The increasingly rapid era of globalization and international integration has caused many multinational companies to carry out cross-border transactions. The existence of gaps and discrepancies in tax regulations in various countries provides an opportunity for multinational companies to engage in tax avoidance. Multinational companies often use transfer pricing as a means to shift profits to countries with low tax rates or concentrate costs in countries with high tax rates.[1] These companies have shifted profits amounted to US$1.15 trillion to tax haven countries every year, causing governments around the world to lose direct tax revenues of US$311 billion per year.[2] Transfer pricing practices are often carried out with a transaction scheme for tangible goods, services, interest payments, use of intangible goods, etc. which will affect the level of income and costs of a company.

One type of transfer pricing transaction that become particular concern to the Organization for Economic Co-operation and Development (OECD) is intragroup services. Intragroup services are activities provided by a party in a business group that provide benefits to 1 (one) or more other members of the business group.[3] These activities can be in the form of management services, administrative services, technical services, support services, purchasing services, marketing services, distribution services and other commercial services.[4] Intragroup services are regulated in several regulations including the following:

1. Regulation of the Director General of Taxes Number 43/PJ/2010 (PER-43) juncto Regulation of the Director General of Taxes Number 32/PJ/2011 (PER-32) concerning the Application of the Arm’s Length Principles (PKKU) in Transactions between Taxpayers and Parties who have Special relationship;
2. Regulation of the Director General of Taxes Number 22/PJ/203 (PER-22) concerning Audit Guidelines for Taxpayers Who Have Special Relationships; And
3. The Circular Letter of the Directorate General of Taxes Number SE-50/PJ/2013 (SE-50) concerning Technical Instructions for Auditing Taxpayers Who Have Special Relationships.

The delivery of intragroup services is also aimed at efficiency interests for companies and affiliates in a business group, such as using cheaper labor and capital, as well as avoiding duplication among each related party.[5] This allows a company to improve its competitive position because it is able to reduce the prices charged to customers. Furthermore, intragroup services transactions have their own challenges for tax authorities because it is difficult to ascertain the veracity of the transactions. Intragroup services transactions are not as obvious as transactions for tangible goods that have physical proof of delivery such as documents across national borders. Determining a fair price for intragroup services transactions is relatively difficult because there is no definite market value standard to determine the value of services. Prices for services are usually determined based on the complexity of the problem being handled and the expertise of the service provider. Therefore, PKKU analysis is needed in terms of providing or receiving intragroup services. Based on Appendix I SE-50 Chapter II letter B, there are several steps to ensure that intragroup services transactions are consistent with PKKU, namely the existence test, benefit test, and calculating the arm’s length of intragroup services payments.

1. Existence Test

Existence test is a step to ensure the existence or realization of the services provided, including:

• Examining the background process for the need for the services and related documents;
• Examining the service provider appointment process including examining the qualifications of the service provider;
• Examining the negotiation process regarding compensation for services provided;
• Examining the process and results of service provision as well as related documents/evidence;
• Reviewing documents related to service activities such as contracts and invoices; And
• Examining the parties involved in the implementation of service provision (service provision can be carried out by affiliated parties themselves or by involving taxpayers and/or third parties).

2. Benefit Test

Benefit test is a step to ensure that the services provided provide economic benefits, including:

• Ensure compatibility between the functions performed by the taxpayers and the intragroup services received;
• Examining the details of the services charged (if more than one service) and understanding specifically how these services can or have provided economic benefits to the taxpayers.

Furthermore, it should also be noted that there are types of transactions that are included in the negative list of intragroup services. Transactions on the negative list of intragroup services are types of transactions that do not provide direct economic benefits for service recipients, so intragroup services transactions do not meet the benefit test, including:

a. Shareholder activity

Shareholder activity is an activity of a parent company that will charge service fees to members of its business group, but members of the business group do not need and will not pay for these services if carried out with parties who do not have a special relationship.

b. Duplicative services

Duplicative services is a service provided by members of an affiliated group which is a duplication of activities carried out by the taxpayers themself or from an independent party.

c. Incidental benefits

Incidental benefits is an activity carried out by a member of a business group for members of a particular business group which also provides incidental benefits to taxpayers in that business group, where other members of the business group are likely to obtain incidental benefits from these services.

d. Passive associations

Passive associations are services paid to an affiliated party solely because the taxpayer is a member of the affiliated group.

e. Standby services (on call services)

On call services is a service provided by one of the affiliated group members which is always available if needed by the taxpayers, but if the service is provided by an independent party then a special fee is charged to ensure its availability. On call services cannot be charged if:

• The potential need for these services is very small;
• The benefits obtained from these services are not significant; or
• On call services can be immediately obtained and available from other independent parties without having to make a standby agreement first.

