Transfer pricing continues to be a critical issue for the Indonesian Tax Office (“ITO”). In an effort to provide much needed clarity on transfer pricing practices, particularly in relation to transfer pricing audits, the ITO issued PER 22 to provide guidance to auditors on what they should be focusing on in terms of transfer pricing audits. Although auditors are the primary audience for PER 22, which came into effect on July 1 2013, taxpayers can rely on this guidance in order to anticipate the focus and direction of scrutiny in relation to transfer pricing audits in Indonesia.
PER 22, to some extent, reinforces the already existing transfer pricing provisions and guidelines that have been issued by the ITO in previous years. At the same time, they also provide additional focus and guidance on specific issues that will be raised during the first part of the process. It is likely taxpayers operating in Indonesia will start seeing some form of consistency in how issues are being dealt with. The Indonesian Tax Office also hopes to present a much needed principled approach in relation to taxation in order to also help boost its political image.
PER 22 first sets the scene in terms of the audit process. Before the commencement of a transfer pricing audit, specific forms have been introduced that taxpayers must to complete and provide to the relevant authorities. The information that is needed to complete these forms is highly detailed – in order for the taxpayer to complete these forms in an accurate manner, it is necessary to have robust transfer pricing documentation already in place. In addition, taxpayers need to have understood the transfer pricing process in order to be able to explain it at ease. It should be noted that these forms have to be submitted within seven days of receipt – making it very clear that taxpayers have to be prepared with all the supporting documents for transfer pricing – it will not be possible to start thinking of the transfer price policy once the request for information has been received.
RELATED: Declaration Now Required on Transfer Pricing Documentation in Malaysia
In addition to the detailed information gathered in respect to related party transactions, PER 22 also focuses on trying to get an understanding of the group’s value / supply chain. Form E outlines a very traditional supply chain that starts with research and development, design, procurement, manufacturing, marketing and distribution and requests the taxpayer to allocate a value to each broad activity in the value chain.
However, little guidance is provided on how such a reflection of value should be presented. In addition, no consideration has been provided for non-traditional business models. Examples would be companies operating in the digital economy / technology space (i.e., the likes of Apple / Google) which will not have any “core manufacturing” activity and where the value drivers are very different from a traditional brick and mortar company. Another example is a company operating that basically operates as a service provider – either project finance / financial services / general services. Companies that operate in this space are not likely to have R&D / design or manufacturing activities. Again, their core value drivers are completely different from a more traditional company. Is this likely to mean that taxpayers operating in less traditional business models are less likely to face transfer pricing scrutiny or that they will face more issues as the tax authority does not have a good understanding of their business model.
A third observation is the use of defined terms to characterize the business. PER 22 expects taxpayers to identify the intensity of the Indonesian’s taxpayers functional, asset and risk profile by labelling the activities as high / medium / low based on “x”s or crosses. Stemming from this tabulatory depiction, a business characterization of the Indonesian taxpayer is made in line with traditional labels – e.g., contract manufacturer / limited risk distributor, etc. However these labels only work best in tax efficient structures. Furthermore, they raise questions as to who should be the “tested party” in cases such as when a full-fledged manufacturer transacts with a full-fledged distributor. Such considerations and guidance on how to handle these transactions has not been provided as the outcome of this process will also have an implication on who the “tested party” is – i.e. from whose perspective are we trying to test the profitability, thus working back to the value of the related party transaction.
Business characters of the taxpayer is limited to manufacturing and distribution – characterization of other entity types (e.g., services) is not provided and again this may be a stumbling block for taxpayers who adopt non-traditional business models.
Finally, PER 22 also sets out to educate tax auditors on how services and loan transactions should be reviewed. This is quite interesting as the previous transfer pricing guidelines have been silent on how services and intercompany financing should be treated – with PER 22 tax auditors have been instructed with how these transactions should be evaluated. Specifically, the ITO is focused on whether the transaction should necessarily have taken place and if there is a benefit to the Indonesian taxpayer – or has the transaction been structured essentially as a “profit shift” transaction.
Overall, although the target audience for PER22 is the tax auditor, PER22 can be viewed as a guide to taxpayers in the event that they face a transfer pricing audit in Indonesia. In light of the guidelines, although taxpayers will expect a more robust transfer pricing audit process, we are hopeful that a more consistent treatment on transfer pricing matters will be adopted.