Robertus Winarto, Jakarta
Indonesia marks a significant development in the transfer pricing area this year. For the first time, companies engaged in related party (controlled) transactions are required to maintain transfer pricing (TP) documentation. A number of disclosures pertinent to it must also be presented in their 2009 corporate income tax returns (CITRs). This is part of the rules set out in regulation issued by the Director General of Taxation (DGT) in July 2009.
As the CITR filing deadline is drawing closer, taxpayers need to observe this requirement. Ignoring it could cost them significantly as transfer pricing adjustments normally entails a substantial amount of tax assessment.
Tax has accounted for a bigger and bigger part of the Indonesian state revenue. Given its growing importance, the DGT always keeps a watchful eye on any potential linkage of tax. transfer pricing within groups of multinational companies (MNCs), and as in many other countries, has apparently been perceived as an area bearing such a drawback. The DGT may use TP documentation to mitigate this potential problem.
Taxpayers engaged in controlled transactions, on the other hand, may use TP documentation to demonstrate their adherence to the arm’s length principle. This is a universal principle adopted by most countries in the world including Indonesia, which asserts that deals be structured and prices for goods or services be established in such a way so as to reflect what would have resulted had the transactions been conducted between unrelated parties.
Determining the arm’s length nature of controlled transactions is a complex process. It involves identification and analysis of economically significant factors affecting the prices charged in the controlled transactions. It then goes to comparing those factors with uncontrolled transactions taking place in comparable circumstances. The OECD 1995 Transfer Pricing Guidelines for Multinational Enterprises and Tax Administration provide detailed steps on this process.
Many countries have adopted the OECD TP guidelines as a standard to deal with transfer pricing issues. In relation to the TP documentation requirement above, the DGT has also declared the adoption of the OECD TP guidelines where a tax treaty is in force. This may improve TP practice in Indonesia, however uncertainty may still remain as every issue is not always adequately addressed in the guidelines.
The most difficult part of the OECD guidelines is the search for comparable uncontrolled transactions.
In this respect, unless the taxpayer also concludes transactions with unrelated parties, the search has to rely on public information, i.e. general financial statements filed by companies following certain legislation or stock exchange regulations.
Ideally a given set of controlled transactions should be compared with contemporaneous uncontrolled transactions taking place in the same geographical area. However, information regarding contemporaneous uncontrolled transactions is normally only available months after the CITR filing date. This entails a question on the extent to which past-year information can be used to determine the arm’s length nature of controlled transactions taking place in a particular year.
Additionally, if the use of local comparables becomes a norm, there is another potential problem in the Indonesian context. In practice, searches for comparables mainly rely on commercial databases containing regional financial statements. Sometimes it is difficult to locate Indonesian companies on databases. Can regional comparables be used if local comparables cannot be found?
Given the universal applicability of the arm’s length principle, the DGT and taxpayers engaged in related party transactions actually have a common interest in ascertaining adherence to this principle; and TP documentation can serve as a media of communication between them. However, because the complexity of the issue compounded by the public information constraints, even the best-intentional taxpayers and tax authorities may arrive at a different conclusion regarding the arm’s length nature of the same set of controlled transactions. Uncertainty will therefore prevail as long as the risk of TP adjustments remains high.
Some measures of the DGT may reduce uncertainty. Because of the time lag on the availability of public information, contemporaneous comparables should be used only in exceptional situations, e.g. in an audit of a taxpayer who fails to prepare TP documentation. Taxpayers should be allowed to prepare TP documentation either before concluding controlled transactions or after concluding transactions, but before filing CITRs based on the information reasonably available to them by then.
It makes sense to give priority to local comparables. However, in the absence of local comparables the DGT may need to rule the relevance of regional comparables.
Additionally, to broaden the basis for local comparables, the DGT may need to encourage the enforcement of another regulation that requires Indonesian limited liability (PT) companies to file their financial statements on an annual basis to the Trade Ministry.The writer is the managing partner of PreciousNine.