Corporate growth and business group expansion are driven by strategies to increase profit and operational efficiency. At the business unit level, companies can implement Porter's generic strategies through cost leadership or product differentiation. To support growth, business groups can also carry out vertical or horizontal integration. Vertical integration aims to secure the supply chain and reduce production costs, while horizontal integration aims to expand market share and improve efficiency through operational synergy.
These strategies can increase the volume of transactions between entities within a single business group. The pricing of transactions between affiliated entities is referred to as transfer pricing. This practice is a legitimate business policy used to allocate resources, share risks, and determine returns among affiliated entities. Transfer pricing must be distinguished from fraudulent practices such as under-invoicing, which involves reporting a transaction value below its actual worth using documents that do not reflect the true facts of the transaction. In such practices, elements of forgery or document manipulation cause the reported value to deviate from the actual transaction.
To provide legal certainty and prevent Base Erosion and Profit Shifting (BEPS), the Ministry of Finance of the Republic of Indonesia issued Minister of Finance Regulation Number 172 of 2023 (PMK 172/2023) on December 29, 2023. This regulation consolidates three previous regulations: PMK 213/2016 on transfer pricing documentation, PMK 49/2019 on the Mutual Agreement Procedure (MAP), and PMK 22/2020 on Advance Pricing Agreements (APA). This consolidation unifies the provisions regarding documentation, dispute resolution, and transfer pricing agreements into a single regulation.
Related Parties
The obligation to apply the Arm's Length Principle (ALP) or Prinsip Kewajaran dan Kelaziman Usaha (PKKU) arises when a taxpayer's transaction is affected by a related party relationship. Under PMK 172/2023, a related party is defined as a state of dependence or affiliation that influences decision-making and price setting and may deviate from conditions that would apply between independent parties. This provision applies to both cross-border and domestic transactions.
Related party relationships are determined based on three main factors: ownership or equity participation, control, and familial relationships.
- Ownership or Equity Participation. A related party relationship arises if a party holds a direct or indirect equity participation of at least 25% in another taxpayer. This connection also applies if two or more taxpayers are owned by the same shareholder with an equity participation of at least 25% in each respective taxpayer.
- Control. A related party relationship can arise when one party controls another party through management or the use of technology. This connection can also occur if the same person is involved, directly or indirectly, in managerial or operational decision-making across two different entities. Furthermore, a related party relationship can be identified, among other things, when a party commercially or financially declares itself to be part of the same business group.
- Familial Relationship. A related party relationship can arise due to blood or marital relationships in a direct and/or collateral line of descent to the first degree.
The determination of a related party relationship is based not only on the formal form of the connection between parties, but also on the actual conditions. Consequently, a transaction between formally independent parties can still be influenced by a related party relationship if dependence or affiliation results in one party lacking independence in conducting its business activities.
Application of The Arm’s Length Principle
PMK 172/2023 requires taxpayers to apply the Arm's Length Principle (ALP) based on actual conditions using an ex-ante approach and in accordance with the application stages of the Arm's Length Principle. This approach is ideally applied at the time of transfer price setting and/or based on available data, as well as the economic and commercial conditions at the time the affiliated transaction takes place.
The ALP is fundamentally applied separately for each type of affiliated transaction (transaction-by-transaction approach). However, the analysis of several transactions may be aggregated when the transactions are closely linked or integrated, such that the contribution of each party cannot be separated or reliably analyzed if evaluated individually.
PMK 172/2023 establishes six stages in the application of the ALP as follows.
1. Transaction Identification. The taxpayer identifies the types of products or services transacted, the parties involved, and the basis of the related party relationship between them.
2. Industry Analysis. The taxpayer analyzes the factors affecting business conditions and pricing. This analysis includes product characteristics, industry conditions, business cycles, value chains, competition, location savings and efficiencies, government regulations, and macroeconomic conditions such as inflation, interest rates, and exchange rates. The results of this analysis are used to understand the economic conditions of the transaction and to identify differences between affiliated transactions and independent transactions.
3. Transactional Analysis. The taxpayer evaluates the commercial conditions of the transaction based on contractual terms, characteristics of the products or services, business strategies, as well as the Functions, Assets, and Risks (FAR) analysis of each party.
4. Comparability Analysis. The taxpayer compares the affiliated transaction with independent transactions to assess their degree of comparability. If there are material differences affecting price determination, relevant adjustments must be made to the comparable data to ensure more reliable analysis results.