3. Calculating the Arm’s Length of Intragroup Services Payments

Once the intragroup services transaction has been confirmed as actually being carried out and providing economic benefits for the service recipient, taxpayers need to pay attention to the following matters:

a. Review the actual cost base and cost base components

taxpayers need to ensure that the cost base and cost base components for intragroup services are based on the actual costs incurred to provide those services. Taxpayers need to review whether the intragroup services cost base component can be fully charged or not. This can be done by reviewing documents or agreements relating to intragroup services transactions.

b. Identify the actual use of service cost methods

The service cost method consists of the direct method and the indirect method. The direct method is used in conditions where the service, the service recipient, the costs charged, and the base for the charge can be clearly identified so that costs can be allocated directly to the service recipient. The direct method should be applicable to service provider companies when similar services other than those provided to affiliated parties are also provided to independent parties. Furthermore, the indirect method is used if the direct method cannot be applied or if the costs related to the services provided are not easily identified and attributed to the affiliated company.[4] 

c. Identify the base for the allocation of service cost

If the intragroup services transaction provided to each party cannot be identified, then the service costs must be allocated based on the benefits received by each party.[6] Therefore, the indirect cost method uses a cost allocation and distribution base that refers to a key allocation base that is appropriate to the nature and purpose of providing services.[4] Key allocation must meet several requirements to be consistent with PKKU, namely:[7] 

• Must be measurable;
• Relevant to the type of service;
• Must be determined consistently at the company concerned; and
• Must be documented.

Key allocation The indirect method is acceptable if the taxpayers can explain the correlation between sales and costs incurred. For example, if services are related to Human Resources (HR) activities, the proportion of the number of employees can be an appropriate measure to measure the respective benefits for each member of the corporate group.

The image below shows an illustration of the use of HR service allocation keys to affiliates:

Figure 1 Key to Allocation of HR Services

The image above is a business group consisting of PT A as the parent company which is domiciled in country A, as well as subsidiaries namely PT B and PT C which are domiciled in country B and country C respectively. PT A is a company engaged in manufacturing. sporting goods, where PT B is a distributor company that sells PT A products to country B, while PT C provides HR services for its business group. Within this business group, HR services are centralized at PT C. Centralization aims for efficiency because labor costs are relatively lower in country C, as well as to avoid duplication of services in the business group. PT C's total costs for providing HR services were US$190,476. Determination of service costs by PT C to PT A and PT B is assumed to provide a markup of 5% based on fair market prices in country C. Therefore, the total cost of HR services provided to PT A and PT B is US$200,000. Furthermore, PT A has 950 (nine hundred and fifty) employees and PT B has 50 (fifty) employees. Intragroup services costs can be determined using key allocation based on the proportion of the number of employees. Key allocation is chosen because it reflects the expected benefits from affiliates for providing HR services within the business group. The costs that must be allocated to each employee are US$200 (US$200,000/1,000). Thus, the value of HR service costs charged to PT A is US$190,000 (950 × US$200) and PT B is US$10,000 (50 × US$200).

d. Analyzing The Arm’s Length of Intragroup Services Transactions

In analyzing the arm’s length  of intragroup services transactions that are consistent with PKKU, taxpayers need to determine reliable comparisons and apply the transfer pricing method that best suits the conditions and facts. There are 2 (two) types of comparison, namely internal comparison and external comparison. Internal comparisons are used if the taxpayers carry out comparable service transactions with independent parties. On the other hand, external comparisons are used if the taxpayers do not carry out comparable service transactions with independent parties so that other taxpayers' transaction data with comparable independent parties can be used. Taxpayers in determining reliable comparators must pay attention to comparable factors to eliminate the material influence of existing differences. Proportionality, analysis is used to determine the most appropriate transfer pricing method in achieving reasonable prices or financial indicators.[8] Based on Appendix I SE-50 Chapter II Letter B, there are 3 (three) transfer pricing methods for analyzing intragroup services transactions that are consistent with PKKU, including:

