Indonesia introduced new regulations for advance pricing agreements (APAs) as an effort to adhere to the minimum standard of BEPS Action 14. Minister of Finance Regulation No. 22/PMK.03/2020 concerning the implementation guidelines on APAs (MoFR-22/2020) came into effect on March 18 2020.
Unlike the previous APA regulations (MoFR No. 7/PMK.03/2015) that focused solely on procedural aspects, MoFR-22/2020 also sets out substantial guidance on applying the arm’s-length principle (ALP) and, arguably, the controversial concept of “transactions affected by special relationship” as a conditio sine qua non for the application thereof.
The common presumption among tax practitioners is that the ALP should only be applied for related-party transactions. Pursuant to Article 2(2) of MoFR No. 213/PMK.03/2016 concerning transfer pricing documentation (MoFR-213/2016), taxpayers who are required to prepare transfer pricing (TP) documentation are those conducting related-party transactions, not those conducting transactions affected by special relationship. In this regard, introducing the concept of “transactions affected by special relationship” in MoFR-22/2020 could be regarded as an extension of the ALP’s scope.
Overall, a special relationship is a relation or association between one party and another that is caused by capital ownership, de facto control, or blood relations that triggers the application of the ALP. In addition to that, MoFR-22/2020 emphasises that not only related-party transactions are subject to the ALP, but also independent-like transactions which, if fulfilling some conditions, are determined as affected by the existence of a special relationship and warrant the application of the ALP.
As such, the issue of the ALP and the provision of “transactions affected by special relationship” become more relevant for all taxpayers, not only for those intending to request an APA. This is because the provision concerning the ALP and the “transactions affected by special relationship,” based on Article 23, paragraph 1 of MoFR-22/2020, must be applied by taxpayers complying with their tax obligations, irrespective of whether or not they request an APA.
As a consequence, it is vital for taxpayers to, firstly, comprehend the provision to determine whether their transactions could be categorised as affected by the existence of the special relationship and could be subject to ALP provisions.
This article intends to shed light on whether the concept of “transactions affected by special relationship” is an extension of the ALP’s application as regulated by the Income Tax Law (ITL).
Analysis of the concept of transactions affected by special relationship
Article 1, No 15 of MoFR-22/2020 defines transactions affected by a special relationship as the transactions encompassing:
(a) Related party transactions; and/or
(b) Transactions carried out between independent parties but the related party(ies) of one or both transacting parties determine(s) the transaction counterpart and the transaction price.
Based on the above, “transactions affected by special relationship” have two aspects. The first aspect is related-party transactions. It is defined as transactions between taxpayers and their related party, ie the party having a special relationship with the taxpayer. This concept is already well-known because it has been introduced since 1983 in ITL and adopted in following regulations covering TP documentation (MoFR-213/2016). As such, there is not much debate over this concept.
However, one may question whether provision (b) above (Article 1 No. 15 b), which includes independent transactions, extends the scope of the ALP’s application from what has been stipulated in the ITL. The discussion is critical because, pursuant to the hierarchy of laws and regulations, the ITL commands a higher position than MoFR-22/2020. Thus, the principium lex superior derogate legi inferiori applies, meaning finance ministry regulations cannot overreach any rules that have been specified in higher law.
To prove whether MoFR-22/2020 overreaches the ITL, the relevant provisions need to be analysed.
Before the enactment of MoFR-22/2020, the requirement to apply the ALP was primarily regulated by Article 18(3) of the ITL, which states that: “The Director General of Taxes is authorised to re-determine the amount of income and reduction and determine the debt as capital to calculate the amount of taxable income for the taxpayer who has a special relationship with another taxpayer in accordance with the arm’s-length principle and the ordinary course of business principle which is not affected by the special relationship using the comparable uncontrolled price method, the resale price method, the cost-plus method, or other methods.” (emphasis added)
From Article 18(3), it is clear that taxpayers are required to apply the ALP when they have special relationships with other taxpayers, and not just because they have related-party transactions. The use of such different terms has remarkably different consequences.
