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Vol. 3, No. 1, Oktober 2008

Hal 13 – 44



Kristian Agung Prasetyo∗

GradCertTax, PGradDipCom, MTax

Bambang Widjajarso∗∗


The twenty first century has witnessed an ever increasing rate of international trade as
a result of globalisation and especially, the development of advanced information tech-
nologies. As a result, transfer pricing policy plays a significant role, particularly in many
multinational enterprises (MNEs). The term transfer pricing itself refers to the pricing
policies in relation to goods or services exchanged between related business units.
As part of their domestic anti-avoidance provisions, most revenue authorities have
transfer pricing regulations in place to prevent the price manipulation and profit
shifting to avoid taxation. The Organisation for Economic Co-operation and
Development (OECD) has been involved in setting out guidelines and principles in
addressing transfer pricing issues, which have been adopted widely.
Like other countries, Indonesia is also faced with the ever increasing rate of global
trade. However – unlike others – the Indonesian taxation authority does not seem to
have adequate provisions to tackle international transfer pricing abuse. Even though
the principles of related-party transactions regulations are set out in the income tax
legislation (currently being amended), they are broad and simple in nature and are not
accompanied by detailed and up-to-date guidelines for taxpayers and its field auditors.
This fact seems peculiar as companies are taxed progressively with the highest marginal
rate of 30% (it has been proposed that it will be changed into a flat rate of 30%). In

The author is a tax practitioner in Jakarta. He received a scholarship to study at a postgraduate level in
Australia, where he earned his graduate certificate, postgraduate diploma, and master specialising in
taxation law.
The author is a lecturer in Public Finance for the Sekolah Tinggi Akuntansi Negara. Other publications
included textbooks of “Public Finance”, “Government Finance Statistics” and “Governmental
Accounting: Theory and Practice”; all published by the Institute for Public Finance and Governmental

JAP Vol.3, No.1, Oktober 2008

relation to this, concerns regarding the lack of transfer pricing guidelines have been
raised by members of parliament involved in the amendment process.
This paper is intended to show that transfer pricing has become an important issue
worldwide and it is likely that it will stay that way. Consequently, it is crucial for
Indonesia to have strong transfer pricing regulations, especially as the Indonesian
taxation authority is responsible for more than 70% of total government expenditure.
The OECD transfer pricing guidelines will be used as a point of reference along with its
application in Australia. In the end, it is expected that this paper will:
1. Show the importance of international transfer pricing and present some basic
principles necessary to address its abuse;
2. Demonstrate that the Indonesian taxation authority does not have an adequate
arsenal to deal with transfer pricing issues. Some possible suggestions will also
be presented based on the OECD guidelines and Australia’s experience.

Transfer Pricing Regulations in Indonesia:
Some Thoughts for Reform

I INTRODUCTION The revolution of information technology

has enabled multinational enterprises
(MNEs) to allocate their resources across
The avoidance of taxes is the only
nations easily. This phenomenon can be
intellectual pursuit that still carries any
identified by the presence of MNEs
worldwide to maximise their profit. This
– John Maynard Keynes – includes the tax minimisation motive, even
though it certainly is not the only reason.
The twenty-first century has witnessed
The allocation of more profits to countries
an ever-increasing rate of international
with lower tax rates can result in the
trade as a result of globalisation. Stiglitz
minimisation of the worldwide tax payable
defines globalisation as:
and in turn, may lead to a higher net
the closer integration of the countries profit. This practice is widely known as
and peoples of the world which has transfer pricing, although that term actually
been brought about by the enormous is neutral in nature. 4 Obviously, tax
reduction of costs of transportation systems have also taken advantage of this
and communication, and the breaking technological revolution. A noticeable
down of the artificial barriers to the example is the use of internet technology
flows of goods, services, capital, in tax return lodgement by taxpayers as
knowledge, and (to lesser extent) applied in Australia, Canada, the USA,
people across borders.1 the Netherlands and – to some extent –
in Indonesia.5
As part of economic decision-making,
taxation is also affected by the globali-
sation.2 Simon James argues that techno- A. The Importance of Transfer
logical changes play an important role in Pricing
shaping the future global tax environ-
ment. 3 The most important event asso-
The history of transfer pricing provisions
ciated with globalisation is the rapid
can be traced back to the World War I.
development of the internet and the
As the war needed money, higher taxes
World Wide Web. This phenomenon has
and tighter regulations to discourage
led to the birth of electronic commerce
companies from entering into tax avoidance
that enables goods and services to be
schemes by diverting profits away from
exchanged across borders almost instantly,
high-tax countries are required. 6
especially when the contents can be
Following the economic contraction in
digitised, like music, films, and services.
the 1930s, many developed nations came
In addition, electronic commerce may
to understand that they might have
cause problems as the flow of funds
problems in preserving their tax base
cannot easily be traced.

Jill C Pagan and J Scott Wilkie, Transfer
Joseph Stiglitz, Globalization and Its Pricing Strategy in Global Economy (1993).
Discontents (2002). Liane Turner and Christina Apelt,
Taxation is affected by a number of factors 'Globalisation, Innovation, and Information
including social, economic, and political Sharing in Tax System: The Australian
aspects. Experience of the Diffusion and Adoption of
Simon James, 'The Future of International Tax Electronic Lodgement' in Rodney Fisher and
Environment' in Andrew Latymer and John Michael Walpole (eds), Global Challanges in
Hasseldine (eds), The International Taxation Tax Administration (2005) 221.
System (2002) 105. Pagan and Wilkie, above n 4, 17.

JAP Vol.3, No.1, Oktober 2008

due to the rapid development of As a result, the overall net profit of the
communication technologies in the 1970s. MNE could be increased.
They responded by fine tuning their
In today’s context, transfer pricing plays
expertise in transfer pricing and attacking
an increasingly important role. The need
the use of tax havens using controlled
to address the income allocation between
foreign corporation provisions.7
countries for tax purposes cannot be
Before the advent of globalisation and neglected as more tax jurisdictions are
the advancement of communication trying to have a ‘reasonable’ proportion
technologies, most companies were of an MNE’s taxable income. Many
restrictted to certain jurisdictions, taking governments address this problem by
advantage of specialisation and geogra- using a formal approach to legislate for
phical benefits. The reason is simple: they transfer pricing provisions. 10 It indicates
had more understanding of local markets. that revenue authorities regard transfer
Later, they realised that they failed to take pricing important and consider it potential
advantage of economies of scale and to increase tax-based revenue.
suffered losses due to duplication of
The significance of transfer pricing be-
resources. To be efficient, an MNE must
comes more evident by looking at the
consider centralising certain functions of
fact that 60% of the world trade takes
their business such as research and
place within MNEs. 11 Additionally, a
development, financial management, and
study of the taxable income of several
marketing. Also, they must be ready to
companies in the USA point out that the
set up the manufacturing functions in
taxable income of foreign-controlled
any place that offers cost-efficiency or an
companies operating in the USA is
abundant, well-trained labour.8
generally lower compared to those of the
When the choice of location involves USA-controlled companies. This indicates
different tax jurisdictions, the transfer that there are reasons to believe that the
pricing process comes into play. If a profits are shifted out of the USA, perhaps
company has branches and subsidiaries through transfer pricing arrangements.12
across countries, the transfer pricing process
does not only concern internal matters,
but also involves other parties as well. A
business unit that has facilities located in 10
The countries that have recently put transfer
different tax jurisdictions has to take into pricing regulatory and administrative rules in
account various aspects to arrive at the place include Malaysia, Thailand, Taiwan,
liability of tax that has to be paid in each and India. Other countries like the USA and
jurisdiction. 9 Therefore, there may be a Canada tighten their transfer pricing
motive to minimise the net profits of the regulations by issuing newer technical
business units located in high-tax juris- guidelines or imposing more audits. For
further information, see Ernst and Young
diction by shifting their profits elsewhere.
Global Transfer Pricing Survey available for
download at
John Neighbour, Transfer Pricing: Keeping it
at Arm's Length (2002) OECD Observer
Ibid 17. <http://www.oecdobserver.org/news/printpag
Ibid 25. e.php/aid/670/Transfer_pricing:_Keeping_it_at
Jamie Elliott and Clive Emmanuel, _arms_length.html> at 4 January 2006.
'International Transfer Pricing' in Andrew Willi Leibfritz, John Thornton and Alexandra
Latymer and John Hasseldine (eds), The Bibbee, Taxation and Economic Performance
International Taxation System (2002) 157. (1997).