• Price Comparison Method between Independent Parties (Comparable Uncontrolled Price/CUP)
  The CUP method is a transfer pricing method which is carried out by comparing prices between affiliated and independent transactions.[9] The CUP method is the most appropriate method if there is a service transaction with an independent party under comparable conditions (internal comparison), or there is another taxpayer who provides similar services to an independent party under comparable conditions (external comparison).[10] Intragroup services analysis using the CUP method can be carried out by comparing the price/rate of intragroup services with the price/rate of similar services by comparable independent parties. Furthermore, this method requires a very high degree of comparability in service characteristics and factors influencing comparability.
  
  
• Cost Plus Method (CPM)
  CPM is a transfer pricing method that adds the gross profit from comparable independent transactions to the costs incurred in affiliated transactions. The financial ratio analyzed in CPM is Gross Profit Markup (GPMU). The GPMU used in implementing CPM is the profit margin which is calculated by subtracting the selling price from direct and indirect costs.[11]  
  Furthermore, a reasonable analysis of intragroup services using CPM can be carried out by comparing the GPMU obtained by the taxpayers with the GPMU obtained by comparable independent service providers.[12] CPM does not emphasize high comparability in service characteristics because it generally does not have a material influence on gross markup. However, in analyzing intragroup services it must be ensured that the GPMU being compared have a comparable cost base.[4] Differences in the application of accounting principles between affiliated and independent party transactions can result in inconsistent GPMU calculations.
  
  
• Transactional Net Profit Method (Transactional Net Margin Method / TNMM)
  TNMM is a transfer pricing method that uses indicators of comparable independent transaction profit levels to determine the net profit of affiliated transaction businesses. TNMM is based on net profit levels, so it has greater tolerance for differences in accounting standards. TNMM uses a profit level indicator (Profit Level Indicator/PLI) in calculating reasonable intragroup services. The provider or recipient of intragroup services must select the PLI that best suits the facts and conditions.[4] The PLI that may be appropriate for service providers is the ratio of operating profit to the base cost of providing services (return on total services costs). The return on total service costs earned by independent service providers performing comparable activities may be available and may provide a reliable comparator to be  used in implementing TNMM.[13]
  Furthermore, a reasonable intragroup services analysis using TNMM can be carried out by comparing the PLI obtained by the taxpayers against the PLI obtained by comparable independent service providers or recipients. Testing using TNMM can be carried out in combination by considering facts and conditions.[4] TNMM was developed based on the theory that profits earned by companies that are in similar conditions, and are in the same industry and market tend to be equal in the long run. Therefore, profits obtained by independent companies can be used as a relevant indicator of profits obtained by companies that carry out affiliated transactions.

References:
[1] Chan, Hung & Phyllis, Agnes W., An empirical analysis of the changes in tax audit focus on international transfer pricing, Vol. 24, Journal of International Accounting, Auditing and Taxation, 2015, page 94-104
[2] Tax Justice Network, State of Tax Justice 2023 (Bristol: TJN, 2023), page 25
[3] PER-22, Attachment I, Chapter 4, Letter A
[4] SE-50, Attachment I, Chapter II, Letter B
[5] Radhakrishnan, L., Intra Group Services: Need for a Uniform Transfer Pricing Regime, VISION: Journal of Indian Taxation, Vol. 5, 2018, page. 84-94
[6] PER-43, Article 16 paragraph (1)
[7] United Nations (UN), Practical Manual on Transfer Pricing for Developing Countries (New York: UN, 2021), paragraph 5.4.8.4.
[8] UN, Practical Manual on Transfer Pricing for Developing Countries (New York: UN, 2021), paragraph 3.1.2.
[9] PER-32, Article 11 paragraph (3)
[10] OECD, Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (Paris: OECD Publishing, 2022), paragraph 7.31
[11] UN, Practical Manual on Transfer Pricing for Developing Countries (New York: UN, 2021), paragraph 4.4.3.3.
[12] UN, Practical Manual on Transfer Pricing for Developing Countries (New York: UN, 2021), paragraph 5.4.3.2.
[13] UN, Practical Manual on Transfer Pricing for Developing Countries (New York: UN, 2021), paragraph 5.4.5.3.

arms-length-principle , transfer-pricing