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Abstract
Transfer pricing has become a major concern for tax authorities and multinational enterprises (MNEs) worldwide. Transfer pricing is one of several tax minimization mechanisms used by MNEs and an especially difficult one to audit. Previous studies on tax compliance have mainly focused on individual compliance with little focus on corporations. Furthermore, studies on transfer pricing compliance specifically have focused primarily on developed regions, such as the United States of America, Japan, Europe, and Australia.
Developing countries (DCs) are handicapped because, on the one hand, they need MNEs for technology transfer, while on the other hand they lack resources and capabilities for transfer pricing audits. Enforcement is weakened by other factors including inadequate transfer pricing provisions, outmoded and misguided audit strategies and corrupt behaviour.
This research examines factors influencing MNEs’ decisions to comply with transfer pricing provisions in the developing country of Indonesia. Indonesian tax auditors were surveyed and interviewed and representatives of MNEs in Indonesia were interviewed.
The research finds that, due to the general Indonesian tax audit policy (particularly relating to the auditing of value added tax (VAT) refund claims), tax office rotation policy, career structures, the lack of training and lack of comparable data on transfer pricing, and tax auditors’ preference to not undertake transfer pricing audits. This led to a relatively low number of transfer pricing audits, with a correspondingly low probability of an MNE being subject to a transfer pricing audit.
The research also found that local subsidiaries of foreign MNEs arranged their affairs, so as not to have refund claims and, thus, avoid most routine audits by the Indonesian Directorate General of Taxation (DGT). This behaviour was consistent with an inference that these MNEs realised that the probability of non routine audits on transfer pricing was low. Both local subsidiaries and foreign MNEs and Indonesian headquartered MNEs indicated that tax audits were poorly organised, involved unpredictable delays and were often associated with corrupt behaviour. Both groups of MNE were sceptical of the ability of Indonesian tax auditors to conduct transfer pricing audits competently and with integrity.
The study concludes that in addition to developing adequate transfer pricing provisions, the overall tax regime plays an important role in improving transfer pricing compliance. In particular, audit policy and strategy, and key human capital policies affecting staffing and career structures, are key elements of the overall tax regime that affect transfer pricing compliance To adequately ensure such compliance, governments will need to train and retain transfer pricing specialists, modernise their audit policy and strategies, and review standard administrative procedures, such as regular rotation and promotion of staff, as well as providing additional support for complex and prolonged transfer pricing audits.