Global Tax Alert (News from Transfer Pricing) | 18 December 2013
Indonesian Tax Authority releases additional transfer pricing audit guidelines
On 24 October 2013, Indonesia's Directorate General of Tax (DGT) released circular number SE-50/PJ/2013 (SE-50) entitled Technical Audit Guidelines for Taxpayers with a Special Relationship. SE-50 is a follow up to the recently released DGT regulation number PER-22/PJ/2013 regarding Guidelines for Audits of Taxpayers with Special Relationships (PER-22).1 The stated purpose of SE-50 is to provide “simplicity and uniformity to tax auditors within the DGT (the Tax Auditors) in performing audits on taxpayers with a special relationship to ensure the quality of the audit.”2
SE-50, expanding on the guidelines of PER-22, contains specific guidance to Tax Auditors on the steps that they should undertake in transfer pricing audits and the technical positions that they should adopt when evaluating specific transfer pricing issues during these audits. This is a positive development for Indonesian taxpayers (Taxpayers) as it should help Tax Auditors develop a more sophisticated understanding of Taxpayer's transfer pricing practices as well as adopt more consistent technical positions across transfer pricing audits.
There are a number of key items that Taxpayers should be aware of in this circular. These key items include:
- • New guidance on transfer pricing considerations for intercompany funding
- • A focus on the licensing of intangible property, intra-group services and interest charges as being special affiliated transactions that Tax Auditors should investigate
- • Continued reference to the collecting of information relevant to the Taxpayer from outside Indonesia
- • Detailed guidance on the types of audit steps and information that should be collected by Tax Auditors
- • Guidance on the use of a joint (or aggregated) transaction approach rather than a transaction by transaction approach previously required in Indonesia
In addition, SE-50 also provides some limited guidance on the completion of the supply chain forms contained in PER-22.
The new guidance on intercompany funding is perhaps the item that Taxpayers should pay the most attention to in SE-50, as guidance in this area represents a significant addition to guidance that has been previously released by the DGT.
Historically the analysis of the arm's length nature of intercompany funding for transfer pricing purposes in Indonesia largely focused on the arm's length nature of the interest rate on intercompany borrowings. However, following on from the broad steps identified in PER-22, SE-50 provides guidance on the steps that Tax Auditors are also required to undertake to analyze intercompany funding. Specifically, in addition to analyzing the arm's length nature of the interest rate used, Tax Auditors are required to:3
- • Analyze the necessity of the intercompany funding
- • Test the reasonableness of a Taxpayer's debt to equity ratio
SE-50 also makes mention of the “Halo effect” in the context of intercompany services, which may be taken as an indication that the DGT has considered an issue that could also impact the Tax Auditor's approach to the analysis of intercompany funding.
Analyzing the necessity of intercompany funding
In considering the necessity of the intercompany funding for a Taxpayer, SE-50 states that Tax Auditors should consider the following points when evaluating whether a related party debt is necessary:
- • Nature and objective of the loan, i.e., Does the loan tie in with the broader economic objectives of the Taxpayer?
- • Is it likely that the Taxpayer would enter into this type of arrangement given the market conditions at a particular point in time (e.g., high interest rates)?
- • Does the Taxpayer need all of the funds that it has borrowed and does the repayment period make sense given the Taxpayer's business objectives?
Through analyzing these questions, Tax Auditors potentially have the ability to either disallow a portion of the loan as being not necessary or to modify the loan arrangement with a subsequent impact on the interest rate that is able to be charged.
Debt to equity ratios
While there is still no guidance from the Ministry of Finance on debt to equity ratios as per Article 18(1) of the Income Tax Law, SE-50 provides Tax Auditors with guidance on how to re-characterize debt as equity under Article 18(3) of the Income Tax Law if the debt to equity levels of the Taxpayer are considered “not fair.” This may mean that the Taxpayer could end up in a situation where interest paid on the re-characterized intercompany debt is disallowed, while subject to withholding tax as a “dividend” payment on the determined equity amount.
In analyzing the debt to equity ratios of Taxpayers, Tax Auditors are to compare the Taxpayer's level of debt to equity to the debt to equity ratios4 of similar companies. This analysis may potentially be considered akin to an “arm's length debt test” which is often applied by tax authorities in other jurisdictions to analyze thin capitalization ratios. In practice, Tax Auditors have already made these types of adjustments in the course of a small number of transfer pricing audits. It can be expected that there will be more focus on this issue moving forward.