Transfer Pricing Regulations in Indonesia:
Some Thoughts for Reform

The Ernst and Young 2005 global transfer two years. The percentage figure rises
pricing survey reveals several findings: 13 significantly compared to the 2001 survey
results which reveals that transfer pricing
1. More than 90% of the respondents
is considered important by only 36% of
consider transfer pricing an important
the respondents. The 2003 survey also
indicates that the risk of a transfer pricing
2. Approximately 31% of the respon-
adjustment audit, the potential penalties,
dents believe that transfer pricing
and possible double taxation, needed to
will be absolutely critical over the
be managed in the overall company’s
next two years.
risk management strategies.16
3. More than 60% of the respondents
have undergone transfer pricing The overall transfer pricing goal of an
audits in the last three years and MNE is beyond tax minimisation per se.
40% resulted in tax adjustments. Abdallah reports that at least a transfer
4. More than 80% of the respondents pricing policy serves a range of objectives,
plan to devote more efforts for namely reducing the worldwide income
transfer pricing issues in 2006. tax burden, reducing tariffs, minimisation
5. More than half of the respondents set of foreign exchange risks, and avoiding
aside a provision for transfer pricing potential conflicts with host govern-
risks in their financial statements. ments. 17 As a consequence, transfer
6. More than 80% of the respondents pricing decisions are subject to various
believe that their transfer pricing internal and external factors that may
policies have a high probability have competing objectives. Choi and
(more than 60%) of being challenged Mueller identified four factors that may
by tax authorities within two years. be responsible for the difficulties asso-
ciated with a transfer pricing decision: 18
Similar facts can be found in the 1995
and 2000 survey.14 This is also consistent 1. It occurs in a large scale environ-
with the 2003 survey that shows that ment at an international level.
most Australian outbound companies 15 2. It is affected by various factors.
(76%) believed that transfer pricing is 3. It varies from companies, indus-
one of the most important tax issues that tries, and countries.
they may face over the period of the next 4. It affects social, economic, and
political relationship aspects.
In relation to Indonesia, the significance
of transfer pricing is apparent. In the
The latest survey was conducted in May and
2006 fiscal year, the Directorate General
June 2005 involving 108 financial institutions
in a wide range of countries including of Taxes (DGT) – the Indonesian taxation
Australia, Canada, Continental Europe, Hong authority – is responsible for more than
Kong, Japan, Singapore, South Africa, United 75% of the total Indonesian Government
Kingdom and the USA. The reports are revenue. It represents a figure of
available for download at Rp402.1 trillion (13.4% of the GDP).
www.ey.com/transferpricingsurvey. This is a continuing increase from 11.3%
Marika Toumi, 'Anti-Avoidance and Harmful
Tax Competition: From Unilateral to
Multilateral Strategies?' in Andrew Latymer
and John Hasseldine (eds), The International David Lewis and Diane Lane, 'Transfer
Taxation System (2002) 83. Pricing: Recent Practices, Perceptions, and
An outbound company refers to an Trends' (2004) 7(5) The Tax Specialist 249.
Australian-controlled company that operates Elliott and Emmanuel, above n 9, 162.
overseas. Ibid 161.

JAP Vol.3, No.1, Oktober 2008

in 2003, 11.6% in 2004, and 12.6% for Amendments of the House of

the last year’s figure.19 Representatives – stated that a number of
foreign-owned companies from at least
In spite of this, the DGT does not seem
five countries – including South Korea,
to have adequate provisions to tackle
the USA, Japan, Australia, and some
international transfer pricing abuse. Even
European countries – have been involved
though the principles of related-party
in transfer pricing abuse. He added that
transactions regulations are set out in the
the problem lied in the fact that there
income tax legislation (currently being
were no comprehensive technical guide-
amended), they are broad and simple in
lines regarding the accounting and
nature and are not accompanied by
auditing procedures on transfer pricing
detailed and up-to-date guidelines for
taxpayers and its field auditors. This fact
seems peculiar as companies are taxed The transfer pricing regulations in
progressively with the highest marginal Indonesia were first introduced in the
rate of 30%, one of the higher rates in 1983 income tax legislation as part of
Asia (it has been proposed that it will be the general anti-avoidance provisions.
changed into a flat rate of 30%). Last amended in 2000 and beginning its
However, the effective rate in reality is implementation in 1 January 2001, the
higher. The World Bank states that current income tax legislation sets out
Indonesia has an effective tax rate of the transfer pricing provisions in Article
38.8% of profits and ranks 19th out of 25 18(3) of the Law Number 17 of 2000 on
countries.20 Income Taxation. 23 In essence, this
article provides that the Director General
As noted earlier, tax minimisation is one
of Taxes is authorised to reallocate
aspect of MNEs overall profit maximisation
income or expenses to assure that the
efforts. As a result, an inadequate anti-
transactions between related parties
avoidance provision could be exploited.
resemble those of between independent
In relation to this, the Indonesian Finance
parties. The methods for reallocating
Minister in November 2005 claimed that
income and expenses include the use of
there were approximately 750 loss-making
comparable data, profit allocation based
foreign companies that had evaded taxes,
on function or participation of related
possibly through the use of transfer
taxpayer, and other methods.
pricing arrangements. 21 Furthermore,
Dradjad H Wibowo – a member of the The operation of Article 18(3) of the Law
Special Committee on Taxation Legislation Number 17 of 2000 on Income Taxation
is explained further by a brief circular
letter number SE-04/PJ.7/1993 which
seems to refer to the 1979 OECD transfer
Nota Keuangan dan Rancangan Anggaran pricing guidelines. 24 In addition,
Pendapatan dan Belanja Negara Tahun
Anggaran 2006 (2005)
NK%20RAPBN%202006.pdf> at 14 March 'PMA Nakal Harus Dikenai Sanksi Pidana
2006. Penghindaran Pajak Melalui Pola Pengalihan
The Economist Intelligence Unit Ltd., Keuntungan', Kompas (Jakarta), 28 November
Indonesia Risk: Tax Policy Risk (2006) Dow 2005.
Jones Reuters Business Interactive LLC Law Number 17 of 2000
<http://global.factiva.com.dbgw.lis.curtin.edu. Gunadi, 'Mampukah ASW Atasi Transfer
au/ha/default.aspx> at 27 March 2006. Pricing?' Bisnis Indonesia (Jakarta), 30 January
Ibid. 2006.

Transfer Pricing Regulations in Indonesia:
Some Thoughts for Reform

commencing from 1 January 2002, tax- B. The OECD Transfer Pricing

payers have been required to attach a Guidelines
statement related to their related party
transactions in their tax returns. The In the 1970s, the OECD published three
information to be disclosed includes the reports regarding transfer pricing. 29 The
type and value of the transactions, the first document – ‘Transfer Pricing and
transfer price, and the methodology that Multinational Enterprises’ – was published
has been used to determine the transfer in 1979. This report outlined the arm’s
price. 25 There is also a provision in length principle and the economic
Article 18(3a) regarding the Advance analysis underlying that concept. After
Pricing Agreements (APA). This article being approved by the Committee on
authorises the Director General of Taxes Fiscal Affairs, it was published in 1995
to conclude an APA unilaterally – as ‘Transfer Pricing Guidelines for
between a taxpayer and the DGT – or Multinational Enterprises and Tax Admi-
multilaterally, where the APA is nistrations’ (hereinafter the Guidelines),
concluded with a competent authority of which is based on the arm’s length
a treaty country concerning the taxpayers principle. Other reports discussed spe-
of that country.26 cific issues within transfer pricing. These
However, the only technical guideline reports – ‘Transfer Pricing and Multinational
for transfer pricing provisions is the Enterprises - Three Taxation Issues’ and
aforementioned circular letter, which is ‘Thin Capitalization’ – were published
unfortunately old and predates the current respectively in 1984 and 1987.
legislation. As a result, there are many The Guidelines are ‘intended to help tax
‘grey areas’ that maybe subject to administrations … and MNEs by indicating
multiple interpretations. For example, ways to find satisfactory solutions to
taxpayers are likely to face considerable transfer pricing cases, thereby minimizing
difficulties in fulfilling the disclosure conflict among tax administrations and
requirements, especially with regard to between tax administrations and MNEs
the transfer pricing methodologies applied and avoiding costly litigation’. 30
in each of the related-party transaction.27 According to Neighbour, it can be said
Moreover, there are no detailed proce- that the purpose of the Guidelines is to
dures to be used to settle a transfer ‘help corporations to avoid double taxation’
pricing conflict between taxpayers and and to ‘help tax administrations to receive
the DGT.28 a fair share of the tax base of
multinational enterprises’. 31 As a result,
the Guidelines can be regarded as an
international standard in transfer pricing
that the OECD members have agreed to
be used.
Ernst and Young, Transfer Pricing Global
Reference Guide (2005) Ernst and Young
at 27 March 2006.
Above n. 23.
PricewaterhouseCoopers, Indonesian Tax
Flash (2003) PricewaterhouseCoopers OECD, Transfer Pricing Guidelines for
<www.pwc.com/id> at 27 March 2006. Multinational Enterprises and Tax
Darussalam and Danny Septriadi, 'Upaya Administration (2001).
Menangkal Praktik Penghindaran Pajak', Ibid.
Bisnis Indonesia (Jakarta), 12 December 2005. 31
Neighbour, above n 11.

