In transfer pricing supervision based on Minister of Finance Regulation Number 172 of 2023 (PMK 172/2023), the Directorate General of Taxes (DGT) does not merely examine the completeness of formal documents and contracts. For certain affiliated transactions, taxpayers must first undergo preliminary assessment before the DGT conducts a comparability analysis and determines the transfer price. This assessment aims to ensure that the transaction possesses economic substance, commercial rationale, and benefits for the parties involved.
The results of this preliminary assessment determine the continuation of the transaction audit. If a taxpayer cannot prove the economic substance of a transaction, it is deemed not to meet the Arm's Length Principle (ALP). Under these conditions, the DGT can make tax adjustments directly without proceeding to the comparability analysis stage.
PMK 172/2023 establishes seven categories of affiliated transactions that must undergo preliminary assessment. First, intra-group services. Taxpayers must prove that the services were actually rendered, needed by the recipient, and provided economic benefits, such as increased sales or cost savings.
Services that are in the nature of shareholder activities, duplication of services, incidental benefits, or mere membership in a group (passive association) do not meet the criteria for service benefits. For on-call services, taxpayers must also prove that similar services cannot be obtained from independent third parties without a prior standby agreement.
Second, the use of intangible assets. Legal ownership of intellectual property rights is not sufficient to prove the right to income from exploiting intangible assets. Taxpayers must explain the economic contribution of each party based on the DEMPE (Development, Enhancement, Maintenance, Protection, and Exploitation) analysis. This analysis covers the functions of developing, enhancing, maintaining, protecting, and exploiting assets, including contributions to decision-making, funding, and risk management.
Third, intra-group loans. Taxpayers must prove that the loan has the legal and economic substance of debt. Proof includes the maturity date, the principal and interest repayment schedule, the purpose of the funds, the consequences of default, collection rights, and the borrower's ability to repay the debt as an independent debtor would.
Fourth, other financial transactions. Taxpayers must explain the economic rationale, legal basis, transaction purpose, and benefits obtained by each respective party.
Fifth, asset transfers. The transfer of assets to affiliated parties must be supported by economic reasons and commercial benefits. Taxpayers need to compare the transaction with other alternatives realistically available to the parties involved.
Sixth, business restructuring. The transfer of functions, assets, or risks in a business restructuring must be supported by commercial reasons and documentation regarding the compensation provided. For example, changing status from a full-fledged manufacturer to a contract manufacturer requires consideration of an exit charge if the transaction conditions meet the requirements for such compensation.
Seventh, Cost Contribution Arrangements (CCA). The sharing of costs among participants must be based on the necessity of the arrangement's outcome and the expected economic benefits. Each participant's contribution must be proportionate to the benefits they receive.
In facing these tests, it is not enough for taxpayers to merely rely on contracts as proof of a transaction. Taxpayers need to prepare documentation demonstrating the actual execution and economic substance of the transactions, which includes business correspondence, strategic meeting minutes, investment feasibility studies, and proof of deliverables. Such documentation is essential to support the proof of economic benefits and to mitigate the risk of tax adjustments by the DGT.
Also Read:
APA and MAP: Strategies for Managing Transfer Pricing Dispute Risks
Transfer Pricing: Applying the Arm’s Length Principle to Affiliated Transactions
Understanding Transfer Pricing: A Legal Practice, Not Underinvoicing
Writer: Yunianto Kurniawan | Editor: Thomas Rizal
