The new Indonesian TP rule: clear path or labyrinth of doubt?

Transactions between members of a company group are unavoidable. Interestingly, large numbers of trading transactions involve related transactions. The tax authorities, however, perceive these transactions as high risk and vulnerable to abuse by companies looking to evade paying taxes. Strategic transfer pricing can achieve this by artificially lowering tax obligations through the prices set between related parties.

To combat this, a principle that business and tax authorities can use as a guide to determine reasonable rates for related-party transactions has been established. This arm’s-length principle (ALP) has been internationally accepted as the standard for allocating a multinational enterprise’s profits from intra-group transactions. It is expected to reduce or mitigate any profit shifting through transfer mispricing that has occurred in related-party transactions.

Indonesia has consistently adopted the ALP in its transfer pricing rules, and recently those have been updated with the issuance of Minister of Finance Regulation No. 172 of 2023 (PMK-172). The three prior regulations – No. 213/2016 (PMK-213) on transfer pricing documentation, No. 49/2019 on mutual agreement procedures (MAPs), and No. 22/2020 on advance pricing agreements (APAs) – and the ALP were combined into one regulation on transfer pricing in PMK-172.

The Indonesian Income Tax Law entered into effect in 1983, which is when the country's transfer pricing regulation first emerged. The first comprehensive guidelines on the ALP in Indonesia were included in the Directorate General of Taxes’ (DGT’s) Letter No. 153 of 2010, issued in March 2010. This marked a milestone in establishing internal transfer pricing rules guidance in performing a tax audit and introduced important points such as the existence test, the benefit test, the ‘willingness to pay’ test, and references to different transfer pricing methods and unusual transactions.

After realising that fairness and transparency were necessary, the DGT issued Regulation No. 43 of 2010 (PER-43). It sought to give Indonesian taxpayers more precise rights and obligations. PER-43 was amended by Regulation No. 32 of 2011, which required taxpayers to provide transfer pricing documentation and permitted modifications to transfer pricing for domestic transactions under certain circumstances, among other requirements. Notably, it also substituted the more adaptable ‘most appropriate method’ for the notion of a hierarchy of transfer pricing methods.

Regulation No. 22 of 2013 and Circular Letter No. 50 of 2013 were issued to complement earlier regulations. These regulations included instructions on how to use the contribution and residual technique when utilising the profit split method.

Prior to the announcement of the OECD BEPS Action Plan in 2015, Indonesia had no formal regulations governing transfer pricing. Indonesia pledged to adopt all the BEPS basic criteria as a member of the Inclusive Framework on BEPS, including the provisions pertaining to transfer pricing documentation and the enhancement of dispute resolution via MAPs. PMK-213 was issued to accommodate some international best practices adopted after the issuance of the BEPS actions. PMK-213 introduced a three-tiered system of transfer pricing paperwork (master file, local file, and country-by-country reporting, or CbCR) to be consistent with BEPS Action 13.

Furthermore, the prior MAP regulation was superseded by Ministry of Finance Regulation No. 49 of 2019, which gave taxpayers more flexibility to submit MAP requests to Indonesia. A 24-month period was also established by this regulation and its implementing regulation as the time limit for MAP discussions, with a further 24-month extension granted to cases that satisfy certain requirements.

A significant change was brought about by Ministry of Finance Regulation No. 22 of 2020, which covered transfer pricing provisions and introduced APAs. It addressed the lack of rollback provisions in the previous APA legislation by incorporating these in response to BEPS Action 14. The ALP standard is also covered by this regulation, including:

• Related parties;

• The stages of the ALP;

• Transfer pricing techniques;

• Comparability analysis;

• Special transactions; and

• Secondary adjustments.

The Ministry of Finance issued PMK-172 on December 29 2023, as the implementing regulation required by the Law on Harmonisation of Tax Regulations and Government Regulation No. 55 of 2022. PMK-172 revokes the three previous regulations issued by the Ministry of Finance.

PMK-172 can be divided into six parts, in accordance with the transfer pricing compliance cycle.

The first section explores the idea of a ‘related party’, which is important because it acts as the ‘gate’ through which the DGT can use its power to recalculate an arm’s-length price. Notably, there have been no substantial alterations in PMK-172 concerning this aspect.

The guidelines for implementing the ALP are outlined in the second section of PMK-172 and apply to taxpayers and the DGT. The requirement to apply the ALP is explained, along with the relevant ALP regulations, application stages, preliminary stages, and transfer pricing methods. Following the previous rule, PMK-172 stipulates that the ALP applies for transactions affected by a related party, which extends beyond just related-party transactions. It also encompasses transactions between non-related parties, provided that a related party (associated with either or both of the parties) plays a role in determining the transaction’s counterpart and price. Compared with previous regulations, PMK-172 provides more comprehensive guidance on activities to be carried out at each stage of applying the ALP. For instance, while the previous rules did not delve into specifics regarding industrial analysis stages, PMK-172 now details activities within this stage. PMK-172 also introduces a preliminary stage to demonstrate the benefits of specific related-party transactions. Transactions falling under this stage consist of intragroup services; the use, or right to use, intangible assets; intragroup loans; other financial transactions; transfers of assets; business restructuring; and cost contribution arrangements.

