Transfer Pricing and Profit Shifting Practices in a Free Trade Zone: A Case in Batam, Indonesia, Based on a Tax Court Decision

This study discusses how the offered tax incentives through the establishment of the Batam Free Trade Zone have been overexploited by Multinational Enterprises (MNE)s’ manufacturers to minimize their tax obligation. The close geographic location to Singapore, the hub of the world’s logistic shipping lane, provides easier access to these practices. The common profit shifting schemes found in the region are transfer pricing and rerouting transactions. Concerning the transfer pricing practices based on the tax court decisions, it was determined that business entities have reported unreasonable business turnover with years of consecutive loss despite an increasing number of assets. The rerouting of transactions has specifically been performed by shipping businesses in order to optimize the benefit of not paying types of consumption taxes. They were able to exploit this benefit because the Indonesian Government granted VAT and import duty exemptions to sea transportation businesses for the supply of ships and ship’s spare parts. These businesses established shipyards in Batam, and the products were subsequently sold to affiliations in another country. Then, the user entity that is a member of the sea transportation business in Indonesia imported the same products from the country where a member of affiliation is located. To address these challenges, the Indonesian Government has made a measure to minimize tax leakages through persuasive enforcement and a systematic investigation that requires continuous monitoring.