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Transfer Pricing Issue: Now on Oil & Gas Taxpayers

Every transaction between the Taxpayers having special relationship[1] is to use fair market price as that of independent transactions. This is concluded from Article 18 paragraph (3) of the Income Tax Law (Law No. 7 Year 1983 as lastly amended with the Law No. 36 Year 2008) stating that:

“The Director General of Taxes is authorized to rectify the amount of income and deduction as well as to determine debt as capital to calculate the amount of Taxable Income for Taxpayers having special relationship with other Taxpayer(s) in accordance with the Arm’s Length Principle which is not influenced by the special relationship using the methods of comparable uncontrolled price, resale price, cost plus, or other method(s).”

The above provision does not elaborate types of business obliged to use the fair price in related party transactions. Article 18 paragraph (3) of the Income Tax Law above only states “for Taxpayer having special relationship with other Taxpayer(s)”. It is very obvious that no distinction is made for the application of fair price in related party transactions based on the type of business a Taxpayer conducts.

The application of the Arm’s Length Principle (ALP) on related party transaction is further stipulated in the DGT’s Regulation No. PER-43/PJ/2010 (PER-43) as lastly amended with the DGT’s Regulation No. PER-32/PJ/2011 (PER-32). PER-43 puts more emphasis on the ALP Principle application by Resident Taxpayers—including the Permanent Establishment—on related party transactions made with foreign parties (Non Resident Taxpayers).

Referring to Article 2 of PER-43 and its amendment, the ALP Principle application  in related party transactions between Resident Taxpayers—including Permanent Establishment—is only mandatory if the transaction is intended to benefit from tax rate difference due to the following:

a.       The imposition of Final Income Tax and Non Final Income Tax in certain business sectors;

b.      The imposition of Sales Tax on Luxury Goods (STLG); or

c.       Transactions conducted with the Contractor Taxpayer under a Working Contract in Oil and Gas Sector.

In this provision, the industrial sector of oil and gas mining transactions in the working contract in oil and gas sector are clearly stated. Even further, the obligation for the Contractor Taxpayer in such transactions to apply the ALP is again affirmed in the Government’s Regulation (PP) No. 79 Year 2010 (hereinafter referred to as “PP 79”).

PP 79

This regulation emphasizes on the obligation to apply the ALP by the technical contractor in oil and gas sector as stated in these articles below:

        “Article 3

(1)  The Contractor shall own asset and technology as well as bear the operating risk in the oil operation based on the working contract in a business area.

(2)  The oil operation stated in paragraph (1) shall be conducted in compliance with  the effective and efficient principlethe ALPand the good business practice and technique norm.”

Article 5

(1)In conducting the oil operation, the Contractor shall arrange the working and budget plan based on the good business practice and technique norm as well as the ALP.”

The one thing missing is that PP 79 does not cover the ALP definition. Accordingly, the definition is supposed to be similar to that of defined in PER-43 and its amendment, particularly considering that the oil and gas sector is the only sector mentioned in PER-43.

The ALP -as stipulated in Article 1 number 6 of PER-43- constitutes the principle regulating that if the condition of a related party transaction is similar or equal to the condition of  an unrelated party transaction as comparable transaction (independent transaction), the price or profit of the related party transaction shall be equal to or within the range of price or profit of the unrelated party transaction. Further, Article 3 of PER-43 requires steps of applying the ALP:

  1. To perform comparability analysis and determine comparables;
  2. To determine appropriate Transfer Pricing Methods;
  3. To apply the ALP based on the result of comparability Analysis and appropriate Transfer Pricing Methods for related party transactions made;  and
  4. To document every stage in determining the fair price or profit according to the prevailing tax provisions.

Risks for Upstream Oil and Gas Taxpayers if Not Applying ALP

According to Article 6 paragraph (1) of Law No. 22 Year 2001 concerning Natural Oil and Gas, the Upstream Oil and Gas Sector shall be executed and controlled through a Working Contract. In a  Working Contract, there is also a clause stating that the capital incurred by the business entity or the permanent establishment constitutes the operating expense which can be returned by the Government at the time when the upstream oil and gas project generates commercial products.

In reality, the refund of the operating expense is not automatically granted at the time of commercial production.  Article 12 of PP 79 requires some terms and conditions to be initially fulfilled  as follows:

(1)                The operating expense which may be refunded in the profit sharing and income tax calculation shall meet the following requirements:

a.    incurred to obtain, collect, and maintain income based on the prevailing regulations and directly related to the oil operating activity in the contractor’s business area in Indonesia;

b.      using the fair price not influenced by any special relationship as stated in the Income Tax Law;


Article 13 of PP 79 further clarifies which operating expenses cannot be refunded, among others, are procurement of goods and services and other activities not complying with the ALP and the proper technical standards, or exceeding the approved expenditure under authorization of more than 10% (ten percent) from the authorized expense amount.

How to Deal with It?

The risks of not complying with the ALP in transfer pricing transactions made by Oil and Gas Contractors are not limited to price adjustments by the DGT. The loss of the chance to refund the operating expenses in the profit sharing and Income Tax calculation can be faced by Oil and Gas Contractors.

Extra attention and efforts in preparing a proper Transfer Pricing Documentation to present the APL application stages as set in the ALP implementation as stipulated in PER-43 are worth-doing. It is important to ensure that the documentation will satisfy the Tax Authority or any other relevant authorities to carry out the expense refund process.

And, similar to other Taxpayers having related party transaction based on the Article 3 paragraph (4) of PER-43 as lastly amended with PER-32, the ALP application as documented in a Transfer Pricing Documentation may only be waived if the transaction value is not more than IDR 10 billion in a year for every transaction partner.


[1]  Taxpayer is deemed having special relationship with other Taxpayer(s) when:

a.    having a direct or indirect investment at minimum 25% equivalent to the other Taxpayer(s);

b.    controlling the other Taxpayer(s), either directly or indirectly; or

c.     having family relationship either from blood or marriage in one lineage and/or sideways.

(Article 18 paragraph 4 of the Income Tax Law)

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