JAP Vol.3, No.1, Oktober 2008

II THE PRINCIPLES OF TRANSFER overpriced, the profit of the buyer in the

PRICING group is reduced but the profit of the
seller is increased (at the expense of the
A. Transfer Pricing Defined buyer). Nonetheless, the overall group
Elliott and Emmanuel define transfer profit is not affected because what
pricing as ‘the pricing policies and happens is only a profit shift between
practices that are established when members within that group.
physical goods, intangible property, and
services are charged between business B. Transfer Pricing Channels
units within a group’. 32 As has been
noted, a transfer price itself is actually a
neutral concept. The Guidelines itself
defines transfer prices as ‘the prices at
which an enterprises transfers physical
goods and intangible property or
provides services to associated enter-
prises’. 33 Therefore, a transfer price is
agreed between two business units and
the structures are governed by commercial
considerations34. A transfer price has to
be able to motivate and guide managers Figure 1 Payment channels within an MNE.
in choosing their inputs and outputs. 35 Source: Plasschaert (1979)
As a result, it plays many important roles
ranging from securing competitive
advantage for a new subsidiary to Plasschaert modifies the model presented
managing foreign currency fluctuations.36 by Robbins and Stobaugh to describe the
various channels in which money can
A transfer pricing policy does not flow within an MNE (figure 1).38 Channel 1
necessarily mean a tax fraud or a tax represents the payment of goods or
avoidance scheme, even though it can services which is often regarded as the
be used for such purposes. However, main financial flow as a result of a real
this term often has negative meaning commodity transfer. Channels 2 and 3
because it induces the idea of a describe the payments related with the
systematic price manipulation to reduce investment from the parent company. In
profits artificially, create losses, and essence, they consist of the initial invest-
avoid taxes or duties.37As explained, the ments in the form of trade credits (channel
overall goal of such scheme is to achieve 2) and equity contributions (channel 3)
the maximisation of after-tax profits by and then the subsequent dividend
minimising worldwide tax payable. If payments from the subsidiary (channel 4).
goods, services or intangibles are Nevertheless – as dividends are paid from
after-tax profits and therefore are not
deductible – most companies tend to
finance their subsidiaries using debts
Elliott and Emmanuel, above n 9, 158.
OECD, above n. 29.
Pagan and Wilkie, above n. 4, 15.
35 38
Ahmed Riahi-Belkaoui, Significant Current Sylvain R.F. Plasschaert, Transfer Pricing and
Issues in International Taxation (1998). Multinational Corporations: an Overview of
Elliott and Emmanuel, above n 9, 172. Concepts, Mechanisms, and Regulations
Riahi-Belkaoui, above n 35, 96. (1979).

Transfer Pricing Regulations in Indonesia:
Some Thoughts for Reform

which are more flexible. 39 These are rights to use industrial assets such as
depicted in channel 5 (loans) and 6 patents, trademarks, trade names, designs
(interests on loans). Lastly, channels 7 to 9 or models. 42 The main concern is its
portray costs incurred in the parent deductibility. In addition, it also has to
company that are charged to the be determined that the payments are for
subsidiaries. They represent fees for the use of the property and that they
intangible properties (channel 7), fees for correspond to its real value.
specific and divisible services (channel 8),
The problem in applying the arm’s
and overhead costs (channel 9). They are
length standard is the availability of
often unique in nature and hence, it can
comparables. Furthermore, this is
be difficult to find comparable transactions.
exacerbated by the related developments
As a result, it is usually hard for tax
in e-commerce where an increasing
authorities to prevent transfer-pricing abuses
amount of value is both specialised and
for such payments. A more in-depth
intangible. In this situation, an industry
discussion on these specific channels
standard can be used. Adjustments can
(channel 7 to 9) will be covered in the
be made in respect of:
next sections.
1. The prevailing industry rates.
This model also reveals the possibility
2. The license terms.
for a parent company to repatriate profits
3. The characteristics of the property.
through the various channels. For example,
4. The availability of supplementary
rather than paying profits in the form of
assistance, rights, and information.
dividends, a subsidiary may prefer to use
5. Any profit potential for the licensee.
excessive payments for the transfer of
6. The benefits for the licensor.43
goods and services transferred by the
parent company, provided that the tax From the transferor’s view, it has to be
treatment is more favourable in the parent examined at what price a comparable
company’s host country. This abuse is independent party is willing to transfer a
continuously being challenged using similar property in a similar situation.
transfer pricing provisions, which are From the transferee’s point of view, an
mainly based on the arm’s length independent entity may or may not be
principle.40 willing to pay for the transfer. It depends
on whether the intangibles would have
C. Intangible Property the sufficient value or usefulness for the
transferee’s business.44
The payment for intangible property
(channel 7) usually manifests in the form D. Intra-Group Services
of royalty for the use of information,
expertise, and know-how. 41 It includes As noted, the main reason behind the
choice to be an MNE is to achieve
synergistic effects. Therefore, it is common
that some functions within an MNE are
centralised to take advantage the
Even though using loans to finance a
subsidiary seems advantageous, it may attract
economies of scale and then the parent
the operation of thin capitalisation rules if it is
used excessively.
There are some countries — Brazil for
instance — that do not rely on the arm’s OECD, above n 29.
length principle. Pagan and Wilkie, above n 4, 115.
41 44
Pagan and Wilkie, above n 4, 115. OECD, above n 29.

JAP Vol.3, No.1, Oktober 2008

company charges the subsidiaries for recognised that a service has been
services provided centrally by the parent rendered, it is necessary to examine
company. There are two main issues that whether independent entities in similar
have to be taken into account. Firstly, situations would agree to such arrange-
determining whether such services are ments so that they can be constituted as
actually provided and secondly, deter- arm’s length. 47 In this case, there are
mining the arm’s length charges.45 some aspects that need to be considered:
In the first instance, it has to be deter- 1. The basis for allocating expenses
mined whether such services have the has to be reviewed in a regular basis.
value to enhance the recipient company’s 2. The expenses have to in proportion
position. Sometimes, this can be easily with the benefits received by the
analysed, such as in a situation where chargee.
intra-group services are provided to meet 3. The review has to be able to be made
a specific need of a group member available to the tax authorities.48
(channel 8). One example would be in
cases where the parent company provides E. The Arm’s Length Principle49
maintenance and support for the manu-
facturing equipments of a group member.
One of the problems in setting a transfer
In other cases (channel 9), it is more
price is that there are various bases for
difficult. This is true in the case of what
determining an applicable transfer price.
the Guidelines refer as ‘shareholder
A transfer pricing policy may rely on the
activity’. This type of activity includes
internal accounting system (internal costs)
the costs relating to the juridical structure
or on market prices (external prices). The
of the parent company (e.g. parent
question arises as to which approach is
company’s shareholder meeting, super-
preferred and how to reconcile the internal
visory board costs, and share issuance in
requirements with those of tax authorities.
the parent company), costs relating to
In addition, there are also problems when
the reporting requirements of the parent
the business units within an MNE are
company, and costs of fund raising. They
located in different tax jurisdictions. This
are performed for the whole members
is because the tax base of one country may
even though some members may not
be increased at the expense of another.
need them. In this situation, a charge to
In this situation, an abusive transfer pricing
those recipient companies certainly cannot
occurs as income and expenses are
be justified. Moreover, a charge also
improperly allocated with the purpose of
cannot be justified if the recipient company
reducing taxable income. It is this shift
only receives incidental benefits. One
that is being challenged by many tax
example would be in event like group
authorities using various transfer pricing
reorganisation, acquisition of a new
provisions in their income tax legislation.
member, or a termination of a division.
However, any centralised-administrative
costs and some ‘on-call’ services would
be justifiable. 46 Once it has been
support – at any time because they would
have the staff or equipments always available
Ibid. for that purpose.
46 47
An on-call service is eligible if a parent OECD, above n 29.
company or a group service centre is on hand Pagan and Wilkie, above n 4, 113.
to provide certain services – such as This section draws heavily from the OECD
technical, legal, financial or managerial 1995 Transfer Pricing Guidelines.

Transfer Pricing Regulations in Indonesia:
Some Thoughts for Reform

The basis of these provisions is substituting being examined (e.g. price or margin)
the transfer price with a market value significantly. In addition, the effects of
between a willing seller and a willing those differences can be eliminated using
buyer that are unrelated to each other.50 accurate adjustments.54
The substituting price is commonly known
In establishing the degree of comparability
as the arm’s length price, which is a
and making adjustments, it is important
result of an arm’s length transaction: a
to compare the attributes of the transact-
transaction between parties each of
tions. These include:
whom acts in their best interest. 51 The
authoritative statement regarding the 1. Characteristics of property or services
arm’s length principle is set out in
Differences of characteristics of
Paragraph 1 of Article 9 of the OECD
property or services are often
Model Tax Convention.52 This paragraph
responsible for differences in their
states that if conditions between related
market value. Similarity is important
enterprises are different from those between
when comparing prices but can be
independent enterprises, profits which
less important when comparing
have accrued by reason of those conditions
profit margins. Some characteristics
may be included in the profits of that
to be considered include: the physical
enterprise and taxed accordingly. 53
features, quality and reliability, the
Members of an MNE are treated as if they
availability and volume of supply
were separate entities rather that a part of a
(in case of tangible property), the
single unified business unit. As a result, it
nature and extent of the service (in
enables taxpayers or tax administrations
case of services), the form of
analyse whether the results of those
transaction (e.g. licensing or sale),
controlled transaction are comparable to
the type of property (e.g. patent or
those of between independent enterprises.
trade mark), the duration and
1 Comparability Analysis degree of protection, and the
anticipated benefits (in case of
The principle of the arm’s length principle
intangible property).
is the use of comparisons using information
from transactions between independent 2. Functional analysis
entities. For this to work, the characteristics
In essence, this analysis tries to
of the transactions should be sufficiently
identify and compare the activities
similar so that both the controlled and
and responsibilities undertaken.
uncontrolled transactions could be
The functions that might need to be
considered comparable. This means that
considered include design, manu-
the differences do not affect the condition
facturing, assembly, or other
functions. If one party provides a
range of functions, it is the economic
Unlike other countries, the Brazilian transfer significance of these functions that
pricing system is not based on a specific arm’s matters.
length standard. Taxpayers are free to choose
any methods specified in the regulations so Another important aspect is the risk
long as they have the required information. assumed by the parties. If the
OECD, above n. 32. differences in risks are so significant
The explicit statement on the commitment to that appropriate adjustments cannot
the arm’s length principle is actually set out in
Article 7 of the OECD Model Tax Convention.
OECD, Model Tax Convention on Income
and Capital (2005). OECD, above n. 29.

