MOTIVES IN THE DECISION OF TRANSFER PRICING. Dr. Alimuddin, SE., MM., Ak. Universitas Hasanuddin. Siti Nafisah Azis, SE.

Transcription

1 1 MOTIVES IN THE DECISION OF TRANSFER Dr. Alimuddin, SE., MM., Ak. Universitas Hasanuddin Siti Nafisah Azis, SE. Universitas Fajar Abdul Saming, SE. Universitas Hasanuddin Author Note Dr. Alimuddin, SE., MM., Ak., Department of Accounting, Universitas Hasanuddin Siti Nafisah Azis, SE., Department of Accounting, Universitas Fajar Abdul Saming, SE., Department of Accounting, Universitas Hasanuddin Contact:

2 2 Abstract The role of transfer pricing become very important as a measurement of right and obligation in the international trading with the presence of cross border transaction. The aim of this study is to investigate motives in the decision of transfer pricing. Factors those examined are tax avoidance, tunneling incentive, bonus scheme, debt covenant, and exchange rate. Samples are collected by purposive sampling method and analyzed using logistics regression. Samples of this study are 30 manufacturing companies listed on the Indonesia Stock Exchange in the period The result of this study showed that tax avoidance and tunneling incentive had a effect on the decision of transfer pricing, while bonus scheme, debt covenant, and exchange rate had no effect on the decision of transfer pricing. These results indicate that there are motives behind the decision of transfer pricing in the form of tax avoidance and tunneling incentive. These motives become an opportunity and a challenge for multinational companies with business operations in Indonesia. Keywords: decision of transfer pricing, motives, tax avoidance, tunneling incentive, bonus scheme Increased cross border transactions resulted in a doubling of the flow of goods, people, services and investments between countries. In this multinational transactions, the role of transfer pricing to be very important. Transfer pricing is the determination of an exchange price for a product or service when different business units within a firm exchange it (Blocher et al., 2010:861). Transfer prices serve two roles, first as prices to guide local decision making and second as profit mesurement to help senior management evaluate the profit centers as separate entities (Kaplan and Atkinson, 1998:454). There are two groups of transfer pricing, that is intracompany and intercompany transfer pricing (Setiawan, 2014). In Indonesia, transactions between members of multinational companies are not spared from the engineering transfer pricing, mainly by the taxpayer in foreign investment and branches of foreign companies in Indonesia are included in the category of permanent establishment. Most of these companies are engaged in manufacturing and have substantial internal link with the parent company or

3 3 their affiliates in foreign countries (Gunadi, 1999:188). One of the taxation issue realted to transfer pricing was first revealed in 2005 when the Ministry of Finance announced that he had received a list of 750 Foreign Direct Investment (PMA) companies that do not pay taxes because of continuous loss. It is then alleged that the transfer price is not arm s length (SGATAR, 2012). Furthermore, there is transfer pricing case of PT Adaro Indonesia and PT AAG that misuse transfer pricing to manipulate the tax, where PT Adaro Indonesia sold coal and PT AAG sold crude palm oil products to affiliated companies abroad at a price below the market price and then sold back to the real buyers at high prices. As a result of this transfer pricing practices, Indonesia expected a loss of at least Rp 10 trillion for the case of PT Adaro Indonesia in 2005 and 2006 (Rakyat Merdeka, 2008), and Rp billion for the case of PT AAG (Oktavia dkk, 2012). Tax office spokesperson said the transfer pricing mechanism is just one way to avoid paying taxes. Finance Ministry taxation director general said around 2000 foreign investment companies in various sectors, had not paid their corporate income taxes properly over the past 10 years based on purported financial losses. The government previously reported that this alleged tax evasion had caused around Rp 500 trillion (US$ billion) in state losses (Sipahutar, 2016). The Canada Revenue Agency wants hundreds of millions of dollars in back taxes from several big firms, they are Cameco Corp., Silver Wheaton Corp. and Loblaw Cos. Ltd. In connection with Panama Papers illustrating the lengths to which wealthy individuals use offshore companies to shield their income, some of

