EY Indonesia Tax Alert

ĞĐĞŵďĞƌ Ϭϱ, 2013

Special Transfer Pricing Alert

As a follow up to the recently released Directorate General of Tax regulation number PER-
22/PJ/2013 regarding Guidelines for Audits of Taxpayers With Special Relationships (“PER-
22”) 1 , on 24 October 2013, the DGT released circular number SE-50/PJ/2013 (“SE-50”)
entitled ‘Technical Audit Guidelines for Taxpayers with a Special Relationship’. The stated
purpose of SE-50 is to provide ‘simplicity and uniformity to tax auditors within the DGT (the
“Tax Auditors”) in performing audits on taxpayers with a special relationship to ensure the
This new regulation
quality of the audit’. 2
expands on the
contents of PER-22 and
contains specific SE-50, expanding on the contents of PER-22, contains specific guidance to Tax Auditors on
guidance to Tax the steps that they should undertake in transfer pricing audits and the technical positions that
Auditors on the steps they should adopt when evaluating specific transfer pricing issues during these audits. This is
that they should a positive development for Indonesian taxpayers (Taxpayers) as it should help Tax Auditors
undertake in transfer develop a more sophisticated understanding of Taxpayer’s transfer pricing practices as well
pricing audits and the as adopt more consistent technical positions across transfer pricing audits.
technical positions that
they should adopt when There are a number of key items that Taxpayers should be aware of in this circular. These key
evaluating specific items include :
transfer pricing issues
during these audits. • New guidance on transfer pricing considerations for intercompany funding

