Raising the GAAR: Indonesia strengthens its transfer pricing regime
Veronica Kusumawardani and Cindy Kikhonia F of DDTC Consulting report that anti-avoidance measures have been introduced in Indonesia despite parliamentary concerns over their impact on investment in the country.
During parliamentary discussions regarding the draft Harmonization of Tax Regulation Law as proposed by the government, lawmakers stated their explicit rejection of proposed general anti-avoidance and alternative minimum tax rules. Their concern was that the regulations could be classed as an abuse of power and excessive tax collection which may hinder the investment climate of Indonesia.
What was clear, however, was the government’s intention to strengthen the country’s anti-tax avoidance rules. Since then, the Harmonization of Tax Regulation Law has been enacted by Law No. 7 of 2021 (the Income Tax Law).
Despite the challenge by Parliament, the enacted law is successful in including amendments concerning anti-tax avoidance rules in the elucidation of the law; i.e., the text of the anti-tax avoidance rules has largely remained the same but the commentaries to the law are significantly amended.
One such example is the inclusion of a general anti-abuse rule (GAAR) in the elucidation of Article 18 of the Income Tax Law, although the text of Article 18 itself is silent on a GAAR.
As is customary in law-making in Indonesia – specifically tax law – further detailed regulations on the law will be set forth via government regulations, Ministry of Finance regulations, and/or Directorate General of Tax (DGT) regulations. This, in the end, creates a web of overlapping regulations that may be adjusted without requiring passage through the strict law-making process of Parliament.
As anticipated, on 20 December 20 2022, the government issued Government Regulation No. 55 of 2022 (GR 55/2022) concerning regulatory adjustments in the area of income tax.
The stated main objective of GR 55/2022 is to provide taxpayers with legal certainty, straightforward tax administration, convenience, and fairness. It also aims to implement international taxation agreements while taking into account good governance. In substance, GR 55/2022 has elaborated upon the anti-tax avoidance rules contained in the elucidation of the Income Tax Law.
This article will discuss significant updates brought forth by GR 55/2022 to the Indonesian transfer pricing regulations, including:
The expanded scope of the definition of related-party transactions;
The specific regulation for businesses that have consecutive losses;
Updates related to advance pricing agreements (APAs); and
Updates regarding interest deduction rules.
Expanded scope of related-party transactions
The Income Tax Law recognises the concept of ‘special relationship’, which is broader than the concept of associated enterprises typically found in tax treaties. The term ‘associated enterprises’ gives the impression that it simply refers to business links under company law, although the term ‘special relationship’ used in Indonesian transfer pricing regulations also refers to family ties and de facto control in addition to a shared ownership threshold.
The first updates relating to the definition of special relationship transactions were set forth in Minister of Finance Regulation No. PMK 22/PMK.03/2020 (MoF 22/2020), which was published in March 2020.
A special relationship based on Article 18, paragraph 4 of the Income Tax Law exists where:
The taxpayer has direct or indirect equity participation of a minimum of 25% in another taxpayer, there is a relationship between the taxpayer with an equity participation of a minimum of 25% and two or more taxpayers, or a relationship between the aforementioned two or more taxpayers;
The taxpayer ‘controls’ another taxpayer, or two or more taxpayers are under the same control, directly or indirectly; or
There is a family relationship by blood or marriage of one degree of direct lineage vertically and/or of one degree of direct lineage horizontally.
MoF 22/2020 provides that control in a special relationship covers the following situations:
One party controls another party or one party is controlled by another party, directly and/or indirectly;
Two or more taxpayers are under the same control, directly and/or indirectly;
The same people are directly and/or indirectly involved or participating in managerial or operational decision-making for two or more parties;
The parties are commercially or financially known, or claim to be in the same business group; or
One party claims to have a special relationship with another party.
One aspect has been added as a result of GR 55/2022, where control in a special relationship now also applies where one party controls another party or one party is controlled by another party through management or the use of technology.
The aforementioned provision is in line with the elucidation of Article 18(4) Point b of the Income Tax Law, where the term ‘control’ is also deemed to exist through management or the use of technology even though there is a shared ownership relationship, as well as the range of transactions by parties with a special relationship as mentioned in Article 35(2) of GR 55/2022.
GR 55/2022, therefore, confirms that the scope of transfer pricing rules is very wide. Despite the elaborations on the term ‘control’ in substance, there is no precise threshold for de facto control. As a result, transactions between independent parties may very well fall within the scope of transfer pricing regulations provided that a de facto control is deemed to exist.
DGT Regulation No. PER 32/PJ/2011 (DGT Reg. 32/2011), a derivative regulation of Article 18(3) of the Income Tax Law that serves as the legal basis for the transfer pricing regulations, specifies the transfer pricing methods that can be used to assess the arm's length principle. DGT Reg. 32/2011 recognises the comparable uncontrolled price method, the resale price method, the cost plus method, the profit split method, and the transactional net margin method (TNMM) as transfer pricing methodologies.
