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The question of "transaction-by-transaction vs. aggregate approach" in transfer pricing analysis occurs in many countries. This is perceived as one of the most controversial transfer pricing issues faced by tax authorities.
The OECD Transfer Pricing Guidelines provide several examples that represent limited situations in which the aggregation basis is preferable. However, the lack of further guidance is considered to exacerbate the problem.
This paper intends to shed light on to what extent affiliated transactions could be deemed as "closely-linked" to prescribe the use of the aggregate approach. An entity carrying out several affiliated transactions does not necessarily mean that those transactions should be aggregated for transfer pricing purposes. Instead, the primary factor is whether multiple transactions have economic substance and are not solely based on contracts.
Introduction
Under a globalized economy, a large part of world trade is carried out by multinational enterprises (MNEs). A recent OECD report estimates that MNEs account for approximately 60% of world trade.1 Given their structures, companies or divisions in an MNE are related and under common control of the parent company. Thus, transfer pricing between those related companies may not reflect the normal result of negotiation between independent parties with competing economic interests.2 Understandably, whenever an MNE attempts to determine the transfer price of any transaction, the issue of transfer mispricing, profit shifting, and taxation-related issues may arise. O'Connor argued that transfer pricing is the most important tax issue facing multinationals today and is expected to remain so for the near future.3
O'Connor's prophecy comes true. The issue of transfer pricing is more prolific these days, thanks to recent structural shifts in MNE global supply chains, which are more centralized.4 Unlike the decentralized model requiring MNEs to provide fully-fledged functions in several geographical areas, the centralized model splits the MNE's structure based on function. Through this new model, an MNE may have its headquarters in the United States. At the same time, it could register its intangible property in Belgium, perform R&D in France, centralize management services in Singapore, carry out manufacturing in Indonesia, and target its market to European countries. This structural shift aims to reap cost savings through economies of scale in procurement and improvement in operational efficiencies.5
In Indonesia, the impact of centralized global supply chains...