4 4 US biggest corporations have merged with companies in low tax countries in order to cut their American tax bill (Milstead, 2016). Against that backdrop, it s worth noting that there s plenty of tax avoidance going on in corporate Canada. The CRA said Cameco Corp. and Silver Wheaton Corp had structured their offshore subsidiaries with no real purpose other than benefits. The other matter of dispute is with the companies transfer pricing arrangement, the contracts by which one subsidiary sells goods to another, thereby creating taxable income in places other than Canada. The studies conducted by Kiswanto and Purwaningsih (2014), Pramana (2014), Hartati et al. (2014) and Hartati et al. (2015) showed that the tax has significant effect on the decision of transfer pricing. The greater tax burden lead companies to select the transfer pricing decisions in the hope of pressing the load. Transfer pricing practice can also be affected by non-tax reasons, one of them as tunneling. Companies in Asia mostly have a concentrated ownership structure (Dynaty et al., 2011). Tunneling is the behavior of management or majority shareholder that transfer of assets and profits of companies for their own sake, but a fee is charged to the minority shareholders (Yuniasih et al., 2012). The studies conducted by Marfuah and Azizah (2014), Syamsuddin and Witjaksono (2015), Pramana (2014), Wafiroh (2015), dan Hartati et al. (2015) showed that tunneling incentive has positive effect on the decision of transfer pricing. Transfer pricing decisions can also be affected by the bonus scheme. When management wants achievement bonus, then through transfer pricing decisions they will be easy to move profits to an entity that is pursuing such bonus. The studies conducted by Hartati et al. (2014) and Hartati et al. (2015)

5 5 showed that bonus scheme has positive effect on the decision of transfer pricing, while the studies conducted by Pramana (2014) and Wafiroh (2015) showed that bonus scheme has no effect on the decision of transfer pricing. There is another motif that is also taken into account in the decision of transfer pricing is based on previous studies, they are exchange rate and debt covenants. When the exchange rate fluctuations and affect the price of the product or service being traded, then the transfer pricing decisions become the choice for management so that the amount of cash available to make payments can be ascertained. However, the results of research conducted by Marfuah and Azizah (2014) showed that exchange rate has no effect on the decision of transfer pricing. The result of research conducted by Pramana (2014) showed that debt covenant has positive effect on the decision of transfer pricing. Companies that have a high debt ratio has a tendency to turn into higher profits through transfer pricing practices in order to influence the investment decisions of investors. Based on the problems that occured and the inconsistency in the results of previous studies related to transfer pricing decisions, then the researcher examined the motives in the decision of transfer pricing. The basis of this research is study conducted by Hartati et al. (2015). Literature Review and Hypothesis Development Transfer Pricing According director general of taxes, transfer pricing is the pricing of transactions in the form of delivery tangible goods, intangible goods or provision of services between parties that have a special relationship (affiliated transactions). Meanwhile according to Hartati et al. (2015) transfer pricing is the price contained in any product or service from one division to another within the

6 6 same company, or between companies related. Thus, transfer pricing is the pricing of various transactions in the form of delivery tangible goods, intangible goods or provision of services between member or both divisions within the same company or between companies that have a special relationship of either the local area as well as in abroad. Effect of Tax Avoidance on the Decision of Transfer Pricing In this study, the agency relationship can be found in the relationship between government and management, where management has the incentive to evade taxes paid to the government with the aim to increae his profits. Tax avoidance is a legal usage of the tax regime in a single territory to one s own advantage to reduce the amount of tax that payable by means that are within the law (Dyreng et al., 2008). Through transfer pricing, management can mobilize operating profit to other divisons that are in tax heaven countries. While the fiscal authorities want the transactions that occur between divisions or among companies within the same group still refers to the fair market value and is an arm s length (Gunadi, 1999). Results of research conducted by Kiswanto and Purwaningsih (2014) and Pramana (2014) show that the tax has positive effect on the decision of transfer pricing. However, results of research conducted by Hartati et al. (2014) and Hartati et al. (2015) show that the tax has negative effect on the decision of transfer pricing in all companies listed on BEI. The greater the tax burden, forced the company to transfer pricing decision in the hope of pressing the load. Transfer pricing in the sale of goods or services performed by minimizing the selling price between the companies in the group