JAP Vol.3, No.1, Oktober 2008

be made, then that transaction will or when several methods are applied to
not be considered comparable. The evaluate a certain controlled transaction.
types of risks to be taken into If the relevant conditions fall within this
account include market risks – such range, there will be no adjustment
as price fluctuations and failure in required. On the other hand, if the
research and development – and relevant conditions indeed fall outside
financial risks, such as exchange rate the range asserted by the tax administration,
fluctuation, interest rate variability, the taxpayers have to demonstrate that
credit risks, and so forth. their conditions satisfy the arm’s length
principle. However, a substantial deviation
3. Contractual terms
among points indicates that the
The contractual terms define the comparables being used in the analysis
behaviour of the parties including are probably not reliable.
the division of responsibilities,
2 The Acceptable Methods
risks, and benefits between parties.
In addition to the written contracts, As discussed, there are several methods
these terms usually can also be preferred by the OECD. These methods
found in the communications or are grouped into two categories: the
correspondence between the parties. traditional transactional methods and the
If there is no written contract, the transactional profit methods. The
relationship can be deduced using Guidelines express a preference over the
their conducts and the economic first group and state that the profit-based
principles that generally govern methods should only be applied if there
such relationship. are practical difficulties that prevent the
use of the transaction-based methods.
4. Economic circumstances
(a) Traditional transactional methods
These factors include geographic
locations, the size of the markets, The arm’s length condition can be
competition, the availability of a established by substituting the price in
substituting product, consumer the controlled transaction with the price
purchasing power, costs of of the comparable uncontrolled transaction.
productions, and so forth. However – as valid comparables are not
always available – sometimes it is necessary
5. Business strategies
to use the less direct approach – such as
This includes innovation and new gross margin comparison – to reflect the
product development, diversification, arm’s length conditions.
risk aversion, assessment of political
(1) Comparable uncontrolled price
changes, and other aspects including
method (CUP)
a market penetration scheme. As
an example, an entity claiming a In essence, the CUP compares the prices
market penetration strategy may in a controlled transaction with the prices
have low income because it charges charged in an uncontrolled situation
a lower price and high penetration with similar circumstances. This method
expenses (e.g. advertising). produces the most reliable result but
requires a high degree of comparability
It is possible that the application of the
in term of products and functions.
arm’s length principle results in a range
Therefore, it is suitable in situations where
of figures. This is because it approximates
there are the same or at least very similar
the conditions between unrelated entities
products are sold to both related and

Transfer Pricing Regulations in Indonesia:
Some Thoughts for Reform

unrelated parties. They have to be similar party for $1.50. If another independent
that any differences have no effect on its distributor charges 10% for the sale and
price or if such differences exist, they purchase of similar products, the arm’s
can be addressed using a number of length transfer price would be $1.35
adjustments. ($1.50 less 10% commission).
Nevertheless, it is difficult to find (3) Cost plus method (CPM)
comparable uncontrolled transactions
This method works based on the gross
because differences may cause significant
profits by comparing the full costs plus
effects on its price. As a consequence,
mark-up of a controlled transaction with
some adjustments are usually required to
the comparable uncontrolled transactions.
reflect such differences in term of product
The arm’s length price equals the cost of
quality, contractual terms, embedded
production plus a gross profit percentage
intangibles, and foreign currency
from comparable uncontrolled transactions.
The result is then adjusted to reflect any
For example, an Australian company differences.
sells fruit juice to its Indonesian subsidiary
For example, the cost of manufacturing
for $1 for each package. That company
the fruit juice in previous example is
also sells the same product to an
$.95 per package. If another company
unrelated Malaysian company for $1.50
produces similar product earns a gross
per package. Using the CUP, it is likely
profit mark up of 20%, then the arm’s
that the transfer price for the Indonesian
length price is $1.14 (being $.95 plus
contract will be changed into $1.50 per
20% mark up).
(b) Transactional profit methods
(2) Resale price method (RPM)
The transactional profit methods consist of
The RPM can be applied to the transfer
the Profit Split Method and Transactional
of both tangible of intangible property,
Net Margin Method. Most countries
especially when intangible property is
usually prefer the Profit Split Method
sublicensed to a third party. The analysis
because it considers both parties and
is based on the gross margin obtained in
hence, generates a less extreme result.
comparable uncontrolled transactions.
The transfer price is the uncontrolled (1) Profit split method (PSM)
resale price less an appropriate mark up
This method is applied if the transactions
to cover costs and profits. Therefore, the
are so closely interrelated that they cannot
arm’s length price would be an
be analysed on transaction-by-transaction
applicable resale price less adjusted
basis. There are two analysis under this
mark up percentage obtained comparable
method, namely contribution analysis and
unrelated transactions. The result is
residual analysis. In the contribution
adjusted to reflect any existing differences.
analysis, the profit/loss in a controlled
This method is suitable in situations
transaction is split based on the proportion
where the reseller does not add a
of the contribution of each party. As it
substantial value to the products (simply
does not depend on the analysis of
a distributor).
comparables, it can be used in situations
For example, an Australian company where there is no comparables. The
sells fruit juice to its wholly-owned residual analysis works similarly with the
Indonesian subsidiary for $1 for each contribution analysis but it requires a
package which resales it to an unrelated highly profitable intangible.

JAP Vol.3, No.1, Oktober 2008

(2) Transactional net margin method Hellerstein’s words, the OECD’s arm’s
(TNMM) length principle turns reality into fancy
and then pretends that it is the real word.
This method examines the net profit
It pretends that the integrated parts of an
margins in a controlled transaction relative
MNE are separate entities transacting
to an appropriate base (sales, costs, or
independently.57 In short, the arm’s length
assets). The result is then compared with
principle ignores the synergistic effects
the net profit margins earned by a taxpayer
which are fundamental within an MNE.
in an uncontrolled situation or with the
net profit margin earned by independent In the second feature, it is recognised
entities. As net profit margin is less that the relationship between members
affected by transactional differences, it is of an MNE is governed by control rather
more tolerant to functional differences than by contract. Even if a contract exists,
than gross profit margin. it cannot be effectively enforced. It can
even be changed according to the will of
3 The Appropriateness of the Arm’s
the parent company. As a result, accepting
Length Principle
such contract is questionable.
(1) Theoretical and practical difficulties
Lastly, internalisation of costs and risks
The arm’s length principle contains both makes an MNE able to operate efficiently
theoretical and practical problems. and achieve synergy. A comparable arm’s
Firstly, it fails to acknowledge that an length transaction will be very difficult to
MNE’s business tends to be: be found as the MNE drives away its
competitors.58 As Lester notes, multinational
1. Highly integrated;
companies are increasingly involved in
2. Conducted predominantly by
transactions where there is simply no
control rather than by contract;
comparable uncontrolled transaction,
3. Many risks and costs are
especially in highly specialised services
such as multinational banking industry.
The first feature is critical to achieve The problem is exacerbated by the fact
synergy through economies of scale. that there is a lack of rules in setting an
However, the arm’s length principle does arm’s length price where there is an
not recognise this. Instead, it assumes that absence of comparables or in situations
entities within an MNE are capable of when related parties are involved in
acting as if they were unrelated. It fails to transactions that independent entities
acknowledge that an entity chooses to would not undertake.59
operate as an MNE because this
Furthermore, the traditional arm’s length
structure enables it to achieve more as a
methods fail to account for profits that
whole compared to the aggregate of
arise as a result of integration within an
what all member-entities earn if they
operate independently. 56 In Jerome

Kerrie Sadiq, The Fundamental Failing of the
Traditional Transfer Pricing Regime - Applying
Jinyan Li, 'Global Profit Split: An Evolutionary the Arm’s Length Standard to Multinational
Approach to International Income Allocation' Banks Based on a Comparability Analysis
(2002) 50(3) Canadian Tax Journal 823. (2003)
Lindsay C. Célestin, The Formulary Approach <http://pandora.nla.gov.au/pan/23524/20030
to the Taxation of Transnational Corporations: 305/Kerrie%20Sadiq.doc> at 28 April 2006.
a Realistic Alternative? (Ph.D. Thesis, Li, above n 55, 834.
University of Sydney, 2000). Sadiq, above n 57.

