The existence of multinational enterprises (MNEs) and increasing globalisation have led to the development of transfer pricing, which consists of the establishment of prices for products and services among related entities within a single multinational corporation. However, these intragroup prices may not align with those that would have been agreed upon by independent parties, which could result in profit shifting and tax avoidance schemes.
As a result, the arm's-length principle has become a widely accepted concept in the field of transfer pricing. Its objective is to establish transfer prices that are consistent with the prices charged by independent parties in analogous transactions and conditions, as determined by market forces. Nevertheless, the intricate procedures, methods, and approaches that are typically involved in such implementation often result in disputes between tax authorities and taxpayers.
Indonesia is a market that MNEs find appealing due to its significant demographic potential and purchasing power, which make it one of the largest economies in Asia. As a result, the Indonesian Directorate General of Taxes (DGT) has implemented policies to safeguard the country's tax base in response to ambitious tax revenue targets. For instance, it has revolutionised Indonesia's transfer pricing environment to improve transparency, fortify enforcement measures, and comply with international best practices. Nevertheless, this has also introduced new complexities and challenges for MNEs that operate in Indonesia.
This article examines the evolving landscape and recent trends in Indonesia's transfer pricing controversy. It focuses on:
An increasing reliance on data and technology;
Recent developments in transfer pricing litigation cases;
The resolution mechanism for transfer pricing disputes; and
The mitigation strategies that MNEs implement to reduce transfer pricing risks.
The application of the DGT's data arsenal in TP audits
The decision-making process is becoming increasingly reliant on data. Consequently, the DGT has publicly declared its intention to implement big data analytics in the evaluation of transfer pricing. This transition to a data-driven approach represents a new era in transfer pricing audits, enabling the DGT to conduct more focused, efficient, and insightful analyses of related-party transactions.
In recent years, the DGT has significantly increased its data arsenal by using a variety of large-scale sources, such as the following:
Filings by taxpayers –valuable intercompany transaction details, financial performance results, and global operations are contained in any information provided by taxpayers to the DGT. These include corporate income tax returns, withholding tax returns, VAT returns, tax invoices, and country-by-country reports.
Commercial financial databases – the DGT has access to domestic and international financial databases, which enables the accumulation of market data, industry benchmarks, and financials of comparable companies. Consequently, the DGT can enhance its comprehension of the arm's-length character of intercompany transactions.
Data from a third party – the DGT has also added third-party data such as customs and mining royalty payment data to keep an eye on the flow of goods or services between related parties. The data can also be used to identify any transfer pricing risks that might be linked to commodity or import-export deals, and make sure that prices are fairly determined.
Information that is open to the public – this includes company websites, industry reports, and economic indicators that are available to the public. The information is useful for learning more about how MNEs do business, the types of industries they work in, and the overall state of the economy.
From the above, it can be understood that the DGT can identify and implement a more focused approach to intercompany transactions that have a high potential for profit shifting and tax avoidance by utilising its data arsenal. The DGT's capacity to evaluate the arm's-length character of related-party transactions and the appropriateness of transfer pricing practices employed by MNEs in Indonesia has been substantially enhanced by this data-driven approach.
Similarly, the DGT has implemented several critical initiatives to implement its data-centric approach to transfer pricing assessment, as follows:
Compliance risk management (CRM) for transfer pricing – one of the fundamental components of the DGT's data strategy is the CRM system that was implemented in 2021. Using big data analytics, this system generates a comprehensive heatmap that encompasses transfer pricing compliance and identifies taxpayers that are considered high risk. The DGT may allocate audit resources to areas that are more susceptible to transfer pricing non-compliance, based on historical data, industry developments, and taxpayer profiles.
Smartweb – along with CRM, the Smartweb platform was released, which gives the DGT even more power to keep an eye on transfer prices. The platform lets connected networks of affiliated taxpayers be made. This makes it easier to track the flow of transactions within these networks and set up structures for possible profit shifting and an overall review of the transfer pricing risk for MNE groups.
The integrated risk engine – the integrated risk engine represents a significant advancement in the DGT's data analysis capabilities. It integrates the current CRM functionality in relation to transfer pricing with a variety of other risk assessment tools. The DGT will be able to target specific areas during transfer pricing audits by obtaining an overall picture of taxpayer conformance through the implementation of a holistic approach.
Discrepancies and irregularities in the process of comparing and evaluating data – the utilisation of big data analytics improves the dependability of comparability analyses. The DGT has the capability to access and analyse vast databases, enabling more precise benchmarking. Simultaneously, it aids in detecting inconsistencies and abnormalities in taxpayers' data, such as significant disparities in profit margins, unusual cost patterns, or deviations from industry standards. This could indicate a potential issue that requires further examination and perhaps a necessary adjustment to a transfer price.
