Indonesian transfer pricing (TP) rules date back to the first enactment of Indonesia’s Income Tax Law in 1983. The elucidation to Article 18(2) of the 1983 Income Tax Law explains that the authority to make a TP adjustment is intended to prevent “tax smuggling”. In 1994, the wording was slightly changed to “tax avoidance”. Since then, TP regulations are still mainly viewed as anti-avoidance rules in Indonesia.
However, anti-avoidance is only one side of the TP coin. Indonesian TP regulation previously had not addressed the other side, which is the prevention of double taxation. Economic double taxation may occur when, for example, one transacting party’s income is inflated by TP adjustment, but the other transacting party’s expense is not deducted by the same amount. To eliminate the double taxation, a corresponding adjustment to the other transacting party’s expense should be made.
On December 29 2023, the minister of finance (MoF) issued Regulation No. 172 (MoF 172/2023), which adopts an ‘omnibus’ approach, codifying guidelines for TP matters related to the definition of ‘related party’, TP documentation (TPD) requirements, mutual agreement procedures (MAPs), and advance pricing agreements (APAs) into a single regulation.
With the enactment of MoF 172/2023, the previous MoF regulations – each focusing on TPD requirements, APAs, and MAPs – are revoked. Although the focus of MoF 172/2023 is on combining existing regulations, there are several key changes. One of them is the endorsement of corresponding adjustments in the regulation, clearly specifying the avoidance of double taxation as the reason for the application.
Corresponding adjustments in cross-border transactions
Article 9 (2) of the OECD and UN model tax conventions requires contracting jurisdictions to make corresponding adjustments. Article 9 (2) provides that in determining such adjustment, the competent authorities of the contracting jurisdictions shall, if necessary, consult each other. MoF 172/202 determines that this bilateral consultation is facilitated through a MAP. Besides bilateral MAPs, via Government Regulation No. 55 Year 2022, the opportunity to initiate multilateral MAPs is now also open.
A MAP may be initiated by:
A domestic taxpayer that is subject to double taxation resulting from a TP adjustment in another jurisdiction;
A domestic taxpayer that is subject to double taxation resulting from a TP adjustment by the Directorate General of Taxes (DGT); or
A foreign taxpayer through the competent authorities in the jurisdiction where the foreign taxpayer is domiciled.
However, the OECD Commentary on Article 9 of the Model Tax Convention on Income and on Capital specifies that a corresponding adjustment is neither automatic nor obligatory. The adjustment is only made if the other jurisdiction agrees with the application of the arm’s-length principle in the primary adjustment. Therefore, the success of the elimination of double taxation would largely depend on the effectiveness of the MAP.
Based on Indonesia’s MAP statistics from 2016–22, the average time to close TP MAP cases (starting from 1 January 2016) is 21.42 months, within the target of 24 months. Almost a third of closed cases for TP resulted in an agreement fully eliminating double taxation, while 17% resulted in an agreement partially eliminating double taxation. There is still a concerning 27% of MAP cases that are closed with an agreement to disagree or any other result.
Furthermore, it is still unclear how many MAP cases resulted in a corresponding adjustment on the Indonesian side. From the authors’ practical experience, most MAP cases concerning TP are in connection with primary adjustments that are proposed by the Indonesian side, which are reduced via a MAP and a corresponding adjustment granted at the treaty partner side.
Corresponding adjustment in domestic transactions
While double taxation concerns often focus on how different countries interpret the arm's-length principle, Indonesia faces a unique challenge. The risk of double taxation in Indonesia might be even greater within its own borders, stemming from inconsistencies in applying the principle across different tax office ‘jurisdictions’ within the country.
Differently from cross-border transactions, domestic transactions do not have access to MAPs and, as such, do not have a procedure to initiate government-to-government or tax office-to-tax office negotiations.
While previous regulations have been silent on corresponding adjustments, MoF 172/2023 has finally endorsed corresponding adjustments, particularly for transactions between domestic taxpayers.
Pursuant to Article 40 of MoF 172/2023, if a primary adjustment has been conducted by the DGT during a tax audit, then the domestic taxpayer that is the counterparty to the transaction may carry out a corresponding adjustment.
The corresponding adjustment could be carried out through:
An amendment to the annual tax return by taking into account the TP adjustment determined by the DGT, if the domestic counterparty has not been tax audited;
The issuance of a tax assessment letter (SKP) by the DGT that takes into account the TP adjustment determined by the DGT, if the domestic counterpart is being tax audited; or
An amendment to the SKP by the DGT on an ex officio basis that takes into account the TP adjustment determined by the DGT, if the domestic counterparty has been issued with an SKP and did not file an objection.