7 7 and transfer the profits to companies domiciled in countries that apply lower tax rates, so the greater the taxes to be paid by the company, the greater the chance of management to minimize or avoid taxes through the decision of transfer pricing. Based on the results from previous studies and analysis of the researcher, the hypothesis formulated is: H 1 : Tax avoidance has negative effect on the decision of transfer pricing Effect of Tunneling Incentive on the Decision of Transfer Pricing The next agency relationship found in the relationship between the majority shareholder and the minority shareholder. When the majority shareholder take part in the management of the company, then the protection of the rights of minority shareholders is becoming weaker, so the mayority shareholder exploit the gap to do tunneling (Syamsuddin and Witjaksono, 2015). According to Johnson et al. (2000), tunnelling is defined as the transfer of assets and profits out of firms for the benefit of their controlling shareholders. Results of research conducted by Marfuah and Azizah (2014), Syamsuddin and Witjaksono (2015), Wafiroh (2015), Pramana (2014) and Hartati et al. (2015) show that the tunneling incentive has positive effect on the decision of transfer pricing. The bigger the profit earned by the majority shareholders in doing tunneling incentive, the greater the possibility of the shareholders affect the decision of transfer pricing. Based on the results from previous studies and analysis of the researcher, the hypothesis formulated is: H 2 : Tunneling incentive has positive effect on the decision of transfer pricing Effect of Bonus Scheme on the Decision of Transfer Pricing Transfer pricing decisions are also influenced by a bonus scheme wherein each bonus compensation award will affect the management in manipulating

8 8 earnings to maximize bonuses that they will receive (Hartati et al., 2014). Bonus scheme can be defined as a process of remuneration other than salary to the directors of the company for the work they have done (Irpan, 2010). In the bonus plan hypothesis explained that managers with bonus plans tend to choose accounting procedures by which changes in reported earnings from future period brought to the current period or prefer methods that increase the current earnings. This earnings related to the decision of transfer pricing, in which manager will move the company s profit to achieve the targets set by the principal in order to receive bonus. Results of research conducted by Hartati et al. (2014) and Hartati et al. (2015) show that the bonus scheme has positive effect on the decision of transfer pricing. While the results of research conducted by Pramana (2014) and Wafiroh (2015) show that the bonus scheme has no effect on the decision on transfer pricing. The greater the desire of management to achieve the bonus, the greater the possibility of management to make decisions of transfer pricing in order to move the earnings easily. Based on the results from previous studies and analysis of the researcher, the hypothesis formulated is: H 3 : Bonus scheme has positive effect on the decision of transfer pricing Effect of Debt Covenant on the Decision of Transfer Pricing In the debt covenant hypothesis, the closer the company for the violations of accounting based on debt covenant, the more likely managers select accounting procedures by which changes in reported earnings from future period brought to the current period. Companies that have a high debt ratio has a tendency to turn

9 9 into higher profits in order to influence the investment decisions of investors. One way that will be taken by the management is through transfer pricing practices. Results of research conducted by Pramana (2014) show that debt covenant has positive effect on the decision of transfer pricing. The higher the ratio of corporate debt, the greater the chance of management to make transfer pricing decisions. Based on the results from previous studies and analysis of the researcher, the hypothesis formulated is: H 4 : Debt covenant has positive effect on the decision of transfer pricing Effect of Exchange Rate on the Decision of Transfer Pricing Exchange rate has two accounting effects, to enter currency transactions and disclosure of profits or losses that may affect the company s overall profits. As a result, multinational companies may try to reduce the risk of foreign currency exchange rates by moving funds to a strong currency through transfer pricing to maximize the overall company profits (Chan et al., 2002). When the fluctuation of exchange rate has occured and affect the price of product or service being traded, the decision related to transfer pricing practices becomes an options to management so that the amount of cash available to make payments can be ascertained. However, results of research conducted by Marfuah and Azizah (2014) show that exchange rate has no effect on the decision of transfer pricing. Based on the results from previous studies and analysis of the researcher, the hypothesis formulated is: H 5 : Exchange rate has positive effect on the decision of transfer pricing

