The legal basis for the arm’s-length principle in Indonesia is provided in Article 18(3) of the Income Tax Law (ITL), where it states that the Directorate General of Tax (DGT) is authorised to recalculate taxable income or deductible costs in accordance with the arm’s-length principle for taxpayers that have a special relationship with other taxpayers.
According to Article 18(4) of the ITL, the definition of ‘special relationship’ applies to circumstances where:
- a taxpayer owns directly or indirectly at least 25 per cent of the equity of the other taxpayer, or a relationship exists between two or more taxpayers through ownership of at least 25 per cent of equity of two or more residents;
- a resident ‘controls’ another resident or two or more residents directly or indirectly; or
- a family relationship exists through either blood or marriage, within one degree of direct or indirect lineage.
DGT Regulation PER-22/PJ/2013 regarding transfer pricing audit guidelines further specifies the types of transactions covered under Indonesian transfer rules, which include transactions on:
- sales, purchases, alienation and exploitation of tangible assets;
- rendering intra-group services;
- alienation and exploitation of intangible assets;
- loan payments of intra-group loans; and
- sales or purchases of shares.
The recent Ministry of Finance Regulation Number 22/PMK.03/2020 (MoF 22/2020) regarding advance pricing agreements (APA), in addition to regulating regarding APA procedures, mentions substantive provisions of the arm’s-length principle, including an expansion of the transactions covered under Indonesian transfer rules that now also covers independent transactions that are affected by related parties.
In general, the Organisation for Economic Co-operation and Development Transfer Pricing Guidelines (the OECD Guidelines) have been adopted in Indonesian transfer pricing regulations; however, several principles related to specific circumstances are not detailed in Indonesian regulations.
The ITL also authorises the Minister of Finance to prescribe the expected ratio of a company’s liabilities to its equity, which shall be valid for tax purposes. Furthermore, on 9 September 2015, the Ministry of Finance released Regulation No. 169/PMK.010/2015 (MoF 169/2015) regarding the ratio of debt and equity for income tax purposes. The regulation provides that the acceptable debt-to-equity ratio for Indonesian companies must not exceed 4 : 1, which means that this provision will deny the deductibility of the interest in connection with the portion of debt that exceeds the 4:1 ratio. In addition, debt-related deductions that could also be denied include fees and charges incurred in respect of the debt. Exclusions from the prescribed debt-to-equity ratio are provided for banks, financial institutions, insurance companies, mining companies, oil and gas companies under production-sharing contracts, taxpayers from the infrastructure sector and taxpayers subject to final income tax.
Broader taxation issues
i Diverted profits tax and other supplementary measures
Electronic transaction tax (ETT) is introduced under Issuance of Government Regulation in Lieu of the Laws No. 1 Year 2020. ETT is taxes imposed on sales of goods and services originating from abroad through electronic systems to buyers in Indonesia.
There are two requirements for ETT to be applied. First, there is a ‘significant economic presence’ of the non-resident seller in Indonesia. Second, the non-resident seller is resident in a tax treaty partner country. ETT is primarily designed to circumvent the permanent establishment threshold in tax treaties so that Indonesia can retain its taxing rights in situations where non-resident taxpayers are carrying out business in Indonesia without physically being present in Indonesia (namely, electronic transactions or e-commerce). Technical regulations on ETT are yet to be issued by the government.
However, ETT will not apply for non-resident sellers that are not residing in tax treaty partner countries. Instead, such non-resident sellers will be subject to the expanded definition of permanent establishment according to domestic law. Although the Income Tax Law retains the definition of permanent establishment based on physical presence, nevertheless Regulation No. 80 Year 2019 states that non-resident taxpayers are ‘deemed’ to have a physical presence in Indonesia if certain criteria are met. Those criteria include number of transactions, value of transactions, number of packet deliveries and amount of traffic from users.
ii Double taxation
Taxpayers seeking to resolve double taxation issues as a result of transfer pricing adjustments can make use of MAPs. All Indonesian income tax treaties contain a MAP article, similar to that contained in the OECD and UN models, although without an arbitration clause (except in the case of the tax treaty with Mexico). The Ministry of Finance has issued detailed regulations on how taxpayers can apply for the MAP.19
There have been a number of tax cases that have been resolved through MAPs. Since 2017 (for reporting period 2016), Indonesia has released its MAP statistics through the OECD website, from which the latest report that can be accessed is MAP report for 2019.20 The DGT has also recently launched a specific website for MAPs and APAs, containing a range of information on the procedural and regulatory aspects of MAPs and APAs in English, including the most recent statistics.