Transfer Pricing Regulations in Indonesia:
Some Thoughts for Reform

MNE. As mentioned, an MNE operates situation. This is because the nature of

in an integrative way so that it can current trade that consists of more
achieve more as a whole compared to specialised information which is unique
the aggregate of what all member-entities and indivisible in nature. As a result, the
earn if they operate independently. If this CUP – which is based on transaction-by-
situation is approached using comparable transaction basis – would be unsuitable.65
unrelated transactions, the residual profit
In addition, it is often difficult to find the
as a result of integration and economies
exact comparables in internal uncontrolled
of scale cannot be recognised as such
comparables, which is undertaken between
profit does not occur in uncontrolled
members within an MNE or between an
transactions. 60 In addition, transfer-pricing
MNE and an independent party. For
arrangements increasingly become more
external comparables – transactions
complex as they involve services,
between two unconnected parties – two
intangibles, and unique properties. 61
problems arise. Firstly, the MNE often
Further, Li adds that the arm’s length
does not have access to detailed
principle violates internation equity
information on such transactions and
principle 62 – as it tends to favour the
secondly, there are only few markets
parent company’s country of resident –
where external comparisons exist. This is
and inter-taxpayer equity 63 as it may
because an MNE operates in a way that
cause over-taxation due to inconsistent
can maximise the integration and risk
application or under-taxation if there is a
protection effects; if an MNE does not
transfer-price abuse. It also fails to satisfy
have an internal comparable, it is
the neutrality principle as a result of its
unlikely that its competitor does.66
subjectivity and uncertainty.64
(3) Resale price method (RPM) and
(2) Comparable uncontrolled price
cost plus method (CPM)
method (CUP)
The RPM or CPM methods can be used
Viewed as the most direct way to arrive
in situations where the application of the
at the arm’s length price, this method is
CUP is either unrealistic or impossible.
not without its flaws. Developed based
As discussed, these methods basically try
on the manufacturing of raw materials
to arrive at the arm’s length price by
into finished goods which prevailed from
calculating gross margins from comparable
the mercantile era in the eighteenth century
transactions and then apply these margins
until the mid of twentieth century, this
to the controlled transactions. The RPM
method might be unsuitable for today’s
deducts the margins from the selling
price whereas the CPM adds the margins
to the costs of sales.
Li, above n 55, 834. Célestin identifies several limitations of
Ibid, 835.
62 both methods.67 Firstly – as they are based
Inter-nation equity refers to a fair allocation of
tax revenue between countries. on comparable uncontrolled transactions
Inter-taxpayer equity deals with the – they are subject to the limited
distribution of tax burden among taxpayers. It availability of detailed information of the
is based on ability-to-pay considerations comparisons, the same as the CUP
which is analysed in terms of horizontal
equity (taxpayers with similar situations
should be taxed approximately the same) and
vertical equity (taxpayers with higher incomes Célestin, above n 56, 63.
should pay higher taxes). Pagan and Wilkie, above n 4, 105.
64 67
Li, above n 55, 838-42. Célestin, above n 56, 64-6.

JAP Vol.3, No.1, Oktober 2008

method. Secondly, they tend to be one- III INDONESIA: SOME THOUGHTS

sided solutions because they allocate FOR REFORM
risks (profits or losses) on the hand of the
purchaser (the RPM) or the supplier (the A. Current Transfer Pricing Regulation
CPM). Finally, there are other difficulties: As discussed, the Indonesian transfer
1. It is difficult to convince that the pricing provisions were first introduced
uncontrolled transactions being in 1983. Article 18(3) Law Number 17 of
used to calculate the mark-ups are 2000 authorises the Director General of
adequately comparable. Taxes to reallocate income or deductions
2. The cost base calculation is often between related parties and to characterise
surrounded with uncertainties. debt as equity. This article is explained
3. The problems in making the through SE-04/PJ.7/1993 which seems to
appropriate adjustments. refer to the 1979 version of the OECD
4. In relation to the arm’s length transfer pricing guidelines. The definition
range, specific issues will still need of related party is explained in Article
to be solved.68 18(4) to include:
In relation to the CPM, additional 1. A direct or indirect ownership of at
problems may also arise regarding the least 25% of equity in other
nature of the relationship between the taxpayers;
parent company and subsidiary. This 2. A taxpayer who controls other
kind of relationship can be seen as a taxpayers or two or more taxpayers
continuum. On one end of the continuum, are controlled by the same person;
the subsidiary may only be a contract 3. A family relationship through blood
manufacturer which is subject to a strict (for example parents and children)
technical and managerial assistance or marriage (for example parents in
from the parent company. All products law, and stepson or stepdaughter).
of the subsidiary are absorbed by the In SE-04/PJ.7/1993, the Director General
parent company. On the other hand, the of Taxes states that non-arm’s length
subsidiary may have a degree of transactions may occur in the form of:
independence in relation to the technical
control, management, and choice of sale 1. Selling price;
outlets for the products. In this situation, 2. Buying price;
the gross margins applicable for the 3. Allocation of administration expenses
more independent subsidiary should and overhead cost;
clearly be higher to cover the commercial 4. Burden of interest on extending
risks. 69 Such risk differences have to be loan by shareholder loan;
taken into account in calculating the 5. Payment of commission, license,
appropriate margins. franchise, rental, royalty, repayment
on management services, repayment
on technical services and another
repayment services;
6. Buying of enterprise property by
shareholder loan or party who has
lower special relationship than
price market;
7. Selling to overseas party through third
party who has lack/not business
69 substantial (example dummy company,
Pagan and Wilkie, above n 4, 107.

Transfer Pricing Regulations in Indonesia:
Some Thoughts for Reform

letter-box company or re-invoicing 2. Losses for a period longer than two

centre). consecutive years;
3. A significant gross revenue without
This circular letter confirms that the
a considerable net profit increase;
transfer pricing provisions can apply to both
4. Irregular profits and losses history;
domestic70 and cross-border transactions
5. Associated parties in tax havens;
between related parties, especially if the
6. A lower profit compared to the
other party is located in a tax-haven
industry average or other similar
country.71 It then provides some examples
in how to work out the arm’s length price
for each of the above category which
basically refer to the CUP, CPM, or RPM. It B. Some Thoughts for Reform
also recognises the use of ‘comparable
profits’ or ‘return on investment’ from Pagan and Wilkie argue that there are six
comparable industries. aspects that need to be considered in
searching for appropriate transfer pricing
In relation to documentation, there is no
formal documentation requirement
although taxpayers are required to disclose 1. The rules apply to which taxpayers.
their related-party transactions. The 2. The type of transactions that are
information to be disclosed includes the affected.
type and value of the transactions, the 3. The basis to analyse the fair price.
transfer price, and the methodology that 4. Whether the transactions and/or
has been used to determine the transfer the price be adjusted.
price.72 In addition, there is no specialised 5. Whether the focus is on flexibility
audit that especially deals with transfer or certainty.
pricing issues. There are also no guidelines 6. The compliance requirements.74
that characterise which taxpayers that
Each aspect will be discussed in the
may subject to a transfer-pricing audit.
following sections.
From a practical point of view, however,
it is believed that taxpayers with the 1 The Taxpayers
following characteristics may be subject
This first aspect addresses the type of
to a transfer-pricing related audit:
taxpayers to which the transfer pricing
1. A large number of related-party regulations apply. This usually can be
transactions; found in the definition of related-party
transactions. Generally, there are several
patterns that emerge:
1. The rules apply to taxpayers that
The transfer pricing provisions apply to conduct business activities, for
domestic transactions between related parties
instance corporations, partnerships,
because grouping of tax losses is not
recognized in Indonesia.
or individual owning such structures.
Tax haven is defined in this circular letter as a 2. Both foreign and domestic entities
country which does not collect tax or collects are included, although sometimes
a lower tax than Indonesia. According to the the rules may be limited to apply
OECD, a tax haven has characteristics that only to international transactions.
include: no or only nominal taxes, lack of
effective exchange of information, and lack of
transparency in the operation of the
legislative, legal or administrative provisions. Ibid.
72 74
Ernst and Young, above n 25. Pagan and Wilkie, above n 4, 43.

