Transactional Net Margin Method (TNMM)

One of the methods used in determining fair transfer pricing is the Transactional Net Margin Method (TNMM). TNMM is a method for determining transfer prices by comparing the operating net profit margin as a percentage of costs, sales, assets, or other bases in transactions between related parties, with the net operating profit margin achieved from comparable transactions by unrelated parties or comparable transactions carried out by other unrelated parties.

When to Use TNMM?

Referring to Article 11, paragraph (1) of Regulation of the Director General of Taxes No. PER-32/PJ/2011, there are two conditions suitable for applying TNMM:

1. One of the parties in the related-party transaction makes a specific contribution.

2. One of the parties in the related-party transaction carries out a complex transaction with interrelated components.

Choosing the Profit Level Indicator (PLI) in TNMM

According to Circular of the Director General of Taxes No. SE-50/PJ/2013, one of the steps in applying TNMM is selecting the most appropriate Profit Level Indicator (PLI) based on the facts and circumstances. The PLI is expressed as a comparison of operating net profit with sales, total costs, assets, or other factors.

The choice of denominator used in TNMM should be made by considering the company’s profit drivers and the independence of the denominator. Other factors to consider when selecting a PLI include the type of business and the availability of data. Typically, service providers, manufacturers, and similar businesses use operating net profit compared to total costs as the PLI, while distribution activities usually use operating net profit compared to sales.

Some common ratios used as PLIs include:

• Net Margin Ratio (Return on Sales),

• Net Mark-up Ratio (Return on Total Costs),

• Return on Assets (ROA).

Enhancing Comparability in Using TNMM

Circular SE-50/PJ/2013 outlines several processes taxpayers can follow to improve comparability when applying the transactional net margin method.

Search Criteria and Manual Screening

When taxpayers use external comparables, the search can be conducted using publicly available data, such as commercial databases. Taxpayers can apply certain criteria (searching strategy), such as industry code, region, data availability, and financial report indicators. The companies selected as potential comparables must undergo a manual review process to determine whether they are reliable. For manual review, taxpayers can study the candidate’s profile, visit their website, search for related information in print or online media, or use other methods.

Use of Multiple Years of Data

Multiple years of data are used when they can improve the comparability analysis. Multiple years of data help identify comparables with significant differences from the tested party. However, using multiple years of data does not mean that the determination of fair prices or profits should be based on the average performance of the data over several years.

Transaction-by-Transaction or Combined Transaction Approach

Testing affiliated transactions can be done either on a transaction-by-transaction basis or in combination, depending on the facts and circumstances. Testing combined transactions is more appropriate when there are closely linked or continuous transactions. SE-50/2013 provides several examples of combined transaction testing, such as:

• Transactions arising from long-term contracts for the supply of commodities or services,

• Use of intangible property attached to a product,

• Pricing of closely related products,

• Companies implementing pricing strategies focused on a portfolio approach, such as minimizing profits for certain products to maximize profits for related products (e.g., setting prices for printers and cartridges).