An overview of Indonesia's tax dispute settlement process
There are two alternative channels for resolving transfer pricing disputes provided under Indonesian tax legislation.
Litigation – tax dispute settlement under this channel includes (i) raising a tax objection with the DGT, (ii) making a tax appeal to the Tax Court, and (iii) conducting a civil review before the Indonesian Supreme Court. A taxpayer may file an objection request if it disagrees with an audit's finding under the tax assessment letters. The DGT shall issue its decision no later than 12 months after the objection application is received. If the taxpayer is still not satisfied with the objection decision, it has the option to take the matter to the next level by submitting an appeal to the Tax Court. Furthermore, the taxpayer and the DGT may ask the Supreme Court for a judicial review if they still disagree with the Tax Court's verdict. The decision made by the Supreme Court is final and binding for both parties.
Non-litigation – settlement under this channel can be in the form of a mutual agreement procedure (MAP) or an advance pricing arrangement (APA).
The regulation allows the taxpayer to take both channels to resolve their tax cases.
Analysing the patterns: observations from recent TP controversy cases
Recent transfer pricing cases in Indonesia reveal some notable trends.
Increased focus on comparability
The arm's-length principle relies heavily on comparability analysis. As a result, it is not surprising that this sector is frequently contested in any transfer pricing dispute. The issues that need to be addressed include:
The characterisation of entities, such as Tax Court case No. Put-107945.15/2013/PP/M.IIIA of 2018;
The selection of the tested party, as seen in Tax Court case No. Put-009743.15/2020/PP/M.XVIIIA of 2022;
The use of a loss-making comparable, as demonstrated in Tax Court case No. Put-009743.15/2020/PP/M.XVIIIA of 2022; and
The choice between using multiple- versus single-year data and the presence of material differences as a basis for rejecting comparable companies, as shown in Tax Court case No. Put-007299.15/2021/PP/M.IB of 2023.
These instances illustrate that the DGT has prioritised conducting comprehensive comparability evaluations and requiring compelling justifications for taxpayers' transfer pricing schemes.
Furthermore, a dispute has arisen concerning the utilisation of the ex ante or price-setting methodology, resulting in significant contention. Although there have been regulations in place since 2016, there is a lack of practical instructions on how to implement this strategy, resulting in an ongoing dispute, as evidenced by the Tax Court cases No. Put-002626.15/2021/PP/M.XIVA of 2023 and No. Put-009269.15/2020/PP/M.VIIIA of 2023. The comprehensive documentation provided by taxpayers, which encompasses data availability and methodology, can be used as a basis for employing the ex ante strategy, as evidenced by prior decisions in the Tax Court.
Selection of a TP method
The selection of the most appropriate transfer pricing method is a highly debated element in most transfer pricing disputes. A dispute frequently arises between traditional methods and transactional profit approaches, such as the transactional net margin method (TNMM).
Several Indonesian Tax Court cases, such as No. Put-007756.15/2020/PP/ M.XIVB of 2022 and No. Put-009697.15/2021/PP/M.VA of 2023, clearly demonstrate contrasting perspectives that prioritise certain methods. In the first case, the taxpayer opted for the cost-plus method, while the tax administration suggested the TNMM method. In the second case, the taxpayer chose the comparable uncontrolled price method, while the tax administration again suggested the TNMM method.
These instances exemplify the complexities involved in choosing and implementing a transfer pricing method.
Intragroup services, royalty payments, and intercompany loans
The DGT has prioritised intragroup services, royalties paid to related parties, and intercompany financing arrangements.
The existence and economic benefit of intercompany transactions are the primary topics of dispute in this context, with the DGT contesting the deductibility of these expenditures. For instance, recent Indonesian Tax Court cases No. Put-006890.15/2021/PP/M.XIIIB of 2023, No. Put-010827.15/2021/PP/M.XXA of 2022, and No. Put-003556.15/2020/ PP/M.VA of 2021 underscore the significance of comprehensive documentation to substantiate the existence and benefits of intragroup charges. The Tax Court appears to believe that taxpayers are susceptible to transfer pricing adjustments by tax authorities and the imposition of penalties in the absence of evidence that demonstrates the economic substance and arm's-length nature of such transactions.
Financial transactions are another critical area for transfer pricing disputes. The DGT typically evaluates the substance of these transactions, specifically whether they are genuine loans or if they function as capital injections. Additionally, disputes frequently arise with regard to determining the arm's-length interest rate for intercompany loans. These challenges are exemplified by cases No. Put-013490.15/2020/PP/M.XIIB of 2022 and No. Put-001021.15/2021/PP/M.XIVB of 2022, which respectively address issues related to financial transaction classification and the determination of arm's-length interest rate ranges.