JAP Vol.3, No.1, Oktober 2008

3. There are rules that define whether transactions with various purposes in
one or more entities are considered addition to tax motives.79
to be related parties so that the
The related-party concept is defined in s.
transfer pricing rules can be
136AD ITAA 1936 to include ‘any
connection’ between any two or more of
In relation to Indonesia, the related-party the parties to the agreement. The phrase
transaction rule applies to taxpayers defined ‘any connection’ is much wider compared
in Article 18(4) of the Law Number 17 of to direct or indirect control contained in
2000 to include: the Indonesian definition because it allows
a facts and circumstances approach.80
1. A direct or indirect ownership of at
least 25% of equity in other It can be seen here that the Indonesian
taxpayers; definition of related party requires an
2. A taxpayer who controls other evidence of control, whether through an
taxpayers or two or more taxpayers equity ownership, family relation, or
are controlled by the same person; managerial/technological presence. On
3. A family relationship through blood the other hand, it is possible to use a wider
(for example parents and children) approach that does not need such
or marriage (for example parents in evidence, like the Australian version. Even
law, and stepson or stepdaughter).76 though some may argue that it might be
somewhat harsh, it covers more taxpayers.
Whilst the first condition clearly requires
an equity ownership, the second condition 2 The Transactions
is to wider. The elucidation of the Article
Here, there are two strategies. Firstly, the
18(4) explains that a dependency relation-
general approach that covers as wide
ship may be the result of an ownership
transactions as possible and then it is at
of share or equity (condition 1), family
the discretion of the tax authority to
relationship (condition 3) or a participation
bring the transfer pricing provisions into
in management or technology (condition 2).
play. Secondly, a specialist provision
By contrast, the Australian definition of can be constructed for a certain type of
the associated party is wider. It can be industry, for instance the mining or
found in Division 13 Part III section financial industry. 81 There are several
136AD of the Income Tax Assessment problems associated with the first approach.
Act 1936 (Cth) (ITAA 1936). 77 This
The first difficulty is that an MNE may
division was introduced in 27 May 1981
continue its operation even if it is not
to replace the former s. 136 which was
profitable. For example, a leading computer
repealed following the decision in FCT v
software manufacturer may still operate
Commonwealth Aluminium Corporation
in a country with high rate of software
Ltd (1980) 11 ATR 42. 78 Division 13
piracy to strengthen and preserve its
does not self-executable even though it
brand and customers’ loyalty. If its
does not require a tax-avoidance motive.
customers from other country with low
Additionally, it can be applied to any
piracy rate – which is the MNE’s target
market – conduct business in this high-

Ibid, 46.
Above n 23.
77 79
Income Tax Assessment Act 1936 (Cth) Ibid.
78 80
RL Deutsch et al, Australian Tax Handbook Pagan and Wilkie, above n 4, 48.
2004 (2004). Pagan and Wilkie, above n 4, 49.

Transfer Pricing Regulations in Indonesia:
Some Thoughts for Reform

piracy country, the MNE can expect that Regarding the specialised provisions for
these customers may still use the MNE’s a certain industry, the choice depends
products. Furthermore, the MNE can on the nature of economic activities in
also expect that these customers would that country. For example, a country like
not switch to competitors’ products in Norway that depends on the oil industry
their business in other parts of the world may have specialised tax provisions for
because they get the same level of the oil industry including specific transfer
service anywhere. If the MNE’s head pricing rules. Other countries that depend
office provides assistance – say by on different type of industries like finance
providing loan with a lower interest rate may also have similar rules.
– to this type of non-profitable offices,
In essence, the Indonesian transfer pricing
the tax authority may see it as an abuse.
provisions conform to the general approach
As a result, the transactions may be
to cover more transactions. The rules in
adjusted and the taxpayer suffers. This
Article 18 of the Law Number 17 of 2000
example shows a tax authority’s incomplete
are basically the general anti-avoidance
understanding of an MNE’s operation
provisions. In addition, there are also
and a failure to understand the benefits
specialised rules in relation to the taxation
of such operation in term of employment
in mining ‘Contracts of Work’ (CoW),
and transfer of knowledge.82
but the emphasis is on the applicable tax
The second problem arises where the rates. The rates are locked over the life of
adjustment is only targeted to situations investment and thus are protected against
where taxpayers’ profitability can be changes in income and royalty taxes. For
increased. This can be achieved in two example, the eighth-generation contract
ways: by drafting the legislation in such – beginning in 2000 – includes a tax rate
a way that it will only be applied if it of 30%.84
results in an increased of profitability or
Article 18(3) grants the Director General
granting the tax authority discretion to
of Taxes discretion to make the necessary
exercise the transfer provisions. It is
adjustments to bring the transfer price to
likely that a tax authority will only use
an arm’s length price. Of course the
this power if it believes that profitability
adjustments are likely to be made only if
– and hence, taxable income – can be
it can be assured that the new price increases
increased. In either situation, there is a
taxable income. As a consequence, it is also
failure to recognise that in the long run,
subject to the problems outlined previously.
two unrelated business entities doing
In such situations, the Director General of
business together tend to average out
Taxes has to base his review on a premise
even though in the short run, one entity
that the taxpayers – not the Director
may be less profitable than another.
General of Taxes – are the expert in their
Such entities may face problems if tax
business. Hence, Director General of Taxes
authorities invoke transfer pricing
has to deal with the facts and circum-
adjustments in times when profits are
stances as they exist and not as if they were
lower. That taxpayer may argue that for
conducted differently. The transfer pricing
a certain period of time – say ten years –
there is no substantial profit shift, but the
result is often uncertain.83
The Economist Intelligence Unit Ltd.,
Indonesia: Tax regulations (2006) Dow Jones
Reuters Business Interactive LLC
Ibid. <http://global.factiva.com.dbgw.lis.curtin.edu.
Ibid, 52. au/ha/default.aspx> at 27 March 2006.

JAP Vol.3, No.1, Oktober 2008

provisions should only be used to substitute relation to its transfer pricing regulations
the transfer price and not the taxpayers’ (Div. 13 ITAA 1936).88
business judgements.85
In Indonesia, Article 18(3) of the Law
3 The Fair Price Determination Number 17 of 2000 authorises the Director
General of Taxes to ‘…assure that the
As discussed, the arm’s length principle
transaction are those which would have
endorsed by the OECD is the de facto
been made between independent parties’
standard adopted by most countries.
(emphasis added). Furthermore, the
However, there are differences in the
elucidation of this Article says that the
details. There are two patterns that emerge:
methods to be used include ‘…comparable
a practical businesslike approach and a
data, profit allocation based on function
detailed provisions approach.86 The first
or participation of related Taxpayer and
method chooses to approach the arm’s
other methods’.
length principle on a case-by-case basis
without the need to rely too much on Whilst it is believed that the problem lies in
detailed provisions. The statutory restrictions the details of the tax laws,89 the practical
are kept at a minimum level but the tax approach is unclear. The fact that Indonesia
officials are usually well-trained and aware does not have detailed provisions on transfer
of an abuse. In addition, it is usually pricing – other than a short circular letter
complimented with continuing discussions SE-04/PJ.7/1993 – is possibly because it
between the tax authority and taxpayers to prefers to use the business like approach.
arrive at a common understanding on the The circular letter number SE-04/PJ.7/1993
acceptable transfer pricing policy. By contrast, is meant to be the implementing regulation,
the detailed-provisions approach arms tax but its day-to-day practicality still faces
officials with lengthy and detailed rules on difficulties, especially in relation to the
what constitutes an arm’s length transaction.87 availability of comparables.90
The main advantage of the first approach By comparison, the Commissioner of
is that it is more flexible. It can be Taxation in Australia (the Commissioner)
effective if the tax officials have good provides the following guidance in
knowledge on the commercial practice choosing the appropriate arm’s length
of transfer pricing policies. Otherwise, methodology.91
they may be heavily exploited and as a
result, the nation’s potential revenue
could be harmed. On the other hand,
the detailed-provisions approach may be The Commissioner of Taxation has published
a number of public rulings including TD
inflexible but it can provide the tax
92/103 (inter-company loan), TR 94/14 (basic
authority the necessary arsenal to tackle concepts of Div. 13), TR 97/20 (transfer
a transfer pricing abuse. However, there pricing methodologies) and other transfer-
is a growing trend in countries with a pricing related rulings.
flexible approach to publish detailed 89
Urip Hudiono, 'Tax laws still complicated,
guidelines and circulars that do not have have grey areas: Analysts', The Jakarta Post
the force of law. Australia for example (Jakarta), 16 November 2005.
Gunadi, above n 24.
published a range taxation ruling in 91
Australian Taxation Office, TR 98/11: Income
tax: documentation and practical issues
associated with setting and reviewing transfer
pricing in international dealings (1998) The
Pagan and Wilkie, above n 4, 89. Australian Taxation Office
Ibid, 55. <http://law.ato.gov.au/pdf/tr98-11.pdf> at 30
Pagan and Wilkie, above n 4, 55. April 2006.

Transfer Pricing Regulations in Indonesia:
Some Thoughts for Reform

Figure 2 Which methods?

Source: TR 98/11

This chart provides taxpayers ideas in the same language’, it is possible to

choosing the appropriate methodology reduce future disputes and at the same
that is suitable for their situations. It can time, safeguard the national income.
be contrasted to the Indonesia’s situation
4 Price or Transaction Adjustments
where taxpayers are ‘left in the dark’.
There are several ways for adjustments
A weak provision in tax law against tax
to be made:
abuse and inadequate technical training
for tax auditors evident in many developing 1. Only the price that is adjusted.
countries are the main weaknesses which 2. The transaction is adjusted to
may cause failure to prevent profit diversion arrive at a fair price.
by foreign investors. 92 Therefore, it is 3. Interest payments are recategorised
essential for Indonesia to have more as dividends.
guidelines so that taxpayers as well as 4. Non arm’s length payments are
tax officials have common understanding not deductible under other
and to reduce different interpretations. provisions.93
For taxpayers, the guidelines are important
(a) Price-only adjustment
as a starting point in fulfilling the legal
requirements. Tax officials also need If goods or services are transferred at
such guidelines as guidance for transfer- below an arm’s length price, the tax
pricing auditing activities. If they have authority usually makes an upward
common understanding and ‘speak with adjustment. Hence, profitability and taxable
income is increased. This approach is
also preferred by Article 18(3).
Vito Tanzi and Howell Zee, Tax Policy for
Developing Countries (2001) International
Monetary Fund
ues27/index.htm> at 27 March 2006. Pagan and Wilkie, above n 4, 60.