The halo effect
The halo effect, at a very high level, is that a Taxpayer's credit rating may be higher (and its cost of external funding potentially lower) simply because of its passive association with a corporate group, its parent entity or another group member. In the context of intercompany services, SE-50 states that no charge should be paid by a Taxpayer where it is the beneficiary of the “halo effect” (a reasonably well accepted principle in other tax jurisdictions).
This guidance will likely impact the Taxpayer in relation to related party funding as if the Tax Auditor considers there to be a halo effect in place then this may raise the credit rating of the Taxpayer and consequently lower the interest rate that it should pay on its intercompany debt by that Taxpayer. Accordingly, Taxpayers may need to start considering whether there may be a “halo effect” in the future when examining their intercompany funding arrangements.
Intangible property, intra-group services and interest charges
SE-50 specifically highlights that related party transactions relating to intangible property, services, and interest charges are “special related party transactions” that should be investigated by Tax Auditors during the preparation stage of an audit.5 Some of the technical points that are referenced in SE-50 which Taxpayers should pay attention to with respect to intangible property and intra-group services include:
Guidance in SE-50
Local ownership of intangible property
Tax Auditors should identify the Taxpayer's contribution in developing, protecting or maintaining intangible property through the identification of cost, functions, risks and local personnel with special qualifications. This is consistent with audit trends where Tax Auditors have used analyses such as the “bright line” test to attribute returns to the local legal entity.
Distribution channels as intangible property
Local distribution channels are a potential marketing related intangible asset that should be identified by the Tax Auditor.
Turnover based charges for management services are not acceptable
SE-50 states that “the imposition of management services should be based on the amount of the actual costs incurred, not based on the turnover of the taxpayer.”6
Detailed audit steps
SE-50 also requires Tax Auditors to conduct detailed audit steps in undertaking transfer pricing audits. Key items mentioned include that Tax Auditors should:
- • Speak to/interview the operational personnel, i.e., key personnel with significant functions, within the Taxpayer's business to ensure that the Tax Auditor understands the business operations.
- • Reference job descriptions in analyzing the functions of the Taxpayer and overseas group members. There are multiple references to sourcing job descriptions in SE-50.
Given this, it is important that the Taxpayer ensures that all documentation underlying its business operations ties in with the economic substance of the entity to ensure that there are no inconsistencies with its transfer pricing model.
Collection of data from outside Indonesia
Further to PER-22 which requires Taxpayers to provide information on the functions, assets and risks, as well as profitability, of relevant group members outside Indonesia in the forms contained in PER-22. SE-50 indicates that Tax Auditors should collect information on the Taxpayer's relevant overseas group members multiple times in the preparation and implementation stages of an audit.
Tax Auditors are also referred to the exchange of information clause in the relevant Tax Treaty as being an alternative source of information on the Taxpayer's operations outside Indonesia.7
Joint (or aggregated) transaction approach
Further to PER-22, SE-50 provides further guidance on when the testing of transactions on a joint basis, rather than the historically applied separate transaction approach, is considered appropriate. Generally, this guidance is very limited and does not provide additional support for Taxpayers looking to analyze all of their related party transactions using a Transaction Net Margin Method approach rather than using a transaction by transaction approach that is more commonly applied.8
PER-22 supply chain forms
SE-50 provides limited additional guidance on the degree to which Tax Auditors will enforce the requirement for Taxpayers to provide supply chain information and profitability information for members of its corporate group. SE-50 states that Tax Auditors should use other information sources to gather this information such as annual financial statements/ prospectuses of group members, the internet or databases. However it also states that to improve the quality of the forms the Tax Auditor may request the Taxpayer to explain the company's group supply chain.9
Overall SE-50 is largely consistent with the guidance contained in the OECD transfer pricing guidelines as well as transfer pricing considerations in a number of other jurisdictions in the Asia-Pacific region. An immediate recommendation for Taxpayers is that they initially consider the contents of SE-50 within the context of preparing their fiscal year 2013 transfer pricing documentation and use this as a basis for determining whether there are any items that should be evaluated for any past years that remain open.
1 See the EY Special Transfer Pricing Alert, Indonesia issues new guidance for transfer pricing audits, released on 19 June 2013.
2 Introduction, page 1.
3 Chapter 2, page 43.
4 Chapter 2, page 44.
5 Chapter 2, page 7.
7 Chapter 2, page 7.
8 Chapter 2, page 33.
9 Chapter 2, page 33.
For additional information with respect to this Alert, please contact the following:
Purwantono, Sarwoko & Sandjaja Consult, Jakarta, Indonesia
- • Ben Koesmoeljana
+62 21 5289 5030
- • Jonathon McCarthy
+62 21 5289 5599
EYG no. CM4046