Corresponding adjustments are therefore not automatic but must be made through written notification to the tax office where the domestic taxpayer that is the counterparty to the transaction is registered. Although, ideally, the DGT should be able to establish the relevant adjustment to the counterparty through internal coordination between tax offices to prevent double taxation in domestic affiliated transactions, as both tax offices are part of one government institution (the DGT).
In addition to the administrative burden on the taxpayer, this procedure also poses a significant risk of uncertainty. The prerequisite to carry out this corresponding adjustment includes that the taxpayer subject to the TP adjustment agrees with the TP adjustment and refrains from contesting the TP adjustment at subsequent dispute resolution processes (objection and appeal to the Tax Court).
Under these conditions, the DGT demands certainty from the taxpayer – i.e., agreeing to the adjustment – before making the corresponding adjustment. Nevertheless, there is no clear language in MoF 172/2023 on whether the corresponding adjustment must be granted by the counterparty’s tax office.
There is also an issue regarding the impact of a corresponding adjustment on the future TP arrangements of a group
In practice, tax audits are usually oriented on tax revenue collection. As granting a corresponding adjustment may result in lower profit, and, hence, lower tax payable for the counterparty, the counterparty’s tax office may be reluctant to grant such adjustment. Moreover, considering the nature of TP issues, the counterparty’s tax office may simply disagree with the primary TP adjustment.
Additionally, the regulation does not stipulate the processing time of these adjustments. Therefore, there is no clear time limit for when the decision of whether the corresponding adjustment is granted or rejected must be issued.
The regulation also does not provide guidance on situations where the counterparty is already undergoing objection or appeal procedures for the relevant fiscal year. The corresponding adjustment may still be granted through revision to the SKP as long as no objection decision letter has been issued yet. Nonetheless, there is no specified procedure in the event that an objection letter has been issued, although, in principle, the DGT has the authority to revise the objection decision letter.
What is also not yet clear in practice is whether it is still possible for the taxpayer to challenge the primary adjustment upon rejection of the corresponding adjustment by the DGT by submitting:
An objection by way of Article 25 of the General Rules of Taxation Law (the GRT Law) if the corresponding adjustment was rejected before the period to submit an objection expires (i.e., three months after the date of issuance of the assessment letter); or
A reduction or cancellation of a tax assessment letter by way of Article 36 of the GRT Law.
The regulation remains silent on this matter, although it is practically possible under Indonesian tax law.
There is also an issue regarding the impact of a corresponding adjustment on the future TP arrangements of a group. One of the prerequisites for a corresponding adjustment is for the taxpayer to agree to the TP adjustment; i.e., the transfer price determined by the DGT. This will usually be proven by a statement of agreement in the formal tax audit document; i.e., minutes of the tax audit closing conference.
A taxpayer may, for certain reasons, choose not to contest the adjustment through an objection process, while stating “disagree” in the minutes of the tax audit closing conference. In this case, the taxpayer's position for not filing an objection cannot be interpreted that the taxpayer has agreed with the TP adjustment.
If, for the sake of a corresponding adjustment, the taxpayer has stated “agree” in the minutes of the tax audit closing conference, then, regardless of whether the corresponding adjustment is granted on the counterparty side, this “agree” statement carries the risk of being used against the taxpayer in future tax audits. The DGT may copy the same adjustment by arguing that the taxpayer has agreed to the correct TP arrangement as determined by the DGT.
Closing remarks on the new Indonesian TP regulation
The enactment of MoF 172/2023 signifies the recognition of the prevention of double taxation as the purpose of TP adjustment and not merely as a tool to prevent tax avoidance, thus aligning with the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations.
While the endorsement of corresponding adjustments is a major improvement from the previous anti-avoidance rule-based regulations, the current corresponding adjustment regulation in Indonesia still lacks certainty for the taxpayer.
It is important for the law to explicitly include the prevention of double taxation as the purpose of TP adjustment, preferably in the highest-level law; i.e., Article 18(3) of the Income Tax Law. This makes a stronger base for corresponding adjustments to be granted. Aside from the taxpayers, it would also be a clear move for the government in showing that it complies with international best practice.
Furthermore, areas of additional improvement for the prevention of double taxation in domestic transactions should include:
Automatic corresponding adjustments through internal coordination of the DGT;
Tax audit guidelines for refraining from TP adjustment on domestic affiliated transactions when there is no tax avoidance risk; e.g., the affiliated entities are subject to the same tax treatment and/or tax rate and there is no loss carry-forward; and
Tax audit procedures for conducting group tax audits to determine the profit allocation based on profit produced in the whole value chain in Indonesia.
