Changes in Related Party Transaction Arrangements and Secondary Adjustment

By Muchamad Irham Fathoni, a Directorate General of Taxes officer

The Ministry of Finance has issued a new regulation related to the implementation of the arm's length principle (ALP) in related party transactions contained in the Minister of Finance Regulation (MoFR) Number 172 of 2023.

The issuance of MoFR 172/2023 is expected to provide a sense of justice, and legal certainty, as well as ease of implementation of rights and obligations by taxpayers. This issuance is also motivated by the development of the business world and the increase in the volume of taxpayer transactions affected by related party transactions.

With the enactment of MoFR 172/2023, three MoFRs are revoked and declared no longer valid. These three MoFRs in question are MoFR 213/2016, MoFR 49/2019, and MoFR 22/2020. There are several different arrangements from the previous, one of which is related to certain related party transactions and secondary adjustment.

Certain Related Party Transactions

Related party transaction is characterized by a situation of dependence or attachment of one party to another party due to ownership or equity participation, control, or blood or marital family relationships.

Regulations regarding related party transactions were previously contained in MoFR 22/2020. When compared, the arrangements related to special relationships in MoFR 172/2023 have several differences from the provisions in MoFR 22/2020. Previously, MoFR 22/2020 only mentioned six types of transactions that were included in transactions affected by certain related party transactions. Meanwhile, MoFR 172/2023 mentions seven types of transactions that are included in transactions affected by certain related party transactions. The seven types of transactions are affected by certain related party transactions whose ALP implementation must be carried out in a preliminary stage.

Based on Article 4 paragraph (6) of MoFR-172/2023, 7 types of transactions affected by related party transactions that require a preliminary stage in applying the arm's length principle are service transactions, transactions related to the use or right to use intangible assets, financial transactions related to loans, other financial transactions, asset transfer transactions, business restructuring, and cost contribution agreements.

The preliminary stage is the initial stage before the implementation of the arm's length principle, which includes proving the motive, purpose, and economic reason for the transaction. The transaction is in accordance with the actual substance and circumstances, the expected benefits of the transaction, the transaction is the best choice, the need for transactions, as well as the provision of services/loans economic and legal recognition.

The Director General of Taxes may redetermine the amount of income and deduction of taxpayers through compliance testing of the principle's implementation of reasonableness and business prevalence, which includes testing the implementation fulfillment of the Transfer Pricing Document and the principles implementation of reasonableness and business prevalence, determining the Transfer Price in accordance with the principles of reasonableness and business prevalence to calculate taxable income and considering the stages of applying the principles of reasonableness and business prevalence that have been carried out by taxpayers.

The difference between the value of affiliated transactions that are not in accordance with the arm's length principle and the value of the corresponding transaction is deemed a dividend, which is subject to income tax.

Secondary Adjustment

MoFR 172 Year 2023 also rearranges the qualifications related to the cancellation of secondary adjustment and the implementation of the Profit Split Method (PSM), which is more detailed than the previous provisions. In Indonesia, the secondary adjustment provisions are contained in Article 22 paragraph (8) of MoFR 22/2020, Article 36 paragraph (6) of Government Regulation Number 55 Year 2022, and in Article 37 paragraph (1) of MoFR 172 Year 2023.

The challenge of secondary adjustment in Indonesia is that there needs to be more detailed implementation guidance related to the technical mechanism of tax imposition on the difference in the value of affiliated transactions and independent transactions treated as constructive dividends. The absence of such an explanation creates errors or multiple interpretations for taxpayers on the imposition of constructive dividends, so it is rearranged in this MoFR.

A secondary adjustment in transfer pricing is a further adjustment made by a country's tax authority after conducting primary adjustment on related party transactions deemed not by the principles of fairness and business prevalence. If there is a difference in price between a related party transaction and an independent transaction, then the difference will be considered or applied as a dividend.

Secondary adjustment can only be carried out after the tax authority first conducts primary adjustment, which is a direct adjustment to a company's profit or loss because its affiliated transactions are considered not arm's length.

The tax authority considers that there has been a disguised distribution of profits from one entity to its affiliated entities in the amount adjusted in the primary adjustment. For example, in the form of dividends or disguised royalty income. As a result of this deemed disguised profit distribution, further tax consequences arise, such as withholding tax obligations, dividend taxes, and the imposition of sanctions for tax evasion.

Therefore, this secondary adjustment aims to ensure that the country where the company is located does not lose its tax rights due to affiliate transactions that shift profits to other countries.

Another challenge of the secondary adjustment arrangement is that taxpayers face double taxation risks if the transfer price correction is considered a dividend and must be subject to income tax. Meanwhile, the withholding tax on the dividend cannot be credited in the counterparty country.

*)This article is the author's personal opinion and does not reflect the attitude of the agency where the author works.

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