An immediate • A focus on the licensing of intangible property, intra-group services and interest charges
recommendation for as being special affiliated transactions that Tax Auditors should investigate
Taxpayers is that they
initially consider the • Continued reference to the collecting of information relevant to the Taxpayer from outside
contents of SE-50 Indonesia
within the context of
preparing their fiscal • Detailed guidance on the types of audit steps and information that should be collected by
year 2013 transfer Tax Auditors
pricing documentation
and use this as a basis • Guidance on the use of a joint (or aggregated) transaction approach rather than a
for determining transaction by transaction approach previously required in Indonesia
whether there are any
items that should be In addition, SE-50 also provides some limited guidance on the completion of the supply chain
evaluated for the forms contained in PER-22.
previous year’s open
audit cases.
1 See the EY Special Transfer Pricing Alert, “Per-22 Tax Alert” released on 19 June 2013
2 Introduction, page 1
Intercompany funding
The new guidance on intercompany funding is perhaps
the item that Taxpayers should pay the most attention to
in SE-50, as guidance in this area represents a significant
addition to guidance that has been previously released by
the DGT.
Historically the analysis of the arm’s length nature of
intercompany funding for transfer pricing purposes in
Indonesia largely focused on the arm’s length nature of
the interest rate on intercompany borrowings. However,
following on from the broad steps identified in PER-22,
SE-50 provides guidance on the steps that Tax Auditors
are also required to undertake to analyse intercompany
funding. Specifically, in addition to analyzing the arm’s
length nature of the interest rate used, Tax Auditors are
required to 3 :
• Analyse the necessity of the intercompany funding
• Test the reasonableness of a Taxpayer’s debt to
equity ratio
SE-50 also makes mention of the ‘Halo effect’ in the
context of intercompany services, which may be taken as
an indication that the DGT has considered an issue that
could also impact the Tax Auditor’s approach to the
analysis of intercompany funding.
Analysing the necessity of intercompany funding
In considering the necessity of the intercompany funding
for a Taxpayer, SE-50 states that Tax Auditors should
consider the following points when evaluating whether a
related party debt is necessary:
• Nature and objective of the loan, i.e., Does the loan
tie in with the broader economic objectives of the
Taxpayer?
• Is it likely that the Taxpayer would enter into this type
of arrangement given the market conditions at a
particular point in time (e.g., high interest rates)?
• Does the Taxpayer need all of the funds that it has
borrowed and does the repayment period make sense
given the Taxpayer’s business objectives?
Through analyzing these questions, Tax Auditors
potentially have the ability to either disallow a portion of
the loan as being not necessary or to modify the loan
arrangement with a subsequent impact on the interest
rate that is able to be charged.
3 Chapter 2, page 43
4 Chapter 2, page 44
5 Chapter 2, page 7
EY Indonesia Tax Alert | December 05, 2013
Debt to equity ratios
While there is still no guidance from the Ministry of
Finance on debt to equity ratios as per Article 18(1) of
the Income Tax Law, SE-50 provides Tax Auditors with
guidance on how to recharacterise debt as equity under
Article 18(3) of the Income Tax Law if the debt to equity
levels of the Taxpayer are considered ‘not fair’.
This may mean that the Taxpayer could end up in a
situation where interest paid on the recharacterised
intercompany debt is disallowed, while subject to
withholding tax as an ‘dividend’ payment on the
determined equity amount.
In analysing the debt to equity ratios of Taxpayers, Tax
Auditors are to compare the Taxpayer’s level of debt to
equity to the debt to equity ratios4 of similar companies.
This analysis may potentially be considered akin to an
“arm’s length debt test” which is often applied by tax
authorities in other jurisdictions to analyze thin
capitalization ratios. In practice, Tax Auditors have
already made these types of adjustments in the course of
a small number of transfer pricing audits. It can be
expected that there will be more focus on this issue
moving forward.
The halo effect
The halo effect, at a very high level, is that a Taxpayer’s
credit rating may be higher (and its cost of external
funding potentially lower) simply because of its passive
association with a corporate group, its parent entity or
another group member. In the context of intercompany
services, SE-50 states that no charge should be paid by a
Taxpayer where it is the beneficiary of the ‘halo effect’ (a
reasonably well accepted principle in other tax
jurisdictions).
This guidance will likely impact the Taxpayer in relation
to related party funding as if the Tax Auditor considers
there to be a halo effect in place then this may raise the
credit rating of the Taxpayer and consequently lower the
interest rate that it should pay on its intercompany debt
by that Taxpayer. Accordingly, Taxpayers may need to
start considering whether there may be a ‘halo effect’ in
the future when examining their intercompany funding
arrangements.
Intangible property, intra-group services and interest
charges
SE-50 specifically highlights that related party
transactions relating to intangible property, services, and
interest charges are ‘special related party transactions’
that should be investigated by Tax Auditors during the
preparation stage of an audit 5. Some of the technical
points that are referenced in SE-50 that Taxpayers
should pay attention to with respect to intangible
property and intra-group services include:
 Issue Guidance in SE-50 indicates that Tax Auditors should collect information on
Local ownership Tax Auditors should identify the the Taxpayer’s relevant overseas group members
multiple times in the preparation and implementation
of intangible Taxpayer’s contribution in
stages of an audit.
property developing, protecting or
maintaining intangible property Tax Auditors are also referred to the exchange of
through the identification of cost, information clause in the relevant Tax Treaty as being an
functions, risks and local personnel alternative source of information on the Taxpayer’s
with special qualifications. This is operations outside Indonesia. 7
consistent with audit trends where
Tax Auditors have used analyses Joint (or aggregated) transaction approach
such as the “bright line” test to
attribute returns to the local legal Following on from PER-22, SE-50 provides further
entity. guidance on when the testing of transactions on a joint
basis, rather than the historically applied separate
Distribution Local distribution channels are a transaction approach, is considered appropriate.
channels as potential marketing related Generally, this guidance is very limited and does not
intangible intangible asset that should be provide additional support for Taxpayers looking to
property identified by the Tax Auditor analyse all of their related party transactions using a
Transaction Net Margin Method approach rather than
Turnover based SE-50 states that ‘the imposition of using a transaction by transaction approach that is more
charges for management services should be commonly applied. 8
management based on the amount of the actual
services are not costs incurred, not based on the
PER-22 supply chain forms
acceptable turnover of the taxpayer’ 6
SE-50 provides limited additional guidance on the degree
to which Tax Auditors will enforce the requirement for
Detailed audit steps Taxpayers to provide supply chain information and
profitability information for members of its corporate
SE-50 also requires Tax Auditors to conduct detailed group. SE-50 states that Tax Auditors should use other
audit steps in undertaking transfer pricing audits. Key information sources to gather this information such as
items mentioned include that Tax Auditors should: annual financial statements/ prospectuses of group
members, the internet or databases. However it also
• Speak to/ interview the operational personnel, i.e., states that to improve the quality of the forms the Tax
key personnel with significant functions, within the Auditor may request the Taxpayer to explain the
Taxpayer’s business to ensure that the Tax Auditor company’s group supply chain8.
understands the business operations
Summary
• Reference job descriptions in analyzing the functions
of the Taxpayer and overseas group members. There Overall SE-50 is largely consistent with the guidance
are multiple references to sourcing job descriptions in contained in the OECD transfer pricing guidelines as well
SE-50. as transfer pricing considerations in a number of other
jurisdictions in the Asia-Pacific region. An immediate
Given this, it is important that the Taxpayer ensures that recommendation for Taxpayers is that they initially
all documentation underlying their business operations consider the contents of SE-50 within the context of
ties in with the economic substance of the entity to preparing their fiscal year 2013 transfer pricing
ensure that there are no inconsistencies with its transfer documentation and use this as a basis for determining
pricing model. whether there are any items that should be evaluated for
any past years that remain open.
Collection of data from outside Indonesia

Following on from PER-22 which requires Taxpayers to

provide information on the functions, assets and risks, as
well as profitability, of relevant group members outside
Indonesia in the forms contained in PER-22. SE-50

6 Chapter 2, page 37
7 Chapter 2, page 7
8 Chapter 2, page 33

EY Indonesia Tax Alert | December 05, 2013

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