interest, intangible goods, or other affiliated transactions.
3. Engage in transactions with affiliates in countries with a lower tax rate than Indonesia (22%).

6. Specific Transactions: Services, Intangibles, and Finance

PMK 172/2023 details the testing for specific transactions:

• Service Transactions: Must prove the services were actually rendered, provide economic benefits (benefit test), and that the value is reasonable.
• Intangible Assets: Focuses on DEMPE analysis (Development, Enhancement, Maintenance, Protection, and Exploitation) to determine who is entitled to the economic returns of the asset.
• Financial Transactions: Includes testing the substance of the loan, interest rate reasonableness, and Debt-to-Equity Ratio (DER) analysis.

7. Primary, Secondary, and Corresponding Adjustments

8. Advance Pricing Agreement (APA) and Mutual Agreement Procedure (MAP)

To minimize future disputes, taxpayers may apply for:

• APA: A written agreement between the taxpayer and the DGT (or foreign authority) regarding the determination of transfer pricing for future periods (usually 3-5 years).
• MAP: A consultative procedure between tax authorities to resolve double taxation disputes arising from transfer pricing adjustments.

9. Compliance and Sanctions

Failure to maintain TP Doc on time (at the latest 4 months after the end of the tax year for Local/Master Files) or unreasonableness in transactions may result in:

• Disallowance of expenses as a deduction from gross income.
• Administrative sanctions in the form of interest based on prevailing market rates.
• Increased risk of in-depth tax audits.

10. Risk Mitigation Strategies

Businesses are advised to conduct regular comparability analyses, ensure the availability of written contracts aligned with economic substance (substance over form), and document every stage of pricing on a contemporaneous basis.

Conclusion

PMK 172/2023 is a significant step for Indonesia in creating a transparent and competitive tax system. By consolidating rules for services, intangibles, and legal procedures into one regulation, it is expected that taxpayers can comply more voluntarily. Proactive Transfer Pricing management is no longer just about document fulfillment, but a vital part of international corporate governance integrity.