JAP Vol.3, No.1, Oktober 2008

(b) Transaction adjustment (d) Non-Arm’s length payments under

other provisions
In this instance, the tax authority tries to
change the nature of the agreements as if Whilst a transfer pricing provision clearly
the commercial agreements are conducted denies a non-arm’s length payment, it is
in different ways. For example, if an possible that there may be other provisions
MNE grants an offshore company a in income tax legislation that also provides
licence to manufacture a product and that such payments are not deductible.
then buy most of those products, this In such situation, taxpayers have to be
approach basically recategorise such aware the advantage of using one rule
transactions to be a contract manufacturing over another.
agreement as if the offshore company
5 Certainty or Flexibility
carries a very limited risk and completely
dependent to the MNE. It does not take Certainty means that taxpayers are able
into account the actual terms of the to know in advance what tax consequences
contract and the independence level of they may face in relation to a certain
the offshore company.94 business transaction. On the other hand,
flexibility approach focuses on the facts
(c) Interest payments are recategorised
and circumstances surrounding the
as dividends
transactions and therefore, it leaves a
In essence, these provisions treat excessive degree of freedom to an agreeable arm’s
interest payments to associated-non resident length transfer price.95 As a result, certainty
company as dividend and therefore, not and flexibility sometimes conflict. A
deductible. Such rules are also present in country that emphasises certainty tends
Indonesian anti-avoidance articles. to have a detailed arm’s length provision
Article 18(3) of the Law Number 17 of compared to the shorter provisions in the
2000 does not clearly states it, however, flexible approach. However, as discussed
its elucidation provides that the Director previously, there is a tendency that
General of Taxes is authorised to flexible-focussed country begins to provide
characterise debt as equity and hence, more detailed guidelines that do have
interest payment is treated as dividend. the force of law. Such guidelines are
Nevertheless, there is no further explanation merely aimed at providing guidance on
on how its practical mechanism and as a the important aspects in a transfer pricing
result, its application is unclear. inquiry. This is usually accompanied
with well-trained tax officials.
In this situation, the Indonesian approach is
unclear. It does not have detailed
transfer pricing provisions – which may
be indicated as focusing on flexibility –
94 and is without more detailed transfer
An example of this approach can be found in
Sunstrand Corporation v Commisioner, a US pricing guidelines. 96 This may cause
case where the Internal Revenue Service (IRS) ‘grey areas’ that may be subject to
recharacterised the contract between multiple interpretations. This needs to be
Sunstrand Corporation and SunPac — its reduced. 97 Without strong legislative
Singaporean subsidiary — to be a contract
manufacturing agreement. The Court rejected
the IRS’s contract manufacturing theory on
the basis that the actual contract did not Pagan and Wilkie, above n 4, 64.
oblige the parent company to purchase the Gunadi, above n 24.
subsidiary’s products. Hudiono, above n 89.

Transfer Pricing Regulations in Indonesia:
Some Thoughts for Reform

provisions and a proper training for tax to justify the outcome of the transactions
officials, it is likely that developing against the arm’s length principle. There
countries – like Indonesia – are unable is also a disclosure requirement for
to prevent profit diversion.98 related-party transactions under
Schedule 25A. The information to be
6 Compliance Requirements
disclosed includes:
There are two concerns relating to
1. Industry classification code;
compliance requirements: the reporting
2. Transaction type;
requirements and a non-compliance
3. Amounts per transaction type;
penalty. 99 The first instance, some
4. Countries;
countries may require taxpayers to
5. Percentage of transactions covered by
complete separate documentation listing
contemporaneous documentation;
all of the related-party transactions.
6. Transfer pricing methodologies
Other countries may only rely on the
selected and applied.
annual standard tax return form. In
relation to penalties, usually there are In Indonesia – even though the DGT
two types of penalties: a flat-rate may require taxpayers to produce
monetary penalty and a percentage- invoices or agreements – there is no
based penalty.100 While the first type of formal documentation requirement.
penalty is usually insignificant in term of However, commencing 1 January 2002,
its monetary value, the second type of there is a disclosure requirement for the
penalty can be more material. type of transaction, the value of the
transaction, the transfer price and the
In Australia for instance – in Taxation
methodology used to determine the
Ruling TR 98/11 – the Commissioner
transfer price.102 There is no deadline for
states that there are four reasons why
documentation preparation and
documentation is important:
submission, leaving taxpayers with
1. Statutory requirements; uncertainties as to what and when the
2. Relevance to penalty considerations; documentations are required.
3. The burden of proof which rests
In relation to penalty, the applicable
with taxpayers;
rates in Australia are as follows:
4. Practical advantages in reducing
the risk of tax audits and adjust- 1. A penalty of 50% of the tax
ments and in communicating your avoided for transfer pricing
position to the ATO.101 arrangements entered into with
the sole or dominant purpose of
The documents to be prepared extend
enabling a taxpayer to pay no or
from budgets, business plans and
less tax; reduced to 25% if the
financial projections to all other documents
taxpayer has a reasonably arguable
required in preparing tax return. In
position (RAP) (s. 225(1)(d) ITAA
addition, the ATO requires taxpayers to
1936); or
have contemporaneous documentation
2. A penalty of 25% of the tax
in relation to transfer pricing, especially
avoided for other transfer pricing
arrangements; reduced to 10% if
the taxpayer has a RAP (s.
225(1)(e) ITAA 1936).
Tanzi and Zee, above n 92.
Pagan and Wilkie, above n 4, 67.
Ibid, 70.
101 102
Above n 91. Ernst and Young, above n 25.

JAP Vol.3, No.1, Oktober 2008

The penalty can be increased by 20% if appropriate method is selected and a

a taxpayer prevents or hinders the ATO’s proper outcome is produced.
transfer pricing audit (s. 226C(b)(i) ITAA
By contrast, the Indonesian transfer
1936) or has been penalised under a
pricing provisions are silent on such
scheme section in previous year (s.
226C(b)(ii) ITAA 1936). However, the
penalty may be reduced by 20% if the The elucidation of Article 18(3) states
taxpayer makes a voluntary disclosure that there are some methods to allocate
after an audit is informed (s. 226D ITAA income and expenses including
1936). There is also an 80% reduction if comparable data, profit allocation based
the voluntary disclosure is made before on function or participation of related
the release of an audit notice (s. 226E Taxpayer, and other methods and SE-
ITAA 1936). 04/PJ.7/1993 provides some examples.
However, the overall process remains
In Indonesia, there is a penalty of 2% per
month up to a maximum of 48% for an
underpayment (Article 13(2) of the Law
Number 16 of 2000 on General
Provisions and Tax Procedures). 103
However, there is no penalty reduction
for taxpayers who make a voluntary
disclosure. As a result, taxpayers are likely
to wait the results of the DGT’s audit
because making a voluntary disclosure
in the event of an audit does not make
any difference. Introducing a penalty
reduction may increase taxpayers’

C. Other Considerations
1 Transfer-Price Tests
Associated entities often deal with each
other surrounded by motives other than
pursuing commercial interests. As a
result, it is necessary to evaluate whether
the transfer prices are set in a fair manner.
In Australia, choosing the appropriate
methodology is part of a four-step
process (figure 3). 104 This chart shows
that step 1 to step 3 do not flow linearly
and is open to possible movements
among these steps until the most

Law Number 16 of 2000 .
Above n 91.

Transfer Pricing Regulations in Indonesia:
Some Thoughts for Reform

Figure 3 The ATO’s four-step process.

Source: TR 98/11

2 Audit-Risk Assessment
standard.105 The ATO may proceed to an
Transfer pricing is complex and its audit
audit if it found that the dealings are
involves an analysis of a wide range of
structured in such a way that it is
factors. As it may threaten the national’s
reasonable to believe that there may be
potential income, transfer pricing abuse
a tax avoidance scheme. Some factors
may attract harsh penalties. A dispute
taken into account include:
between taxpayers and tax authorities
may end-up in court litigations, which 1. The use of tax havens where little
are usually long and costly. As a result, or no economic value is added;
an assessment of a transfer pricing audit 2. The use of back-to-back arrangements
risk is important. In this context, to conceal the full consideration;
taxpayers often require guidelines on 3. Complex and circular arrangements
how a tax authority approaches related- with little or no business purpose.
party transactions they may have.
The following chart illustrates the ATO’s
The Australian approach in this matter approach.106
can be found in TR 98/11. In this ruling,
the Commissioner states that the ATO’s
resources are allocated based on the
perceived risk of taxpayers’ non-
compliance with the arm’s length

JAP Vol.3, No.1, Oktober 2008

Figure 4 The ATO’s approach to arm’s length compliance.

