Legal boundaries of transfer pricing in royalty payments to foreign affiliates

An analysis of tax avoidance and tax crimes under Indonesian tax law

Abstract

International royalty payments between affiliated enterprises often fall within the regulatory gray areas of tax law. This study aims to analyze the legal boundaries separating legitimate tax avoidance schemes from tax evasion within the realm of cross-border royalty transfer pricing in Indonesia, as well as the standing of evidence utilized by tax authorities and taxpayers in such disputes. Employing a normative legal research method with statutory, conceptual, and case-law approaches, this paper dissects the taxpayer’s legal liability from both administrative and criminal law perspectives. The research findings indicate that the primary line of demarcation between the two lies in the presence or absence of mens rea (criminal intent), manifested through material manipulation, fictitious royalties, and falsified documentation. A taxpayer's failure to meet administrative and commercial compliance in proving the arm's length principle constitutes a purely administrative law matter to be adjudicated before the Tax Court, rather than a criminal tax offense under Article 39 of the Law on General Provisions and Tax Procedures (UU KUP). Transitioning from an administrative regime to a criminal investigation requires a stringent standard of proof—beyond a reasonable doubt—to avoid undermining the principles of legal certainty, objectivity, and proportionality.