Outlook and conclusions
Indonesia is actively changing its regulations on transfer pricing to be more in line with the OECD BEPS package. As a result, transfer pricing documentation requirements in Indonesia have become more comprehensive and are now applicable to almost every taxpayer who is part of a multinational group. It is therefore expected that the role of transfer pricing documentation will become even more critical for the following year when the first tax audits under the new documentation rules will take place.
Taxpayers should consider transfer pricing documentation as the first line of defence in the event of an audit. Ultimately, robust transfer pricing documentation can serve well to reduce disputes with the DGT. A major change adopted in its approach to tax audits is the DGT’s focus on inter-company pricing policies (ex ante approach), and not only on testing the arm’s-length principle after the transaction has occurred.
Although the number of tax audits has remained high over the past three to four years, there is also a growing trend for APAs in Indonesia as a means of avoiding disputes or of reaching settlements. Although the APA programme is relatively new, the prospect for APAs is nevertheless promising, since it is reported that Indonesia has already successfully concluded many bilateral APAs with major trading countries.
Indonesia is further anticipated to continue to update its transfer pricing regulations; the latest update in PMK 22/2020 has added significant, new concepts such as ‘independent transactions influenced by special relationship’ and ‘market access’ as comparability factors, but no further guidance on how to implement these new concepts in practice has yet been issued. PMK 22/2020 has now also endorsed secondary adjustment but is silent on corresponding adjustments; additional guidance is especially needed for transfer pricing adjustment in domestic transactions. In practice, this has already resulted in many domestic double taxation cases: tax office A transfer pricing adjustment is not followed by tax office B as a corresponding adjustment, even though tax offices A and B are under the same DGT organisation.
The covid-19 outbreak and following pandemic have significantly accelerated Indonesian policymaking with regard to digital tax. Weeks before the outbreak, Indonesia was still talking about the importance of a global consensus in this area with the G20 and OECD.21 A month later, ETT was introduced. However, the regulation has not yet been implemented because the US Trade Representative (USTR) has raised preliminary concerns that ETT is discriminatory, not in line with the international taxation principles and creates a burden for US commerce. On the basis of those grounds, USTR could potentially retaliate in the form of tariffs on Indonesian products.
However, VAT on digital transactions has also been introduced and is currently implemented without any significant interference. This is because, unlike with income taxes, there is already a general international consensus with regard to VAT, namely the ‘destination principle’. As such, the newly introduced VAT on digital transactions could be viewed as an administrative breakthrough only, and not so much as a change in the allocation of taxing rights between countries.
With regards to the implementation of VAT on digital transactions, the Ministry of Finance Regulation Number 48/PMK.03/2020 (MoF 48/2020) was issued and governs procedures for appointing foreign or non-resident companies for collection and depositing, as well as reporting VAT on the use of intangible taxable goods or taxable services (or both) from outside the customs area but that is used within the customs area through electronic systems.22
In responding to the covid-19 pandemic, the government has taken several measures, including issuing numerous facilities and incentives23 to stabilise the economy and community productivity, which have been greatly affected by the pandemic. The most recent incentive has been reinstated in Ministry of Finance Regulation Number 9/PMK.03/2021 (MoF 9/2021) regarding tax incentives for taxpayers who have been affected by the covid-19 pandemic.
Other than the pandemic, another issue that should be highlighted is the enactment of Omnibus Law on Job Creation that accommodates taxation matters. On the basis of Articles 111–114, the Act amended four taxation laws, namely the Income Tax Law, Value Added Tax, Law on Goods and Services and Sales Tax on Luxury Goods, Law on General Provisions and Tax Procedures, and Regional Tax and Retribution Law. One of the fundamental provisions is the addition of an exemption for dividends in the case of significant shareholdings. The exemption applies as long as dividends are reinvested in the territory of the Republic of Indonesia for a certain period of time.24 The introduction of a dividend exemption regime will mean that Indonesia to a certain degree has moved from a worldwide-based income tax system into a partially territorial income tax regime.