5. Method Selection. The taxpayer selects the transfer pricing method appropriate to the characteristics of the transaction, the availability of reliable comparable data, and the strengths and limitations of each method in testing the fairness of the transaction.
6. Method Application. The taxpayer applies the selected method to determine an arm's length price or profit margin that meets the ALP. The results of the test may take the form of an arm's length point or an arm's length range.
Economic Substance Testing
PMK 172/2023 requires taxpayers to undergo preliminary steps for certain transactions before conducting comparability analysis and determining transfer prices. These preliminary steps generally aim to test the economic substance of affiliated transactions, including commercial rationality and the economic benefits.
If a taxpayer is unable to prove the economic substance of a transaction at this stage, the transaction may be deemed not to comply with the ALP. The Directorate General of Taxes (DGT) may make corrections under applicable regulations without proceeding to further testing through comparability analysis.
PMK 172/2023 specifies seven categories of transactions that must undergo testing in these preliminary steps. The substantiation requirements for each category include the following:
| Transaction Category | Substantiation Requirements |
| Intra-Group Services | The taxpayer must prove that services were actually rendered, needed by the receiving entity, and generated economic benefits—such as cost savings, increased sales, or business protection. The service must not merely consist of shareholder activities, incidental benefits, duplicated services, or benefits arising solely from group membership (passive association). For on-call services, taxpayers must prove that similar services could not be obtained from an independent third party without a prior stand-by agreement. |
| Intangible Assets | Legal ownership of intellectual property rights alone is insufficient. Taxpayers must explain the economic contribution of the parties through DEMPE analysis (Development, Enhancement, Maintenance, Protection, and Exploitation). This analysis includes identifying the parties that perform functions related to development, enhancement, maintenance, protection, and exploitation of assets, including decision-making, funding, and managing risks associated with asset value creation. |
| Intra-Group Loans | Taxpayers must prove that the loan has economic and legal substance as debt. Elements to be examined include maturity date, principal and interest payment schedules, intended use of funds, default consequences, collection rights, and the borrower's capacity to repay the debt similar to an independent debtor. |
| Other Financial Transactions | Taxpayers must explain the transaction's purpose, economic rationality, legal basis, as well as the expected and measurable economic benefits for the involved parties. |
| Asset Transfers | Taxpayers must explain the economic reasons behind transferring tangible assets to an affiliated party and the expected benefits. This decision needs to be compared against other commercial alternatives that are realistically available (options realistically available) in the market. |
| Business Restructuring | Restructuring may include transferring functions, assets, or risks between entities, such as transforming from a full-fledged manufacturer into a contract manufacturer. Taxpayers must document the commercial reasons for the restructuring and the expected benefits for both the group and the involved entity. The analysis also needs to consider compensation for the transfer of relevant functions, assets, or risks, including termination compensation (exit charge or indemnification) where required by transaction conditions. |
| Cost Contribution Arrangements | In a Cost Contribution Arrangement (CCA), taxpayers must prove that cost allocation is based on the expected contributions and benefits of each participant. Every participant must have a genuine need for the agreement's output, such as joint research results, and obtain economic benefits proportional to the contributions provided. |
Taxpayers need to systematically prepare supporting documentation to prove the economic substance of transactions. Such documentation may include business correspondence, minutes of strategic meetings, investment feasibility studies, and proof of work deliverables. A contract alone is not necessarily sufficient to prove that a transaction was actually performed and yielded economic benefits.
Transfer Pricing Methods
PMK 172/2023 regulates eight transfer pricing methods. The selection of a method is not entirely unrestricted, as taxpayers must consider the hierarchy of methods, their degree of reliability in testing comparability, and the availability and/or limitations of comparable data for each method.
Methods that directly compare transaction prices are prioritized provided they can be applied with a level of reliability equivalent to profit-based methods. Gross profit-based methods are likewise prioritized over net operating profit-based methods.
The eight transfer pricing methods along with their characteristics of application are as follows.