Example 1: Conditions under the control of a related party
For example, PT Alpha, a manufacturer in Indonesia, is looking for a supplier. Alpha, as the parent company of PT Alpha in country X, has an excellent relationship with Beta Corp, a supplier in country X. Consequently, Alpha instructed PT Alpha to purchase materials only from Beta Corp with a specific price negotiated between Alpha and Beta Corp of which PT Alpha has no control (see Figure 1).
Figure 1

If Article 18(3) of the ITL used the term “related-party transaction” as the basis for ALP application, then the transaction of PT Alpha with Beta Corp is not a related-party transaction – thus the ALP will not be applied because both parties do not have any special relationship.
However, the term used in Article 18(3) is a “taxpayer who has a special relationship with [an]other taxpayer”. In this case, PT Alpha has a special relationship with Alpha (Alpha is the parent company of PT Alpha). Thus, consistent with the above provision, the Directorate General of Taxes (DGT) has the authority to apply the ALP. The question that may arise thereafter is if the DGT does have the authority to enforce the ALP, which transaction should be applied for the ALP?
One may argue that in the above example, there is no transaction between Alpha and PT Alpha because the transaction occurs between PT Alpha and Beta Corp. Although the transaction is between independent parties, the condition is under the control of the related party of PT Alpha, ie Alpha Corp.
From the perspective of PT Alpha, it has no authority whatsoever to determine a supplier and the purchase price. Were it a transaction under the arm’s-length condition, PT Alpha should have the freedom to choose the supplier and agreed to a particular price to make its position better off, taking into account options realistically available.
In the example above, the transaction PT Alpha entered into with Beta Corp, notwithstanding their status as independent parties from each other, is a controlled transaction because Alpha determined the transaction counterpart of PT Alpha, ie Beta Corp and even the transaction price. This condition is what exactly is being emphasised by Article 1, No. 15 (b) of MoFR-22/2020. In basic terms, it refers to situations where transactions are carried out between independent parties, but where the related party(ies) of one or both transacting parties determine(s) the transaction counterpart and the transaction price.
Considering the term used in Article 18(3) and the aforementioned illustration, up until this point, MoFR-22/2020 did not extend any provision specified in the ITL, particularly the application of the ALP in the situation of Article 1, No. 15 (b).
Example 2: Competing companies and umbrella agreements
The second example covers a situation where there are two competing companies in Country X, ie Jupiter Corp and Zeus.
Due to changes in business strategy, Jupiter Corp decided to sell its manufacturing division to Zeus. The latter, in this case, also agreed to purchase Jupiter Corp’s manufacturing division at a particular price provided that Jupiter Corp also sold all of its manufacturing divisions wherever they operated.
To execute this transaction, Jupiter Corp and Zeus entered into an umbrella agreement that specified the agreed price, including the transaction condition, ie Jupiter Corp was obliged to sell all of its manufacturing divisions all over the world to Zeus, including the one in Indonesia.
Consequently, PT Jupiterindo, the subsidiary of Jupiter Corp in Indonesia, handed over its manufacturing division in Indonesia to PT Zeusindo, the Indonesian subsidiary of Zeus Corp. The selling price of the said transaction between PT Jupiterindo to PT Zeusindo had been determined according to the umbrella agreement between Jupiter Corp and Zeus.
Clearly, PT Jupiterindo and PT Zeusindo are independent parties. Their respective parents are also independent parties and competitors for each other.
However, the sale of the manufacturing division by PT Jupiterindo to PT Zeusindo is a controlled transaction, where both PT Jupiterindo and PT Zeusindo are not free to decide whether they want to enter into the transaction, with whom they wish to transact, and at what price the transaction should be settled.
If the trade was between PT Jupiterindo and PT Zeusindo as a non-controlled transaction, both parties would protect their self-interests and maximise their respective returns, reflecting the prevailing market mechanisms.
Nevertheless, as per the umbrella agreement, both parties have no other choices but to enter into a transaction. This condition is what MoFR-22/2020 intends to elaborate through Article 1, No. 15 (b).
