Tax authorities of commodity-exporting countries including Indonesia have major transfer pricing challenges in ensuring the arm’s length nature of the commodity transactions. During recent years, many transfer pricing disputes on commodity transactions in Indonesia are increasing due to: a) taxpayer has not sufficiently prepared documentation to prove the consistency of the pricing policy set and actual conduct of the arrangements; b) the application of the profit method to the commodity transaction may not serve sufficient approximation of the arm’s length nature of the transactions; c) the interposing of intermediary entity having limited function located in lower tax rate jurisdiction which attracts suspicion of possibility of the Base Erosion and Profit Shifting (“BEPS”).
Directorate General of Taxes (DGT) approach on the commodity transfer pricing assessment
Indonesia has enacted several transfer pricing regulations including the Minister of Finance Regulations number PMK-213/PMK.03/2016 (“MoF 213/2016”) related to Transfer Pricing Documentations, Director General of Tax Regulation number PER-32/PJ/2011 on the application of arm’s length principle, and Director General of Tax Regulation number PER-22/PJ/2013 which covers the transfer pricing audit procedures. The aforementioned regulations do not explicitly require taxpayers to assess commodity transactions by applying a predetermined method. Rather, the selection of the method is based on ‘the most appropriate method’ analysis. Recently, the Minister of Finance also issued regulation number PMK-22/PMK.03/2020 regarding the procedures for Advance Pricing Agreement which explicitly clarifies that the Comparable Uncontrolled Price (“CUP”) method is the most appropriate method for commodity transactions.
Under the MoF 213/2016, the three-tiered transfer pricing documentation i.e., Master File, Local File, and Country-by-Country Report is introduced. The regulation which adopts OECD BEPS Action 13, significantly updates the transfer pricing compliance requirement in Indonesia. Unlike previous regulations which adopt the arm’s length outcome-testing approach, MoF 213/2016 requires taxpayers to implement the ex-ante approach. The approach expects taxpayers to assess the arm’s length nature of the pricing policy of their related party transaction based on data and information available at the time the transaction is conducted. Should taxpayer entered into commodity transactions, the regulation also obliges taxpayers to provide specific information related to the commodity transactions in their Local File including the following:
a) Transaction scheme and its explanation;
b) Pricing policy applied in the last 5 (five) years;
c) Detailed information on the commodity transactions by the minimum of:
· Number and date of invoice;
· The name and jurisdiction of the counterparty;
· Commodity’s specification/quality;
· Quantity and unit price; and
· Dates of delivery/shipment.
Tax officials prefer taxpayers to apply the CUP method, instead of the profit methods, to prove the arm’s length nature of commodity transactions. The profit method may not provide a direct measure for assessing the commodity transactions. Further, due to the lack of the available appropriate comparable within databases, the profit level methods may cause inaccurate approximation of the profit for the tested party.
Arguably, the guidance on the application of CUP method for commodity transactions in the domestic regulation is not sufficiently exhaustive. Therefore, tax practitioners and tax officials rely on guidance provided by the OECD Transfer Pricing Guidelines 2017 (“TPG”) including as follows:
a) Quoted commodity price generally serves as a reliable reference price for determining the price in transactions between affiliates. In certain circumstances, taxpayers should prove that the market reference price is, indeed, extensively utilized in certain commodity industries;
b) For the CUP method to be reliably applied to commodity transactions, the economic characteristics of the commodity products in both affiliated transactions and independent transactions need to be comparable. Therefore, taxpayers should present that the main characteristic of commodity products transacted between affiliates, among others: the physical features; quality of the commodity; and the contractual terms of the controlled transaction; such as volumes traded; the period of the arrangements; the time/date; and terms of delivery; transportation; insurance; and the terms of the foreign currency should be comparable to the commodity settled between independent parties;
c) Taxpayers should provide reliable evidence and supporting documents related to the pricing policies including the proposal and acceptances of the contractual terms agreed between the parties. Consistency between the contractual terms and the actual conducts should also be demonstrated especially at the time of the tax audit performed. Tax officials may apply different pricing dates i.e., price at the time of the shipment date, should there be inconsistencies between the pricing date in the contract and the actual conduct taken by the parties.
Enhancing the arm’s length analysis on commodity transactions
The aforementioned application of CUP method for the commodity transaction can be strengthened by the following:
a) The use of functional and value chain analysis to accurately delineate commodity transaction
Functional analysis is one of the foundations in a conduct of arm’s length analysis. The analysis basically seeks to map the economic contribution and profitability of the parties involved in the transaction by identifying the functions performed, the assets used, and the risks assumed by each party. A complete understanding over the value chain helps in effective delineation of affiliated transactions which can be used to assess whether the transfer pricing outcomes already align with value creation. The analysis can identify whether appropriate remuneration is already allocated and aligned to the commercial value contribution of each entity in the value chain.
b) Transaction-by-transaction approach
Paragraph 3.9 of TPG elucidates that depending on facts and circumstances, the transaction-by-transaction approach may provide precise approximation of the arm’s length condition of the affiliated transaction. The approach can be adopted by examining the commodity transaction on an invoice-by-invoice basis and segregating the various related party transactions for the transfer pricing analysis. By segregating the transfer pricing analysis, taxpayers can identify specific transactions which are not consistent with the arm’s length principle. Further, the approach can assist tax officials in mapping the transfer pricing risk which need to be prioritized.
c) Application of conjunctive analysis on commodity transactions
Although the CUP method is generally the most appropriate method to test commodities in transactions between affiliated parties, there are situations in which the use of more than one method can be applied simultaneously to increase the reliability of the arm’s length test results, or in the case of CUP method, the application does not generate conclusive result. The conjunctive method is important to apply especially in ‘triangular’ transactions where the overseas affiliates performed their functions as procurement center, trader/marketing hub, etc. In this case, profit methods i.e., the Cost Plus Method or Resale Price Method as a conjunctive method can be applied to ensure that the remuneration received by overseas affiliates is already aligned with their contribution for the value creation.
The CUP method is the most direct and reliable method in assessing the arm’s length nature of commodity transactions. Sufficient documentation related to pricing determination is crucial to be presented during tax assessment. Although, in applying the CUP method the main comparability factor is the characteristics of products and services, the functional and the value chain analysis still play an important role for accurately delineating the actual transactions between affiliates. In addition, to mitigate potential disputes due to inconclusive CUP method application, usage of conjunctive method is a valuable option to be considered for commodity transactions between affiliated parties.