The third part discusses transfer pricing documentation. It still adopts three-tiered transfer pricing documentation that consists of:

• A master file, containing the business group information;

• A local file, containing the taxpayer’s data and information on their ALP implementation; and

• CbCR, which contains standardised data for business groups with consolidated revenue above IDR 11 trillion.

The fourth part describes the DGT's authority to evaluate taxpayers' compliance with the ALP. It covers primary and secondary adjustments, and emphasises how the ALP permeates the VAT regime. Using the norm in the VAT Law, the DGT’s authority to apply the ALP and adjust transfer pricing for VAT is executed when the selling price falls below the market price. Notably, PMK-172 clarifies that such pricing adjustments do not impact the input tax credit for related-party users of invoices.

The fifth section outlines the taxpayer’s entitlement to mitigate double taxation by adjusting the transfer price in related-party transactions through a process known as corresponding adjustment. In the case of cross-border transactions, this adjustment is resolved via a MAP. Similarly, domestic affiliated counterparts have the right to request a corresponding adjustment if they agree with the adjustment or tax assessment issued by the DGT and refrain from initiating tax litigation based on the tax assessment.

The procedure for resolving and preventing transfer pricing conflicts using MAPs and APAs is elaborated on in the final section. This regulatory framework introduces the concept of multilateral APAs and eliminates administrative sanctions for taxpayers that adhere to agreed-upon APAs.

Some transfer pricing concerns that were unclear or not regulated in the earlier regulations were finally included in PMK-172. Several unresolved issues that are settled in PMK-172 include the following:

• PMK-172 explicitly emphasises that when exercising its authority to assess compliance, the DGT must comply with the ALP. Simultaneously, the DGT shall consider the stages of ALP application by taxpayers that meet the stipulated requirements. This level of clarity was absent in previous regulations.

• PMK-172 provides clarification on how the ALP aligns with norms within the VAT Law. Prior regulations remained silent on this matter, making PMK-172 a more definitive guideline.

• Pre-PMK-172 transfer pricing rules did not explicitly address how taxpayers could make corresponding adjustments for domestic affiliate transactions, along with the necessary administrative processes.

PMK-172 asserts that secondary adjustments apply to domestic and cross-border transfer pricing corrections. Furthermore, it explains that secondary adjustments, treated as deemed dividends, encompass all types of related parties, whether due to ownership, control, or family ties. This provision was not clearly explained in the previous regulations, which led to increased uncertainty.

PMK-172 provides administrative procedures to relieve double taxation by allowing adjustments to the transfer price of the affiliated counterparty. While correction for cross-border transactions can be resolved through a MAP, corresponding adjustments resulting from primary adjustments in domestic transfer pricing are among the most important explanations offered by PMK-172. Prior to PMK-172, there was no explicit guidance regarding the availability of such an adjustment in domestic transfer pricing, which resulted in unrelieved double taxation and a greater disadvantage for domestic transfer pricing.

The relief procedure from these potential corresponding adjustments, as offered by PMK-172, can be executed if the taxpayer accepts the DGT's primary adjustment and chooses not to pursue a judicial remedy. This one-sided fair mitigation offered by PMK-172 was included to secure the primary adjustment. However, for taxpayers, this provision will not resolve the adjustments, unless the adjustment is acceptable for taxpayers.

Such corresponding adjustments for domestic transactions will be carried out through the following:

• An amendment of the annual corporate income tax return if the counterpart has not undergone a tax audit. Essentially, the counterparty revises its tax return to reflect the appropriate transfer pricing adjustments.

• The issuance of a tax assessment letter when a tax audit for the counterpart has already begun. The tax assessment letter will consider the corrections made by the DGT.

• An amendment of a tax assessment letter if a tax assessment letter has been previously issued and the taxpayers agree with the results.

The secondary adjustments proposed by PMK-172 treat the difference between the actual price and that under the ALP as a deemed dividend paid to the related party. Prior to PMK-172, there was a provision for secondary adjustments; however, the nature of the related party that supported the adjustments was not made clear earlier. In addition, the previous regulation did not make the timing clear as to when secondary adjustments might be used, during the audit or regular monitoring phases of compliance work.

PMK-172 makes it clear that secondary adjustments occur regardless of in-audit or in-compliance monitoring activity, though they may be made voluntarily by the taxpayer during the monitoring activity phase. All other related-party categories – including those based on ownership, control, or even a family relationship – are likewise subject to secondary adjustment.

PMK-172 provides for a unique self-mitigation of the secondary adjustment by waiving the adjustment if the taxpayer accepts the main adjustment and returns the money to its home country or related party.