Source: TR 98/11

The chart below shows the ATO’s risk

guidelines in relation to a transfer
pricing audit that may be faced by


Transfer Pricing Regulations in Indonesia:
Some Thoughts for Reform

Figure 5 Audit risk assessment.

Source: TR 98/11

In Indonesia, there is no specialised

transfer pricing audit. Transfer pricing D. Alternative Methods
investigations are conducted as part of
regular tax audits. However, it is unclear 1 Cost-Based Approach
at what situation a taxpayer face a higher In this approach, the fair transfer price is
risk of transfer pricing audit and how it calculated based on its cost. Chalmers
will be approached. suggests the following formula:
Additional outlay costs per unit incurred Opportunity costs per unit to
+ = transfer
to the point of transfer the supplying division

Kerrie Chalmers, International Transfer Pricing - Determining an Arm's Length Price (2003)
<http://pandora.nla.gov.au/pan/23524/20030304/CHALMERS.doc> at 19 April 2006.

JAP Vol. 3, No. 1, September 2008

However, the formulary apportionment

He further adds that there are four
may not be the universal remedy, as
scenarios that may be encountered:
evident for income from intangible
1. The appropriate transfer pricing properties. In addition, it is also argued
methodology is the full cost if that the formulary apportionment can
there is a competitive intermediate lead to more aggressive tax planning
market and the supplying division activities. For example, a firm may hire
has no idle capacity. independent contractors to exclude
2. The transfer price consists of salary and wages in the calculation of a
variable costs plus a negotiated profit portion for a jurisdiction. In
portion of fixed costs if there is a addition, determining what constitute a
competitive intermediate market unitary enterprise can be difficult and
and the supplying division has may increase compliance and enforce-
idle capacity. ment burden.112 It may not be accepted
3. The transfer price also consists of on tax-sovereignty basis as well as it
variable costs plus a negotiated would oblige participants to comply
portion of fixed costs if there is no with formulas and tax rules set at a
market for the intermediate supranational level. It is often unrealistic
products. to expect that a country would willingly
4. If there is no competitive inter- abandon its self-interests for the benefits
mediate market and the supplying of others.113
division has idle capacity, the
Broadly, the mechanic is as follows:
aforementioned formula cannot
be used. In such situations, a 1. The entire net income for a whole
market has to be created possibly MNE is computed.
by reducing the price.109 2. Income not related to the unitary
business is deducted from the
2 Global Formulary Apportionment
entire income.
and Global Profit Split
3. The remaining is the taxable
The traditional arm’s length approach income to be apportioned among
has both theoretical and practical jurisdictions.
difficulties and the formulary apportion-
In relation to this, Jinyan Li proposes the
ment methodology could be an appro-
‘Global Profit Split’ (GPS) which is
priate alternative. This is because it
similar to the formulary apportion-
accepts the firm-integration concept and
ment. 114 The term ‘global profit split’ is
proposes a workable solution that provides
chosen to avoid the use of ‘formulary
each jurisdiction with tax revenue based
taxation’ which is considered ‘dirty’ in
on economic activities that take place in
some international tax circles.115
that jurisdiction. Additionally, it can be
used as a mean to solve the ‘source-state
base erosion’ by employing factors such
as sales in the jurisdiction of
consumption. 110 Moreover, it offers Among Doubting Thomases, Purists, and
certainty and simplicity.111 Pragmatists' (2004) 52(1) Canadian Tax
Journal 114.
Célestin, above n 56, 379-80.
Cockfield, above n 110, 117-8.
109 113
Ibid. Ibid, 120.
110 114
Arthur J. Cockfield, 'Formulary Taxation Li, above n 55, 844.
Versus the Arm’s-Length Principle: The Battle Cockfield, above n 110, 116.

Transfer Pricing Regulations in Indonesia:
Some Thoughts for Reform

Under the GPS, an ‘integrated business’ lastly, there may be transitional

has to be identified first. This definition difficulties because it requires changes in
is crucial as it provides the parameters of legislations and international treaties. In
profit to be split. Li states that there are addition, it requires strong political will.
two tests available for this purpose: the
Li asserts that the first problem could be
flow-of-value test and the operational-
dealt with by improving uniformity. The
interdependence test. A business is
second weakness can also be addressed
integrated under the first test if there is a
using a well thought-out design of the
flow of value among associated entities.
apportioning formula. However, the last
Under the latter, a business is integrated
difficulty could be more complicated as
if there is a significant amount of
it involves a strong political will.
‘interdependent basic operations’ under-
Nevertheless, Li believes that the current
taken in different jurisdictions.
application of formulary apportionment
Once an ‘integrated business’ has been in Canada and the USA and the
defined, the ‘global profit’ needs to be adoption of a global accounting standard
determined. The global profit ascertains have provided some precedents. Further,
the size of profit to be split among she believes that if formulary apportion-
participants. Only revenue derived from ment were adopted in European Union
independent third-parties that would be countries, others would certainly follow.
included. Lastly, the profit is allocated Besides, the GPS actually stems from the
among participants based on a certain historical evolution of the arm’s length
formula. The variables to be used may principle and the application of the
include payroll, sales, tangible and/or existing formulary apportionment in
intangibles assets. Each participant has a many situations. These conditions would
portion of the global profit represented support the implementation of GPS
as a percentage in proportion to its share internationally.117
of payroll, sales, tangible property, and
In summary, the formulary apportion-
other intangibles.
ment is a compromised approach. To be
Li argues that the GPS is superior applied successfully, it requires signifi-
compared to the existing system because cant international efforts. 118 As for
it promotes inter-nation equity, it is Indonesia, one possible way would be to
consistent with economic theory, it can bring it forward through the ASEAN level.
overcome the tax haven problems, and it
supports the simplicity principle. 116
However, she also recognises that it also IV CONCLUSION
has the weaknesses of traditional
formulary apportionment.
Recent international surveys have shown
Firstly, there is a potential double that transfer pricing issues are
taxation if a consensus on the definition considered fundamental by most
of ‘integrated business’ and ‘global respondents. Transfer pricing is defined
profit’ or on the measurement and as the pricing policies and practices that
location of the variables in the formula are established when physical goods,
could not be reached. Secondly, it intangible properties, and services are
endorses an arbitrary allocation, and

Ibid, 855-7.
Li, above n 55, 851. 118
Célestin, above n 56, 303.

JAP Vol. 3, No. 1, September 2008

charged between business units within a tests, risk assessment, and its application
group. Within an MNE, transfer prices in banking and financial industry. A
take several forms: payments of goods, number of proposed suggestions include
trade credits, equity contribution, a wider definition of related-party
dividend payments, loans, interests, fees transaction, reducing ‘grey area’ that
for intangible property, fees for specific may be subject to multiple
divisible services, and overhead costs. interpretations, and a penalty reduction
Originally carrying a neutral meaning, to increase taxpayers’ compliance. It is
transfer pricing is often perceived also suggested that the DGT introduces
negatively as it induces an idea of profit its approach on transfer pricing audits to
diversion. gives taxpayers more certainty and
knowledge on what to expect in the
The OECD transfer pricing guidelines
event of such audits. Additionally, a
plays a significant role in this matter
guideline that enables taxpayers to
which is based on the arm’s length
assess their own situations in relation to
principle. These guidelines introduce
a transfer-pricing audit risk may be
several methods in analysing related-
party transactions. Broadly, these methods
can be grouped into the traditional In cases where comparables are
transactional methods (CUP, RPM, and unavailable, it has been shown that the
CPM) and transactional profit method traditional arm’s length methods may not
(PSM and TNMM). The OECD expresses apply. In this case, it is argued that other
its preference on the first group. methods should be applied. The
Australian Commissioner of Taxation
Increasingly adopted as the de facto
chooses to approach such transactions
standard, the arm’s length principle is
using profit based method or other
not without weaknesses. The main flaw
indirect arm’s length methods, even
is that it ignores the synergistic effects
though he asserts his preference over the
within an MNE. In addition, it relies
traditional arm’s length methodologies.
heavily on comparable transactions. As
By contrast, the Indonesian approach is
long as the comparable are available,
unclear. However, the elucidation of
the arm’s length principle can result in
Article 18(3) opens a possibility to use
an unbiased and precise standard.
methods other that the traditional
However, finding such comparables is
approaches. In such situations, the
often difficult. Moreover, the application
formulary apportionment method or
of the RPM and the CPM tend to
cost-based method can be considered.
produce one-sided solutions as they
allocate risks (profits or losses) on the In conclusion, while transfer-pricing
hand of the purchaser (the RPM) or the regulations are clearly not new for
supplier (the CPM). Indonesia, it is the view of this paper that
Indonesia could still benefit from more
Analysing transfer pricing provisions in
detailed regulations as evidenced by the
income tax legislation generally involves
Australia’s approach to transfer pricing
a discussion of a number of factors: the
rules and guidelines. After all –
taxpayers, the transactions, the fair price
according to an Indonesian economist,
determination, the price or transaction
Faisal Basri – ‘[t]he devil is in the
adjustments, certainty and flexibility issues,
and the compliance requirements. In
addition, there may other factors to be
considered including the transfer price
Hudiono, above n 89.

Transfer Pricing Regulations in Indonesia:
Some Thoughts for Reform


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