A Policy Proposal to Address Tax Base Erosion Caused by Transfer Pricing in Indonesia

Prior studies indicate that developing countries face the problem of aggressive transfer pricing practices by multinational enterprises (MNEs) which cause tax base erosion. This study finds that the Indonesian transfer pricing regime fails to accurately allocate the income of MNEs among taxing states in accordance with actual economic reality. To overcome this problem, this study considers different interpretations of transfer pricing regimes in four countries: (a) Mexico's minimum profit, (b) Brazil's pre-fixed profit margin and (c) India's and China's location-specific advantage rules. This study argues that adopting the location-specific advantage criteria for determining an arm's length price could help Indonesia address the problem of aggressive transfer pricing practices and assist Indonesia to reduce tax base erosion.