| Method | Characteristics and Application |
| Comparable Uncontrolled Price (CUP) | This method compares the price of an affiliated transaction with the price of a comparable independent transaction. CUP is suitable for commodity transactions with transparent market prices, as well as goods or services possessing similar characteristics. Differences in transaction conditions must be accounted for if they materially affect the price. |
| Resale Price Method (RPM) | This method determines an arm's length price based on the resale price to an independent party minus an appropriate gross profit margin. RPM is suitable for distributors or resellers that do not perform significant marketing or product development functions and maintain a relatively limited functional and risk profile. |
| Cost Plus Method (CPM) | This method determines an arm's length price by adding an appropriate gross profit mark-up to relevant costs. CPM can be used, among other applications, for routine services provided between entities within the same group, provided transaction conditions support its use. |
| Profit Split Method (PSM) | This method splits combined profits among parties based on their respective economic contributions. PSM can be used when the business operations of the parties are highly integrated, or when each party contributes unique and valuable assets while sharing interrelated economic risks. |
| Transactional Net Margin Method (TNMM) | This method tests net operating profit indicators, such as operating margin or markup on total costs, by comparing them against those of comparable independent parties. TNMM can be used when other methods are less reliable or when comparable price and gross profit data are inadequate. |
| Comparable Uncontrolled Transaction (CUT) | This method compares the transaction value or rate of return of an affiliated transaction with a comparable independent transaction. Its application can include testing loan interest rates, fee provisions, discount rates, marketing commissions, and royalty rates, provided the transaction characteristics and comparable basis align. |
| Valuation of Tangible and Intangible Assets | Asset valuation methods are used to determine the fair value of tangible and intangible assets in affiliated transactions. Applications may cover leasing, transfer of intellectual property rights, transfer of financial instruments, and transfer of exploitation rights in the mining, forestry, or plantation sectors. Valuations must apply approaches consistent with asset characteristics and tax regulations. |
| Business Valuation | This method assesses the value of an entity or business activity as a whole. Applications may include business restructurings, share transfers, transfers of divisions or business lines, as well as non-cash equity contributions (inbreng). Valuations must consider economic conditions, business prospects, assets, liabilities, and relevant risks. |
Comparability Analysis
The reliability of a transfer pricing method depends on the quality of the comparable data. PMK 172/2023 establishes a hierarchy for using comparable data. Internal comparables, namely transactions between a taxpayer and an independent party, must be given priority when their level of reliability is equivalent to that of external comparables.
If internal comparables are unavailable or unreliable, taxpayers may use external comparables. The search for external comparables must prioritize companies operating in the same country or jurisdiction as the tested party. Regional comparables, such as companies in the Asia-Pacific region, or global comparables may be used if data within the same country or jurisdiction is inadequate.
In applying profit-based methods such as CPM, RPM, and TNMM, the tested party should ideally be the entity with the simplest functional and risk profile (FAR) that does not hold unique intangible assets affecting the analysis. The tested party does not necessarily have to be located in Indonesia. A foreign affiliated entity may be selected as the tested party if its business profile is simpler and its comparable data is available and reliably verifiable.
Annual Data
PMK 172/2023 prioritizes single-year data to determine the arm's length range. Such data reflects the economic and business conditions during the year the transaction took place, including inflation changes, market conditions, and supply chain disruptions.
Multi-year data may be used, for example, to analyze products with long life cycles or to identify abnormal market conditions in a specific year. Taxpayers must explain the rationale for using multi-year data and demonstrate its benefit to the analysis results.
Transfer Pricing Documentation
Taxpayers engaging in affiliated transactions must fulfill transfer pricing documentation (TP Doc) obligations in accordance with applicable regulations. This documentation consists of a master file, a local file, and a country-by-country report (CbCR).
Documentation Thresholds
The obligation to prepare a master file and a local file is determined based on specific criteria evaluated using gross turnover and affiliated transaction values from the preceding tax year.
Taxpayers engaging in affiliated transactions are required to prepare a master file and a local file if they meet at least one of the following criteria:
- Gross turnover in the preceding tax year exceeds IDR 50 billion.
- The value of affiliated transactions for the supply of tangible goods in the preceding tax year exceeds IDR 20 billion.
- The value of affiliated transactions for each category of services, interest payments, utilization of intangible assets, or other transactions in the preceding tax year exceeds IDR 5 billion.
- Engaging in transactions with affiliated parties located in a country or jurisdiction with an income tax rate lower than the rate applicable in Indonesia, in accordance with the criteria in tax regulations.
For CbCR, the preparation obligation applies to the ultimate parent entity of a business group with a consolidated gross turnover of at least IDR 11 trillion in the preceding tax year.
If the ultimate parent entity is located overseas, an Indonesian affiliated entity may be required to submit CbCR locally (secondary local filing) if the group's consolidated gross turnover reaches the equivalent of EUR 750 million and the requirements for automatic exchange of information with the parent entity's country of residence are not met. Such conditions include the absence of a qualifying automatic exchange mechanism or exchange failures by the foreign tax authority.
Deadlines and Filing
The master file and local file must be available no later than four months after the end of the tax year. Meanwhile, CbCR must be available no later than 12 months after the end of the tax year.