Disputes on secondary adjustment
Indonesia implements the deemed dividend methodology for secondary transfer pricing adjustments. Consequently, the escalation in primary adjustment disputes within transfer pricing cases is directly correlated with the disputes over the deemed dividends as secondary adjustments. The secondary adjustment is a direct consequence of the transfer pricing adjustments. According to the Tax Court cases No. Put-001022.15/2021/PP/M.XIVB of 2022 and No. Put-010303.35/2020/PP/M.VIIIB of 2022, the secondary adjustment decisions were determined by the outcomes of the primary adjustment disputes.
Riding the crest of TP uncertainties
The most effective approach to mitigate the risk of excessive taxation is to decrease the probability of transfer pricing adjustments. This can be accomplished by the following measures:
Implementing a proactive strategy for transfer pricing compliance – MNEs are no longer able to employ a reactive approach to transfer pricing compliance. In a timely manner, they must guarantee that all intragroup transactions are fully documented and adhere to the arm’s-length principle, and they must also prepare for more rigorous scrutiny.
Enhancing transfer pricing risk management strategies – to manage these risks effectively, MNEs must proactively identify their own transfer pricing risks by understanding the transfer pricing risk variable, conducting an extensive impact analysis of each factor on the group's transfer pricing risk profile, and strategically allocating resources.
Operational transfer pricing (OTP) implementation – strategic OTP initiatives enhance compliance and efficiency within MNE organisations. By automating processes and streamlining data transfers, OTP promotes alignment among tax, finance, and IT functions by integrating existing ERP systems. This integration enhances financial reporting accuracy and reduces compliance costs, particularly for organisations with manual processes and fragmented systems. Due to incomplete data and a lack of transparency, multinationals are at a higher risk of costly transfer pricing audits and potential double taxation because of the failure to implement robust OTP systems.
Proactive engagement with tax authorities through APAs – early engagement with the DGT using an APA may assist in the management of risks associated with transfer pricing, thereby eliminating the possibly of a dispute entirely. These agreements offer both parties involved certainty, thereby preventing a potential dispute. In Indonesia, an APA can be unilateral, bilateral, or multilateral. These agreements pertain to agreements between an Indonesian taxpayer and one or more tax authorities in accordance with the provisions of a relevant tax treaty. An APA can reduce the risk of transfer pricing disputes and increase certainty by encompassing multiple years.
Potential developments in TP dispute resolution in Indonesia
Significant progress has been achieved in the resolution of transfer pricing disputes in Indonesia, particularly through the implementation of MAPs and APAs. These methods have been instrumental in the resolution of complex global tax issues and the promotion of equity and fairness in tax practices.
The utilisation of APAs in Indonesia has shown a positive trend. Indonesia received 149 APA submissions from 2016 to 2024, and 99 of these applications were successfully completed, according to data from the Directorate of International Taxation presented at the International Fiscal Association (IFA) Lecture in March 2024. Forty-five per cent result in agreement, in conjunction with a formal rejection and disagreement rate of 8% and 28%, respectively, and 19% completed by taxpayers’ withdrawal. It indicates a high level of engagement and a relatively successful resolution rate. The average completion time of an APA is approximately 34.9 months, which is indicative of the successful collaboration between tax authorities and taxpayers.
For cases that are not addressed by APAs, alternative dispute resolution can be pursued through a MAP. The MAP is an alternative mechanism in international tax agreements that addresses a variety of issues related to the resolution of double taxation, including transfer pricing. Indonesia resolved 185 cases out of 231 MAP application during the above period, according to a comparable report presented during the same IFA lecture. In 43 cases, double taxation was eliminated, while 26 cases were partially resolved. Although substantial, the average time required to resolve a MAP case is approximately 31.78 months, which underscores Indonesia's dedication to the efficient and effective resolution of disputes. The DGT is proactively implementing transparency and enhancing MAP processes in accordance with international best practices.
Although these trends are encouraging, there are still obstacles to overcome. The prolonged resolution periods that are encountered in APA and MAP cases do not align with the aim to have timely resolution of disputes. Nevertheless, the trends are indicating a positive trajectory.
In addition to its efforts to streamline processes and promote transparency, the DGT has demonstrated its strong commitment to resolving transfer pricing disputes efficiently and fairly by increasing the utilisation of APAs and MAPs. These mechanisms offer increased certainty, which is advantageous to the government and all taxpayers.