PMK-172 restates that the adjustments would also be subject to VAT. In fact, when taxable goods or services are transferred domestically to a related party or third party, the VAT Law requires that market prices be used for VAT purposes. On the other hand, the previous transfer pricing rule was never clarified, which resulted in differences in the transfer pricing adjustments in VAT reporting. Other questions left unexplained by the prior regulations were whether the counterparty may credit the input VAT that was included in the tax audit and whether the counterparty could modify the VAT invoice to conform to the DGT adjustment.

According to PMK-172, the ALP is applicable to VAT as well, and the related-party buyer is still able to credit the input VAT if it complies with the VAT Law. PMK-172, however, states that the related-party buyer's input VAT is not adjusted because of the transfer pricing adjustment made to the selling price of taxable goods or services. There is a chance that this will put further strain on companies.

A major change in the transfer pricing documentation environment is also included in PMK-172.

• New transfer pricing documentation – commencing from fiscal year 2024, new transfer pricing documentation following the rules of PMK-172 must be adopted by the taxpayers.

• CbCR – the year prior to the reporting year is now used to determine who is required to submit CbCR.

• Furthermore, as of the date of the DGT's request, taxpayers must submit their master file and local file within a strict one-month period stipulated by PMK-172. Punishments will be applied for non-compliance. As a result, companies must make sure that the transfer pricing documentation is prepared on time to reduce the possibility of DGT demands.

MAPs and APAs undergo revolutionary alterations following the implementation of PMK-172.

• MAP results and their execution – PMK-172 states that the basis for tax collection or a refund, depending on the output of the MAP discussion, will be a decree of mutual agreement. It summarises a MAP agreement, which is executed directly without any further implementing decree. This removes the requirement for additional administrative letters, as applied in the past.

• In addition, PMK-172 provides for a multilateral APA, a groundbreaking mechanism intended to avert conflicts over transfer pricing involving three or more jurisdictions.

• For APAs, there is also a very positive rule that can eliminate rollback periods and administrative fines for APA-covered years before the agreement was finalised. This incentive could greatly encourage taxpayers to submit an APA application.

Despite PMK-172's increased clarity, there are still several unresolved matters.

• Companies are struggling with how to reduce the possibility of ‘triple taxation’ that results from the combination of primary, secondary, and VAT from transfer pricing adjustments. Unquestionably, the over-taxation risk is severe, requiring strong transfer pricing documentation and calculated steps to avoid, and settle, future disputes.

• To mitigate the application of a secondary adjustment, PMK-172 establishes the process of repatriation or a cash refund. Nevertheless, the rule does not provide any additional information about this repatriation. It is unclear if this solely applies to local transactions or to cross-border related-party transactions, and if repatriation is considered at the compliance monitoring stage, as well as during a tax audit.

• Primary adjustments that are started by the DGT through audits are meant to be covered by the matching adjustment provision in PMK-172. However, PMK-172 does not go into greater detail as to how the corresponding adjustment operates if the taxpayer chooses to make the primary adjustment voluntarily during the compliance monitoring phase. For taxpayers, this could lead to legal confusion in the absence of additional legislation.

• The ALP covers transactions affected by related parties in PMK-172 . It is important to remember that transactions affected by related parties consist of two categories: affiliated transactions and independent parties’ transactions in which the price and counterpart have already been determined by related parties or might be stated as a ‘deemed-affiliated transaction’. Consequently, compared with affiliated transactions, a wider range of transactions are impacted and required to implement the ALP. However, the transfer pricing documentation provisions only apply for taxpayers engaging in affiliated transactions. Consequently, businesses will have uncertainty when the DGT examines compliance with the ALP for independent transactions influenced by related parties. Meanwhile, no documentation to prove the application of the ALP is obliged by PMK-172 for deemed-affiliated transactions.

• Finally, while PMK-172 outlines administrative procedures to avoid secondary adjustments, the use of deemed dividends for all types of transfer pricing adjustments, without considering the cause of the related party, poses a risk of double taxation for taxpayers in cross-border transactions. There is a double taxation risk when withholding tax on the deemed dividend is not creditable in the counterparty’s country because the counterpart’s taxation regime does not acknowledge the deemed dividend approach as a secondary adjustment.

With the release of PMK-172, numerous transfer pricing concerns that were left unresolved by the previous regulations have been properly clarified. As mentioned in the regulation's preamble, this move is advantageous to taxpayers, particularly in terms of establishing legal certainty. Nonetheless, there are several ambiguities that still require clarification and should be addressed in the implementing regulation. As a result, taxpayers need to plan for the legislation's diverse effects and reduce their potential exposure from the very beginning.

It should also be noted that the DGT is working on a Core Tax Administration System that could include the administration of related-party transactions. Affected parties that conduct related-party transactions must properly identify, and mitigate, any potential issues.