Taxpayers must also submit a summary of the master file and local file using the designated form in the annual corporate income tax return (SPT Tahunan PPh Badan). Under the Coretax administration system, the submission of the summary is carried out in accordance with the mechanisms specified by the DGT.
During compliance monitoring or tax audits, the DGT may request taxpayers to submit TP Doc in physical or digital format. Under applicable regulations, taxpayers must submit the requested documentation no later than one month from the date the request is issued.
Delays in preparing or submitting documentation can result in TP Doc failing to meet the formal requirements prescribed by regulation. Consequently, the taxpayer risks being deemed non-compliant with the ALP. This condition may affect the audit process and the determination of transaction fairness by the DGT, potentially leading to tax adjustments and administrative penalties under applicable laws.
Transfer Pricing Adjustments
Transfer pricing disputes occur when the DGT deems an affiliated transaction non-compliant with the ALP. Such assessments may stem from differing views between the taxpayer and the tax authority regarding the economic substance of the transaction or the selection and/or application of the transfer pricing method. Under these circumstances, the DGT may issue tax adjustments in accordance with applicable tax regulations.
Transfer pricing adjustments may result in several tax consequences, primarily consisting of primary adjustments and secondary adjustments.
Primary Adjustments
A primary adjustment is a correction made by the DGT to a taxpayer's income or expenses resulting from an affiliated transaction deemed not at arm's length. The adjustment is carried out by aligning the reported transaction value with the results of the ALP assessment conducted from the tax authority's perspective in accordance with applicable regulations.
For example, if the export price of coal to an overseas affiliated company is determined to be underpriced, the DGT may increase the sales value for tax purposes. This adjustment increases taxable income and may result in additional corporate income tax liabilities.
Secondary Adjustments
A secondary adjustment relates to the secondary discrepancy arising from a primary adjustment. Under certain conditions, this difference may be treated as constructive dividends to the affiliated party.
In addition to the supplementary corporate income tax resulting from the primary adjustment, the taxpayer may face withholding tax obligations on the constructive dividends. For foreign dividend recipients, the domestic Income Tax Article 26 rate is generally 20% of the gross amount, unless otherwise provided under applicable rules. Rates under Double Taxation Avoidance Agreements (DTAAs) or tax treaties may apply.
Primary and secondary adjustments can directly increase tax risks for the taxpayer and indirectly impact the business group.
Fund Repatriation
Under conditions specified in PMK 172/2023, secondary adjustments can be avoided through fund repatriation back to Indonesia. The application of this mechanism depends on fulfilling criteria set forth in the regulations.
These requirements include:
- Taxpayers agree with the primary adjustment value established during the audit process.
- Taxpayers satisfy the provisions regarding the waiver of rights to pursue legal remedies against said adjustment.
- The funds corresponding to the price difference are repatriated by the affiliated party to Indonesia, with proof of repatriation provided prior to the issuance of the Tax Assessment Letter (Surat Ketetapan Pajak).
Compliance with these criteria must be verified according to applicable provisions before the repatriation mechanism can be utilized.
Corresponding Adjustments
A corresponding adjustment aims to mitigate double taxation risks when one jurisdiction imposes a transfer pricing adjustment. If one country increases an entity's taxable profit, a corresponding adjustment on the counterparty entity may be required to ensure the same income is not taxed twice.
For domestic affiliated transactions, corresponding adjustments can be executed through an amended annual income tax return or other tax administrative mechanisms under applicable rules. Implementation depends on specified requirements, including the status of the primary adjustment and taxpayer’s agreement where required.
For cross-border transactions, corresponding adjustments generally require agreement between the tax authorities of both jurisdictions through the Mutual Agreement Procedure (MAP). Corresponding adjustments cannot be made unilaterally by one country.
Transfer pricing adjustments may also impact Value Added Tax (VAT). If the DGT adjusts the selling price of goods or services upward, the seller may incur additional VAT liabilities under applicable regulations.
Dispute Prevention and Resolution
PMK 172/2023 regulates instruments to prevent and resolve transfer pricing disputes, primarily through Advance Pricing Agreements (APA) and Mutual Agreement Procedures (MAP).
APA
An APA is a written agreement between a taxpayer and the DGT, or between tax authorities of two or more countries, regarding the application of a transfer pricing method for affiliated transactions over a specified period.
An APA may take the form of a unilateral agreement involving a single tax authority, a bilateral agreement involving two countries, or a multilateral agreement involving more than two countries. The agreement determines the transfer pricing method and critical assumptions to be used during the APA term. Under applicable regulations, the APA coverage period may extend up to a maximum of five tax years.
