Transfer pricing refers to the pricing of goods, services, and intangible assets that are transferred between different entities within a multinational enterprise. It is a key issue in taxation because it can affect the allocation of profits between different jurisdictions and therefore impact the tax liabilities of each entity involved.
For example, if a subsidiary in one country sells goods to a subsidiary in another country at a price that is lower than the market price, the subsidiary that sells the goods will have a lower profit, and the subsidiary that purchases the goods will have a higher profit. This can lead to a lower tax liability for the subsidiary that sells the goods and a higher tax liability for the subsidiary that purchases the goods, which can be advantageous from a tax perspective.
However, tax authorities may view this as a way to shift profits to jurisdictions with lower tax rates, which can result in tax evasion or avoidance. Therefore, most countries have transfer pricing rules that require transactions between related parties to be conducted at arm’s length, which means that the price should be similar to what would be charged in a transaction between unrelated parties.
The arm’s length principle is used to ensure that profits are allocated to the entities that create them, based on their contribution to the value chain of the multinational enterprise, and to prevent artificial profit shifting. Failure to comply with transfer pricing rules can result in penalties, interest, and adjustments to the tax liability of the entities involved.
The Five Factor Comparability Analysis
The Five Factor Comparability Analysis is a commonly used framework for determining whether a controlled transaction between related parties meets the arm’s length standard. The five factors are:
- The characteristics of the property or services: This factor considers the nature of the goods or services being transferred, including their physical attributes, quality, and functionality.
- The functions performed by the parties: This factor looks at the activities performed by the parties involved in the transaction, including their roles and responsibilities, risks assumed, and the assets and resources used.
- The contractual terms: This factor examines the terms of the agreement between the parties, including the pricing mechanism, payment terms, and any other relevant terms.
- The economic circumstances: This factor considers the economic conditions and market factors that could impact the transaction, such as supply and demand, competition, and market trends.
- The business strategies: This factor looks at the long-term objectives and business strategies of the parties involved, including their goals, expectations, and investment plans.
By comparing the five factors between the controlled transaction and similar transactions between unrelated parties, a comparability analysis can be performed to determine whether the transaction meets the arm’s length standard. If the transaction is found to be not at arm’s length, adjustments may be made to ensure that the transaction is priced appropriately, and the tax liability of the related parties is accurately determined.
Methods used to evaluate transfer pricing
There are several methods used to evaluate transfer pricing, and the appropriate method depends on the facts and circumstances of each transaction. The most commonly used methods are:
- Comparable Uncontrolled Price (CUP) method: This method compares the price charged for a controlled transaction to the price charged for a similar transaction between unrelated parties.
- Cost Plus method: This method adds a reasonable profit margin to the cost incurred by the seller in producing the goods or providing the services.
- Resale Price method: This method calculates the profit margin earned by the seller by subtracting the resale price of the goods from the price paid to the related party.
- Transactional Net Margin method (TNMM): This method compares the net profit margin earned by the related party to the net profit margin earned by independent parties engaged in similar transactions.
- Profit Split method: This method divides the profits earned from the controlled transaction between the related parties based on the value contributed by each party to the transaction.
The appropriate method is determined based on the availability of reliable comparables, the nature of the transaction, and the degree of complexity involved. It is important to note that the method used should be consistent with the arm’s length principle and reflect the economic reality of the transaction. In addition, proper documentation should be maintained to support the transfer pricing methodology used and demonstrate compliance with applicable laws and regulations.
TP Rules in Indonesia
In Indonesia, transfer pricing rules are primarily governed by the Directorate General of Taxes (DGT) under the Ministry of Finance. The Indonesian transfer pricing regime is based on the arm’s length principle, which requires that transactions between related parties be conducted at prices and terms that would apply between independent parties under similar circumstances.
The key regulations that govern transfer pricing in Indonesia are:
- Law No. 36 of 2008 on Income Tax, which provides the legal basis for transfer pricing rules in Indonesia.
- Government Regulation No. 46 of 2013 on the Income Tax Treatment of Transactions Between Related Parties, which sets out the detailed rules for implementing transfer pricing in Indonesia.
- Director General of Taxes Regulation No. PER-32/PJ/2011, which provides guidance on transfer pricing documentation requirements and the penalties for non-compliance.
Under these regulations, taxpayers are required to prepare transfer pricing documentation to support the pricing of their related-party transactions. This documentation should include a master file, which provides an overview of the taxpayer’s global business operations and transfer pricing policies, and a local file, which provides a detailed analysis of the related-party transactions conducted in Indonesia.
Taxpayers in Indonesia are also required to maintain contemporaneous documentation, which means that the transfer pricing documentation must be prepared and updated annually, and must be available for inspection by the DGT upon request. Penalties for non-compliance with transfer pricing rules in Indonesia can be severe and can include fines, additional taxes, and even criminal prosecution in extreme cases. Therefore, it is important for taxpayers to ensure that their transfer pricing policies and documentation are in compliance with the applicable regulations.
Transfer Pricing Documentation Rules
PMK 213/PMK.03/2020 is a regulation issued by the Indonesian Ministry of Finance that provides guidelines for transfer pricing documentation in Indonesia. The regulation was issued to replace the previous transfer pricing documentation rules, which were contained in Director General of Taxes Regulation No. PER-32/PJ/2011.
PMK 213 sets out the requirements for the transfer pricing documentation that taxpayers must prepare and maintain to support the arm’s length pricing of their related-party transactions. The key requirements under PMK 213 include:
- Master File: Taxpayers are required to prepare a master file that provides an overview of their global business operations, including their organizational structure, business activities, and transfer pricing policies.
- Local File: Taxpayers are required to prepare a local file that provides a detailed analysis of their related-party transactions in Indonesia, including information on the transactions, the parties involved, and the transfer pricing methods used.
- Country-by-Country Report: Taxpayers that meet certain revenue thresholds must also prepare a Country-by-Country (CbC) report that provides information on the global allocation of their income, taxes paid, and other indicators of economic activity.
PMK 213 also sets out the penalties for non-compliance with transfer pricing documentation requirements. Taxpayers who fail to prepare or maintain the required transfer pricing documentation may be subject to penalties, including the potential disallowance of related-party expenses and the imposition of additional taxes.
Overall, PMK 213 provides updated and more detailed guidance on the transfer pricing documentation requirements in Indonesia, and emphasizes the importance of maintaining contemporaneous documentation to support the pricing of related-party transactions.
Also read : The OECD Transfer Pricing Guidelines , OECD