10 10 Research Method The Location and Design of the Study The study was conducted on Indonesia stock exchange using secondary data from the manufacturing company s annual report for the period and collected through the BEI website ( The dependent variable used is the decision of transfer pricing. Independent variables used are tax avoidance, tunneling incentive, bonus scheme, debt covenant, and exchange rate. Purposive sampling method is used to collect the sample. The criteria sample in this research is manufacturing companies listed on the BEI for the periode , the company controlled by a foreign party with an ownership interest of 20% or more, the company did not experience a loss in the period of observation, the company has a gain or loss on foreign exchange and the company has a fiscal year end of December 31. Companies that are eligible to be sampled in this study were 30 companies or the number of observations by 90 firm-years. Data Analysis The hypothesis in this study were tested using logistic regression. The statistical model in this study are stated as follows: P i TP ln B 1 Pi 0 BTA B TI B BS B DC B ER Note: TP β 0 β 1, 2,3,4,5 = Transfer pricing decision is measured using a dummy variable, companies that sell to those who have a special relationship rated 1 and which are not rated 0 (Yuniasih et al., 2012) = constant = coefficient

11 11 TA TI BS DC ER = Tax avoidance is proxied by the effective tax rate which is the ratio of the tax expense was reduced by differed tax expense divided by income before tax (Bernard et al., 2006) = Tunneling incentive is measured using percentage of shareholding above 20% by foreign shareholders = Bonus scheme is measured using percentage of net income in year t against the net income of the year t-1 (Hartati et al., 2014; Hartati et al., 2015; Purwanti, 2010) = Debt covenant is measured using the debt to equity ratio = Exchange rate is measured using gain or loss on foreign exchange divided by income before tax Result and Discussion Descriptive Statistics Mean of the variable decision of transfer pricing (TP) is 0.89 means that 89% of 90 samples have made the decision of transfer pricing. Variable tax avoidance (TA) has mean value of , which means that the companies have an average tax expense of 30.64%. This tax amount exceeds the corporation tax that is governed by Undang-undang Nomor 36 Tahun 2008 which is 20%, thus indicating the possibility of the company taking a decision of transfer pricing to avoid or minimize taxes. Variable tunneling incentive (TI) has mean value of , which means that the average companies controlled by a foreign party with an ownership of 55.86%. Variable bonus scheme (BS) has mean value of , which means that the net income of the average companies was 29.26%. This achievement is still low to be considered that there is a bonus scheme in the company. Variable debt covenant (DC) has mean value of , which means that the average companies have a composition of debt to equity is 73.07%. It is still categorized as a safe codition bacause the debt portion remains under equity,

12 12 thus indicating that the chances of the company s sample was not in the position of violating debt covenant. Variable exchange rate (ER) has mean value of , which means that the average companies experienced a foreign exchange loss in the amount of 26.04%. Classical Assumptions Test Multicollinearity test in the logistic regression using the correlation matrix to see the magnitude of the correlation between the independent variables. The test results show that there is no correlation coefficient between variables greater than 0.8. So it can conclude that there are no symptoms of serious multicollinearity between independent variables. The magnitude of the effect of five variables consisting of tax avoidance (TA), tunneling incentive (TI), bonus scheme (BS), debt covenant (DC) and exchange rate (ER) on the decision of transfer pricing (TP) was 55.1% based on the value of Nagelkerke R Square. While the rest of 44.9% is explained by other variables not included in the research model. The regression model has been viable for use in further analysis, because there is no real difference between the classification of the predicted and observed classification. It can be seen from the statistical value Hosmer Lemeshow s Goodness of Fit Test is with a significance probability of above So it can be concluded that the model is acceptable Hypothesis Test Here is an equations and summary table of the results of logistic regression to test the motives in the decision of transfer pricing: TP = TA TI BS DC ER