Generally speaking, DGT Reg. 32/2011 only accepts the aforementioned five transfer pricing methods, which are also the only transfer pricing methods available under the disclosure requirement for company income tax returns. Nonetheless, DGT Regulation No. PER 22/PJ/2013 (DGT Reg. 22/2013), another derivative regulation of Article 18(3) of the Income Tax Law, acknowledges the use of the following other methods for the valuation of intangibles:
The income-based approach;
The cost-based approach; and
The market-based approach.
All the above methods are restated in MoF 22/2020 and in GR 55/2022. However, the regulations are still silent on the guidance for applying the other methods for the valuation of intangibles.
An audit could be initiated if a taxpayer experiences a loss, because it means the tax authorities will not collect any tax revenue in that year. According to Article 6 of the Income Tax Law, losses may be carried forward for a maximum of five fiscal years without incurring a new tax liability for the taxpayer. However, under DGT Circular Letter SE-15/PJ/2018, taxpayers with losses for three years in a row may be prioritised for investigation during the relevant years, whether in the form of supervision or an audit.
GR 55/2022 has introduced a new specific anti-avoidance rule (SAAR) that targets taxpayers that have been in business for five years and have reported losses continuously for at least three of those years. In this situation, the DGT has the authority to recalculate the taxpayer's taxable profit based on a benchmark with other taxpayers in the same industry. It is still unclear if this legislation functions as an independent SAAR or as a component of the transfer pricing regulation. Only transactions involving parties that are affected by a special relationship are covered by this new SAAR.
Advance pricing agreements
The APA programme in Indonesia started in 2010 and was governed only by DGT regulation-level provisions at the time, namely PER-48/PJ./2010 (MAP) PER-69/PJ./2010 (APA). Since then, the regulations have been improved by a series of amendments via MoF regulations. The latest is MoF Regulation No. 49/PMK.03/2019 concerning mutual agreement procedures, MoF Regulation No. 22/PMK.03/2020 (MoF 22/2020) concerning APAs, and procedural rules in DGT Regulation No. 17/PJ./2020.
In parallel with the regulatory improvements, APAs are frequently sought by taxpayers because they offer many advantages. APAs uniquely provide the opportunity for taxpayers and tax administrators to discuss the relevant tax positions proactively in a transparent and cooperative manner under neutral circumstances.
Most of the improvements in the APA regulatory area relate to legal certainty, the simplification of procedures, consistency with BEPS Action 14 standards, and the accommodation of the changes in the organisational structure of the DGT. More specifically, the improvements concern:
The availability for a roll-back period of up to five prior years,
A clear timeframe for presenting cases to competent authorities,
Access to transfer pricing cases irrespective of the availability of Article 9 (2) of the OECD model; and
Timely implementation of the outcomes.
GR 55/2022 added to this framework of APA regulations the availability of multilateral APAs, whereas previously only bilateral APAs were possible. Presumably, this is to accommodate the TNMM method in APA negotiations where the controlled transaction is with multiple related parties in different jurisdictions.
Interest deduction rules
GR 55/2022 recognised earnings stripping rules (ESR) to limit interest deductions. The purpose is to prevent tax avoidance by limiting the amount of interest deduction by a certain percentage of borrowing costs compared with EBITDA.
The ESR complement the method that had been applied previously, based on the debt-to-equity ratio (DER) as stipulated in MoF Regulation No. 169/PMK.010/2015. The DER ratio is set at 4:1 at present. If the debt-to-equity ratio exceeds this limit, the interest on the debt or loan cannot be recorded as an expense.
More detailed arrangements for the use of the ESR will be stipulated in the MoF regulation. Most likely, the introduction of ESR could be seen as the implementation by Indonesia of the recommendation under BEPS Action 4, where, according to the OECD, the limit for the ESR value can be set in the range of 10 to 30%.
Implementation of the BEPS pillar one and pillar two proposals
Along with the above changes, GR 55/2022 also laid the regulatory foundation to implement the BEPS pillar one and pillar two proposals, which will be regulated further via MoF regulations.
GR 55/2022 states that the government has the authority to conclude agreements to resolve tax challenges due to the digitalisation of the economy and/or other BEPS challenges. Furthermore, the DGT is granted the authority to implement such agreements.
Article 53 of GR 55/2022 deals specifically with the pillar one proposals, under which multinational enterprises that do not necessary have a physical presence in Indonesia could be deemed to fulfil objective and subjective requirements to be taxed in Indonesia.
Article 54 of GR 55/2022 deals specifically with the pillar two proposals, under which multinational enterprises could be taxed in Indonesia based on a global minimum tax agreement.
2022 featured considerable challenges in transfer pricing in Indonesia. The global legislative framework experienced several relevant changes, while the OECD and the Inclusive Framework on BEPS continued to provide guidelines on transfer pricing topics that could ensure the effective implementation of the BEPS Action Plan.
Indonesia’s update to its transfer pricing regulations (GR 55/2022) can be perceived as the Indonesian government’s attempt to strengthen its transfer pricing regime. The issuance of GR 55/2022 hopefully provides legal certainty, simplification, and ease of tax administration. In addition, the important point is to reduce tax avoidance, thus aligning with the BEPS project.