Taxpayers must submit applications in accordance with prescribed schedules and procedures. Applications must be accompanied by information regarding the affiliated transactions, business conditions, proposed methods, and required supporting documentation.
An APA may be applied retroactively to tax years prior to the agreement period through a roll-back mechanism, provided specified criteria are met. Retroactive application is not automatic and must be explicitly requested in the application.
Requirements for roll-back include:
- No material differences exist in the facts and circumstances surrounding the transactions in the requested roll-back tax years compared to those in the proposed APA period.
- The DGT has not issued a Tax Assessment Letter (Surat Ketetapan Pajak/SKP) for the requested tax year, pursuant to applicable requirements.
- The requested tax year remains within the required period prescribed by applicable regulations.
If the roll-back is approved, adjustments for previous years are executed in accordance with the agreed terms and tax provisions.
MAP
MAP is a procedure used to resolve cross-border tax issues, including double taxation resulting from transfer pricing adjustments. Through this mechanism, the tax authorities of both countries negotiate to arrive at a resolution pursuant to the provisions of the applicable Double Tax Avoidance Agreement (DTAA).
The MAP process may run simultaneously with domestic objection or appeal procedures where permitted by applicable regulations. However, the process must observe procedural limitations, including the impact of court rulings that have attained final and binding legal force.
The agreed outcome between tax authorities is formalized in a mutual agreement document in accordance with established mechanisms. This document serves as the basis for executing the resolution, including any tax adjustments or tax refunds, provided all requirements are met.
Strategic Directions
The issuance of PMK 172/2023 strengthens transfer pricing assessments in Indonesia. Tax audits focus not only on document completeness, but also on transaction substance, economic benefit, and commercial rationale behind affiliated transactions both cross-border and domestic.
Based on these provisions, there are four strategic aspects that corporate taxpayers need to consider:
- Prioritize Transaction Substance. Transfer pricing testing cannot rely solely on contracts and formal documents. Management fee payments, royalty fees, and business restructuring transactions must be supported by proof of economic benefits, business rationality, and relevant analysis, including DEMPE analysis for intangible asset transactions. Without adequate support, such transactions may be subject to adjustments by the tax authorities.
- Strengthen Compliance and Comparable Data. Transfer pricing documentation must align with price-setting practices. Taxpayers also need to ensure that the selection of comparable data complies with applicable regulations, including the use of single-year data and prioritizing domestic comparables where relevant.
- Utilize APA and MAP. APA and MAP can help manage transfer pricing dispute risks and double taxation. Taxpayers should consider these mechanisms early on, including the roll-back provisions in APAs and the possibility of submitting a MAP concurrently with domestic dispute procedures, subject to applicable requirements.
Transfer pricing management must involve sales, operations, tax, legal, and finance functions. This coordination is essential to ensure that transfer pricing policies reflect commercial substance and are backed by adequate documentation.
Companies should also engage transfer pricing experts starting from the planning stage of affiliated transactions. Documentation, economic benefit analyses, and price-setting rationales can thus be prepared in advance to minimize the risk of tax adjustments and disputes.
Legal References
- Minister of Finance Regulation Number 172 of 2023 concerning the Application of the Arm’s Length Principle in Transactions Affected by Special Relationships.
- Minister of Finance Regulation Number 213/PMK.03/2016 concerning the Types of Documents and/or Additional Information Required to Be Maintained by Taxpayers Engaging in Transactions with Parties Having Special Relationships, and the Procedures for Their Management.
- Minister of Finance Regulation Number 49/PMK.03/2019 concerning Procedures for Implementing the Mutual Agreement Procedure.
- Minister of Finance Regulation Number 22/PMK.03/2020 concerning Procedures for Implementing Advance Pricing Agreements.
- Law of the Republic of Indonesia Number 7 of 1983 concerning Income Tax, as amended several times, most recently by Law of the Republic of Indonesia Number 7 of 2021 concerning the Harmonization of Tax Regulations.
- Double Taxation Avoidance Agreements (DTAAs) between the Government of the Republic of Indonesia and the relevant treaty partner countries or jurisdictions.
Also Read:
Late Local File Preparation: Understanding the Risks and Next Steps
Audit Readiness: Preparing Local Files for Tax Scrutiny
Understanding Transfer Pricing: A Legal Practice, Not Underinvoicing
Writer: Yunianto Kurniawan | Editor: Thomas Rizal