13 Table 1 The Summary of the Results of Hypothesis Test HYPOTHESIS B Sig. Wald H 1 : Tax avoidance has negative effect on the decision of transfer pricing H 2 : Tunneling incentive has positive effect on the decision of transfer pricing H 3 : Bonus scheme has positive effect on the decision of transfer pricing H 4 : Debt covenant has positive effect on the decision of transfer pricing H 5 : Exchange rate has positive effect on the decision of transfer pricing Effect of Tax Avoidance on the Decision of Transfer Pricing 13 Significance Of Hypothesis Accepted Accepted Rejected Rejected Rejected Based on table 1, the magnitude of the regression coefficient of variable tax avoidance is with sig. Wald is 0.003, therefore the first hypothesis is acceptable. This result indicate that the smaller the ratio of TA or the smaller the tax paid, the more likely there is a transfer pricing in the company observed. This indicates that the company will seek to reduce the tax expense by increasing transfer pricing transactions with parties that have a special relationship. This result is consistent with the research conducted by Hartati et al. (2014), Hartati et al. (2015), Marfuah and Azizah (2014) that found a negative influence from the tax on the decision of transfer pricing. Klassen et al. (2013) found that there has been a shift in income by multinational companies as a response to changes in tax rates in Canada, Europe and the United States. Multinational companies shift income from Canada to the US and when occured the reduction of tax rates in Europe, income is shifted from the US to Europe. Gusnardi (2009) also mentioned that multinational companies choose transfer pricing to minimize global tax liabilities of their company. The greater the taxes to be paid by the company, the greater the chance of

14 14 management to minimize or avoid taxes through the decision of transfer pricing. This result is consistent with the research conducted by Bernard et al. (2006). Effect of Tunneling Incentive on the Decision of Transfer Pricing Based on table 1, the magnitude of the regression coefficient of variable tunneling incentive is with sig-wald is 0.013, therefore the second hypothesis is acceptable. This result indicate that the higher the ratio of TI the more likely there is a transfer pricing in the company observed. This indicates that the higher the practice of tunneling incentive the more companies will choose transfer pricing with parties that have a special relationship. This result is consistent with the research conducted by Pramana (2014), Marfuah and Azizah (2014), Syamsuddin and Witjaksono (2015), Wafiroh (2015), and Hartati et al. (2015) which stated that the tunneling was greater in highly concentrated ownership structure than the low concentrated ownership structure. In other words, tunneling greater done by the majority shareholders rather than the minority shareholders. Consistent with the research conducted by Marfuah and Azizah (2014), there are two things to be considered as an encouragement for companies to do tunneling. First, ownership structure. Second, the aviability of financial resources that will be in tunnel. By controlling and significant influence possessed, the controlling shareholders can adopt policies that benefit themselves, including contractual policy with those who have a special relationship. The aviability of resources would also be a boost for the controlling shareholder to tunnel out of the company s resources for the benefit of the controlling shareholder. Effect of Bonus Scheme on the Decision of Transfer Pricing Based on table 1, the magnitude of the regression coefficient of variable

15 15 bonus scheme is with sig-wald is 0.466, therefore the third hypothesis is rejected. This result indicates that a bonus scheme which is programmed by the company do not affect the company s decision to choose a transfer pricing practices. The result of this study is not consistent with the research conducted by Hartati et al. (2014) and Hartati et al. (2015) which stated that the bonus scheme has positive effect on the decision of transfer pricing or at the time of giving bonusses to directors, the owners will see the performance of the directors in managing the company. In this case as an assessment, the owner will see an overall profit generated. Therefore, the board of directors will make an effort in order to increase profit, including by way of transfer pricing. The result of this study is consistent with the research conducted by Pramana (2014) and Wafiroh (2015) which stated that the bonus scheme has no effect on the decision of transfer pricing. It could happen because there are bonus policy which is appropriate, moreover, because the company is predominantly owned by foreigners, where strict controls have been applied so that an assessment of management performance can not be engineered. Another factor can also be caused by the measurement of bonus scheme used in this study do not reflect the phenomenon of bonus scheme is actually happens in the company, where the bonus scheme should be viewed directly from bonus contract which took place between management and the company, but it is difficult because information about the bonus contracts is a private company information. Effect of Debt Covenant on the Decision of Transfer Pricing Based on table 1, the magnitude of the regression coefficient of variable debt covenant is with sig-wald is 0.047, therefore the fourth hypothesis is

