Arm’s Length Principle: A Cornerstone of TP Doc

As 2025 draws to a close, taxpayers are reminded to start preparing their financial statements and supporting documents for tax return filing. For taxpayers engaging in related-party transactions, one crucial requirement that must not be overlooked is transfer pricing documentation (TP Doc).

Since the issuance of PMK 213/PMK.03/2016, the rules on TP Doc have continued to develop. The most recent refinement appears in Minister of Finance Regulation (Peraturan Menteri Keuangan/PMK) Number 172 of 2023 concerning the Application of the Arm’s Length Principle to Transactions Affected by Related Parties.

At the heart of TP Doc requirements lies one fundamental concept known as the arm’s length principle (ALP).

What Is the ALP?

According to the OECD, the ALP requires that transactions between related parties be treated as if they were conducted between independent parties. This ensures that profits arising from those transactions are taxed appropriately, in line with Article 9 of the OECD Model Tax Convention.

In Indonesia, the ALP is understood as a standard of fair business practice, meaning that related-party transactions must be conducted as if the parties were not related.

ALP Application in Indonesia

The application of the ALP must reflect the economic reality at the time the related-party transaction occurred. It must also follow the stages stipulated in PMK Number 172 of 2023.

Stages of Applying the ALP

Entities conducting related-party transactions under the ALP must complete six main stages, as outlined in PMK Number 172 of 2023, which include:

1. Identification of Transactions Affected by Related Parties
   1. Identify the related-party transactions carried out by the taxpayer.
   2. Identify all parties involved in the transactions.

   3. Identify the nature and form of the related-party relationship.

       

2. Industry Analysis

   Analyze the industry relevant to the entity’s business activities, including factors that influence performance within that industry. These may include product types, industry and market characteristics, competition levels, efficiency and location advantages, economic conditions, regulatory environment, and other factors influencing operating performance.

    

3. Identification of Commercial and Financial Relationships

   Analyze contractual arrangements, functions performed, assets used, risks assumed, product characteristics, economic conditions, and business strategies adopted.

    

4. Conducting a Comparability Analysis
   1. Understand the characteristics of the controlled transaction being tested.
   2. Identify independent transactions that may serve as potential comparables.
   3. Determine the party being tested for the chosen transfer pricing method.
   4. Identify material differences between the related-party transaction and potential comparables.
   5. Make reliable adjustments to eliminate the impact of those differences.

   6. Select final independent transactions to be used as comparables.

       

5. Determining Transfer Pricing Methods

   PMK Number 172 of 2023 prescribes eight approved transfer pricing methods, including:

   1. comparable uncontrolled price method;
   2. resale price method;
   3. cost plus method;
   4. profit split method;
   5. transactional net margin method;
   6. comparable uncontrolled transaction method;
   7. tangible and intangible asset valuation methods;

   8. business valuation method

       

6. Applying and Determining Transfer Pricing

   PMK Number 172 of 2023 provides detailed guidance on how each method should be applied.

   1. The comparable uncontrolled price method involves comparing prices between a related-party transaction and an independent transaction.
   2. The resale price method involves deducting an appropriate gross profit from the resale price.
   3. The cost plus method is carried out by adding an appropriate gross profit margin to the cost of goods sold.
   4. The profit split method involves allocating the combined profits from related-party transactions among the parties.
   5. The transactional net margin method involves comparing the net operating profit margin of the tested party with that of independent comparables.
   6. The comparable uncontrolled transaction method involves comparing prices or profits between controlled and uncontrolled transactions.
   7. Tangible and intangible asset valuation methods are carried out in accordance with valuation procedures for tax purposes.

   8. The business valuation method is carried out in accordance with applicable valuation regulations.

       

Legal Basis

The ALP and TP Doc requirements are supported by several important regulations, as follows:

1. Law of the Republic of Indonesia Number 7 of 1983 concerning Income Tax, as amended by Law of the Republic of Indonesia Number 7 of 2021 concerning the Harmonization of Tax Regulations.
2. PMK Number 213/PMK.03/2916 concerning Types of Documents and/or Additional Information Required to Be Maintained by Taxpayers Engaging in Related-Party Transactions and Procedures for Their Management.
3. PMK Number 172 of 2023 concerning the Application of the Arm’s Length Principle to Transactions Affected by Related Parties.

Taxpayers often find the ALP and TP Doc requirements confusing. Below are some frequently asked questions on this topic.

1. What is the purpose of the ALP in taxation?

   The ALP ensures that related-party transactions between related parties are conducted fairly and not used to shift profits improperly.

    

2. When should the TP Doc be prepared?

   TP Doc must be completed no later than four months after the end of the fiscal year, in parallel with the preparation of financial statements for the tax return.

    

3. Do taxpayers need to apply all transfer pricing methods?

   TP Doc must be completed no later than four months after the end of the fiscal year, in parallel with the preparation of financial statements for the tax return.