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Application of Arm’s Length Principle in Indonesia – Your Guidelines
For the purposes of levying tax, tax legislation generally requires all transactions to be reported at arm's length value. Empirically, multinational corporations frequently engage in transfer pricing between affiliates, or companies that have a special relationship - meaning that the prices and profits charged are different from those that would be charged in a transaction between unaffiliated parties. Transfer pricing often has a negative impact on the reporting of income and the amount of deductible income for the purposes of calculating taxable income, including the withheld value added tax and sales tax on luxury goods. Taxand Indonesia addresses the guidelines that the Indonesian tax authority has issued on the application of the Arm's Length Principle, as set out in Director General of Taxes Regulation Number Per-43/PJ/2010.
The Essence of the Regulation
The Indonesian Tax Authority is entitled to adjust the taxable income of a taxpayer that engages in transactions with related parties to reflect the application of the Arm's Length Principle.
Taxpayers that engage in transactions with related parties are required to apply the principle by following the stipulated steps so as to arrive at arm's length price / profit in respect of the transaction, and to maintain the required documentation as well.
Arm's length price or profit is determined based on the following
- A comparability analysis to determine the most appropriate comparables. The internal comparables is higher priority than the external comparables.
- An analysis of transfer pricing methods on the basis of hierarchy. CUP method is the most preferential, followed by Resale Price/Cost Plus, and Profit Split method. TNMM is considered as the last resort.
- Arm's length range may be applied, provided that there are several comparables, using prices/profits between the range of the first and third inter- quartile.
The taxpayer who has affiliated transactions with value of maximum IDR10 million (approximately US$ 1.111) is not obliged to follow the above steps in determining the arm's length price / profit.
This regulation also covers the application of arm's length principle on intra-group services, cost contribution arrangements and intangible properties.
In principal, it requires that those transactions are substantially exist, giving measurable economic benefit to the recipient of service/intangible properties and using the arm's length value.
In assessing the validity of comparables the following elements must be considered
- the characteristics of the tangible, intangible goods and services
- the functions of each party involved in the transaction (principal functions of the organisation, types of assets used, risks, etc.)
- the contractual terms
- the economic conditions, including availability of goods)
- the business strategies (level of product innovation, product diversification, market penetration, etc)
The adjustment will be taken by the Director General of Taxes if Taxpayer is unable to provide sufficient explanations and/or the supporting documents.
Obligation to Document the Application of Arm's Length Principle
- The steps involved in applying the Arm's Length Principle, selecting the comparables, the factors that influence the comparables, and the results of the comparability analysis, all need to be documented
- Documentation is also required in the case of information that supports the application of the Arm's Length Principle, such as documents describing company organisational structure, group business structure, ownership structure, operational aspects, competitors, corporate environment, pricing policy, cost allocation
- Selected comparables and transfer pricing methods
The Director General of Taxes may request other tax authority to make correlative adjustments as a follow-up of the domestic primary adjustment made or make correlative adjustments to follow-up request of tax authority of other country.
In case that the tax authority of other make a primary adjustment on overseas taxpayers, the related domestic taxpayer is not permitted to make correlative adjustment by himself.
These guidelines will prove to be of great benefit in providing legal certainty to multinational companies in applying the Arm's Length Principle.
For the sake of efficiency, it is recommended that multinational companies operating in Indonesia draw up Advance Price Agreements (APA) and seek application of the Mutual Agreement Procedure (MAP) from the Indonesian Tax Authority. This will be beneficial if the multinational companies in Indonesia are in dispute with the tax authorities or in order to prevent the double taxation that may arise in their affiliated transactions.
Your Taxand contacts for further queries are:
T. +62 21 8399 919
T. +62 21 8399 919