16 16 rejected. This result indicate that the smaller the ratio of DC the more likely there is a transfer pricing in the company observed. The result of this study is not consistent with the research conducted by Pramana (2014) that found a positive influence from the debt covenant on the decision of transfer pricing. Thus, the greater the debt ratio, the greater the chance of management to make the decision of transfer pricing with the aim to shrink the value of debt covenant. The result of this study indicates that the company does not only depend on the decision of transfer pricing to security debt agreement. There are some other things that affect the security of the debt agreement, such as credibility, the guarantee given by the company and timeliness of payment of installments. Effect of Exchange Rate on the Decision of Transfer Pricing Based on table 1, the magnitude of the regression coefficient of variable exchange rate is with sig-wald is 0.067, therefore the fifth hypothesis is rejected. This result indicate that the size of the exchange rate ratio does not affect the company s consideration in selecting transfer pricing decision. The result of this study is consistent with the research conducted by Marfuah and Azizah (2014) which found that the exchange rate does not affect the decision of transfer pricing. However, the result of this study is not consistent with the research conducted by Chan et al. (2002) which found that multinational companies may try to reduce the risk of foreign currency exchange rate by moving funds to a strong currency through transfer pricing to maximize the overall company profits. The fifth hypothesis is not proven because the average sample company experienced a foreign exchange loss of 26.04%, so it is not become the main focus for management to choose the decision of transfer pricing. When the

17 17 company suffered foreign exchange losses, the management does not need to make a decision to reduce the risk of foreign currency exchange rate by moving funds to a strong currency through transfer pricing to maximize the overall company profits. Conclusions, Limitations and Recommendations Based on the analysis above, it can be concluded that the testing of the first hypothesis about the tax avoidance that has a negative effect on the decision of transfer pricing showed negative direction and significant. This result indicates that the smaller the ratio of tax avoidance the more likely there is a transfer pricing in the company observed. The testing of the second hypothesis about the tunneling incentive that has a positive effect on the decision of transfer pricing showed positive direction and significant. This result indicates that the the higher the practice of tunneling incentive the more companies will choose transfer pricing with parties that have a special relationship. The testing of the third hypothesis about the bonus scheme that has a positive effect on the decision of transfer pricing showed negative direction and not significant, so that the third hypothesis is rejected. This result indicates that a bonus scheme which is programmed by the company dose not affect the company s decision to choose a transfer pricing practices. The testing of the fourth hypothesis about the debt covenant that has a positive effect on the decision of transfer pricing showed negative direction and sifnificant, so that the fourth hypothesis is rejected. The result of this study indicates that the company does not only depend on the decision of transfer pricing to security debt agreement. The testing of the fifth hypothesis about the exchange rate that has a

18 18 positive effect on the decision of transfer pricing showed positive direction and not signficant, so that the fifth hypothesis is rejected. This result indicate that the size of the exchange rate ratio does not affect the company s consideration in selecting transfer pricing decision. This research has several limitations. First, this research has not considered the distinction between foreign and Indonesia companies, thus for the future research can use the intervening variable that differentiate between foreign and Indonesia companies. Second, this research has not considered the arm slength transaction as indicator of the presence or absence of transfer pricing abuse in the company, thus for the future research can use the intervening variable that differentiate between the presence or absence arm s-length transactions. Data on this variable can be obtained from the document of tax income returrn. Implications In practice, transfer pricing is widely used illegally to avoid or minimize taxes and a unique condition is the ownership of public companies in Indonesia which is concentrated so there is a tendency of the majority shareholder to perform tunneling. This study also provides evidences that there are motives behind the decision of transfer pricing that could be an opportunity and a challenge for multinational companies with business operations in Indonesia. References Bernard, A. B., Jensen, J. B. and Schott, P. K Transfer Pricing by US-Base Multinational Firms. Blocher, E. J., Stout, D. E. and Cokins, G Cost Management: A Strategic Emphasis 5th Edition. New York: McGraw Hill/Irwin.

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