Special Relationship & Special-Relationship-Influenced Transactions

In March 2020, the Minister of Finance issued Minister of Finance Regulation (MoF Reg.) Number-22/PMK.03/2020 which stipulates procedures for Advance Pricing Agreement (APA).

This MoF Reg. is noteworthy because, in addition to containing the regulation of APA implementation procedures, it also contains legal norms in the context of transfer pricing in Indonesia, among others, further elaboration of the terminology ‘special relationship’ and ‘transactions influenced by a special relationship’.

Special Relationship
Article 18 paragraph (3) of the Income Tax Law authorises the Director General of Taxes to assess the application of the arm’s length principle to transactions between related parties.

Article 18 paragraph (4) of the Income Tax Law and the elucidation thereto define that ‘special relationship’ may occur due to ownership or equity participation, control through management or use of technologies even though there is no ownership relationship and family relationship by blood or marriage.

Article 4 of MoF Reg. 22/2020 further affirms that ‘special relationship’ is deemed to exist if there is one of the three conditions referred to in Article 18 paragraph (4) of the Income Tax Law which results in a condition of dependence or attachment of one party to another party. The condition of dependence or attachment is evident where one or more parties control(s) the other party or one of the parties is not independent in conducting business or activities.

The terminology ‘control’ outlined in Article 18 paragraph (4) subparagraph ‘b’ of the Income Tax Law and the elucidation is restated in Article 4 paragraph (1) subparagraph ‘b’ of MoF Reg. 22/2020 and further elaborated in Article 4 paragraph (4) of MoF Reg. 22/2020 as follows:

“The special relationship due to control shall be deemed to exist if:

1. one party controls another party or one party is controlled by another party, directly and/or indirectly;
2. two or more parties are under the direct control of the same party directly and/or indirectly;
3. there are the same people who are directly and/or indirectly involved or participating in managerial or operational decision-making for two or more parties;
4. parties that are commercially or financially known or claim to be in the same business group; or
5. one party claims to have a special relationship with the other party.”

MoF Reg. 22/2020 intends to clarify the definition of ‘control’ outlined in Article 18 paragraph (4) of the Income Tax Law. On the other hand, this definition may raise issues if the definition is not in line with the definition of special relationship in tax treaties with partner countries.

As such, what is the definition of special relationship in the Tax Treaty context? Article 9 paragraph (1) of the OECD Model and UN Model outline the definition of ‘special relationship’, referred to as associated enterprise. Both the OECD Model and the UN Model contain the same formulation of associated enterprises as follows.

“Associated Enterprise, Where: (a) an enterprise of a Contracting State participates directly or indirectly in the management, control or capital of an enterprise of the other Contracting State, or (b) the same persons participate directly or indirectly in the management, control, or capital of an enterprise of a Contracting State and an enterprise of the other Contracting State”

The concept of associated enterprises is fundamental in the application of the arm’s length principle as an internationally recognised standard related to transfer pricing taxation (Dwarkasing, 2013).

However, unfortunately, there are no further detailed and clear provisions on the concept of associated enterprises in the Tax Treaty Model, both the OECD and the UN Model.

Therefore, if each country specifically defines ‘special relationship’ or associated enterprises based on each country’s domestic provisions, Dwarkasing (2013) suggests that this may lead to potential economic double taxation.

Transactions Influenced by a Special Relationship
In following up on the APA application, the Director General of Taxes will conduct a material assessment by applying the arm’s length principle. The assessment is carried out not only on controlled transactions but also on transactions influenced by a special relationship, namely transactions between non-related parties provided that the related party of one or both transacting parties influences the counterparty and the price of the transaction.

Thus, the material assessment of the arm’s length principle outlined in MoF Reg. 22/2020 is aimed at controlled transactions and transactions influenced by a special relationship. The question is, is the above assessment only applied limited to APA procedures or also other aspects of transfer pricing in a broad sense?

The above question arises because in respect of the provisions under Article 10 paragraphs (1) and (2) of Government Regulation Number 74 of 2011 in conjunction with Article 2 paragraph (2) of MoF Reg. Number 213/PMK.03/2016 as well as the Appendix of the Director General of Taxes Regulation Number PER-22/PJ/2013, it is stated that the arm’s length principle assessment is only for assessing transactions.

Addressing the above question, MoF Reg. 22/2020 should apply because it is in line with Article 18 paragraph (3) of the Income Tax Law which states that the arm’s length principle assessment applies to taxpayers related with other taxpayers, as per the definition of special relationship regulated under Article 18 paragraph (4) of the Income Tax Law and the elucidation thereto.