In this example, the transaction between PT Jupiterindo and PT Zeusindo falls within the category of a transaction between independent parties but the related parties of both transacting parties (ie Jupiter Corp and Zeus) determine the transaction counterparts and the price (see Figure 2).
Figure 2

Once again, the DGT has the authority to re-determine the selling price of the manufacturing division from PT Jupiterindo to PT Zeusindo. This is due to the authority given to the DGT in Article 18(3), which is in the context of a taxpayer having a special relationship with another taxpayer, not solely for related-party transactions.
Potential challenges
The two examples above show that Article 1, No. 15 (b) of MoFR-22/2020 does not extend beyond what has been specified in Article 18(3) of the ITL in regards to the application of the ALP. This is because Article 18(3) allows the DGT to apply the ALP where the taxpayer has a special relationship, regardless of whether the transaction is clearly between related parties, or where the transaction is between two independent parties but where the condition of the transaction is controlled by a related party (or parties) of one (or both) transacting parties.
Based on the analysis of Article 18(3), the authority given to the DGT to re-determine the amount of income, deduction, and debt recharacterisation as capital for the purpose of computing taxable income is not assessed as a related-party transaction, but as the taxpayers having a special relationship.
In addition, consistent with Article 18(3) of the ITL, MoFR-22/2020 clarified that the ALP should be applied in a controlled transaction where the taxpayer has transactions affected by special relationships with independent parties that are controlled by a party having a special relationship with the taxpayer.
Although the provisions in the MoF regulations do not go beyond the ITL, there might be some future challenges.
Firstly, based on MoFR-213/2016, the scope covered by TP documentation is limited to the application of the ALP for related-party transactions. As such, it is unclear whether transactions falling within the category of Article 1, No. 15 (b) should also be articulated in TP documentation.
The second challenge is with respect to APAs. MoFR-22/2020 accommodated APA applications for related-party transactions only so that taxpayers could obtain certainty on such transactions and the pricing thereof. However, the introduction of provision Article 1, No. 15 (b) will be a new source of transfer pricing disputes which has not considered APAs granted as per MoFR-22/2020, negating the value of an APA to lower the potential of lengthy and costly disputes. Thus, it will potentially increase the uncertainty for the taxpayers.
The third challenge potentially arises from the application of the secondary adjustment. MoFR-22/2020 also emphasises that tax should be withheld on the amount adjusted in the primary adjustment treated as a constructive dividend. The conceptual problem would be identified when the adjusted transaction is between independent parties. In such cases, would a dividend treatment be appropriate? Could the independent party claim a credit/exemption in its resident jurisdiction based on a tax treaty to avoid double taxation? Of course, by delineating the actual transaction, which ultimately benefits the related party/ies, the dividend could be constructed as paid to such party/ies and not to the independent counterpart/s. However, further clarification is necessary.
Taking the elaboration above into account, we can conclude that the concept of “transactions affected by special relationship”, particularly Article 1, No. 15(b) of MoFR-22/2020 covering transactions between independent parties, but where the related party(ies) of one or both transacting parties determine(s) the transaction counterpart and the transaction price, does not extend the requirement to apply the ALP as regulated under Article 18(3) of the ITL.
Article 1, No. 15(b) of MoFR-22/2020 is consistent with Article 18(3), which grants the DGT authority to apply the ALP. However, there might be future challenges that should be addressed in MoFR-22/2020 when considering the introduction of the “transactions affected by special relationship” concept, particularly the issue of transfer pricing documentation, the eligibility of such transactions submitted for an APA application, and the problem of secondary adjustments as constructive dividends.
This article was written for ITR by Nala Kurniawan and Bobby Savero. Both authors are senior analysts of mutual agreement procedures (MAPs) and APAs, as well as a specialist in international tax and TP in the Directorate of International Taxation department of the DGT at the Indonesia Ministry of Finance. The views expressed herein are strictly personal and do not reflect the institution they work or are associated with.