Thin Capitalization and Transfer Pricing on Tax Avoidance: The Moderating of Firm Size

Available online at www.rajournals.in International Journal of Management and Economics Invention ISSN: 2395-7220 DOI: 10.47191/ijmei/v11i11.03 Volume: 11 Issue: 11 November 2025 International Open Access Impact Factor: 8.518 (SJIF) Page no. 4805-4810 4805 Yati Mulyati1, IJMEI Volume 11 Issue 11 November 2025 Thin Capitalization and Transfer Pricing on Tax Avoidance: The Moderating of Firm Size Yati Mulyati1, Diana Sari2, Dyah Purnamasari3 1,2,3 Widyatama University, Jl. Cikutra No.204A, Cibeunying Kidul, Kota Bandung, Jawa Barat, Indonesia ARTICLE INFO ABSTRACT Published Online: 11 November 2025 Corresponding Author: Yati Mulyati Tax avoidance remains a phenomenon in taxation research. This study’s purpose is to find out about the effects of thin capitalization and transfer pricing on tax avoidance, also using a moderating factor, which is company size. This research is a quantitative study of mining companies that are on the Indonesia Stock Exchange list during 2018–2022. Using purposive sampling, 115 data points were obtained. Data processing in this study implemented EViews 13. The regression analysis implemented for this study was panel data regression with a Moderated Regression Analysis (MRA) model. The study’s results reveal that thin capitalization affects tax avoidance, transfer pricing shows no effect on tax avoidance, company size moderates thin capitalization’s effect on tax avoidance, and company size does not moderate transfer pricing’s effect on tax avoidance. KEYWORDS: Tax Avoidance, Thin Capitalization, Transfer Pricing, Firm Size. 1. INTRODUCTION Taxes on the mining sector play a role in increasing tax revenue in Indonesia. Tax revenue has a function in the management of a country's government. In 2024, tax revenue in Indonesia reached IDR 1,932.4 trillion, which was only 97.2% of the state revenue target in the state budget. Tax revenue from the mining sector contributed 6% of total tax revenue, down 37.3% compared to the previous year. However, on the other hand, the growth of the mining sector in 2024 increased by 4.9% in comparison to the year before. This shows that even though the mining sector grew in 2024, tax revenue did not contract in line with this growth. This indicates companies’ tendency to engage in tax avoidance. In addition, the Tax Justice Network (2020) reported that Indonesia is one of the countries that has suffered significant losses in potential corporate tax revenue. Indonesia's potential corporate tax revenue loss reached US$4.78 billion in 2020 due to tax avoidance practices by companies. In various parts of the world, tax avoidance practices are often carried out by the manufacturing sector, as seen in the cases of Shell Company (Shimizu, 2021) and (Bousso, 2020). This is also marked by a slowdown in tax ratio growth over the last 5 years with various problems arising in Indonesia, ranging from the COVID-19 pandemic that disrupted the Indonesian economy, tax system reforms in 2022, and inflation in 2023, which will impact slow economic growth in 2024. Figure 1. Indonesia's Tax Ratio 2020-2024 Various phenomena that have emerged indicate the existence of tax avoidance. Tax avoidance is a process of tax planning that is carried out legally by exploiting loopholes in existing tax regulations, thereby minimizing the tax burden without violating the law (Pohan, 2018). One form of tax avoidance is thin capitalization, which is characterized by the capital structure of a company formed by obtaining a large amount of debt (Reisa Mahardika, 2022). Thin capitalization is the establishment of a company’s capital structure in which debt ownership is greater than capital, so that a large amount of debt can result in high interest expenses as a deduction from profits. Transfer pricing is one factor in tax avoidance (Iriyadi, 2024). Two of the most popular tax avoidance schemes are transfer pricing along with thin capitalization. 0.00% 10.00% 20.00% 2020 2021 2022 2023 2024 Tax Ratio “Thin Capitalization and Transfer Pricing on Tax Avoidance: The Moderating of Firm Size” 4806 Yati Mulyati1, IJMEI Volume 11 Issue 11 November 2025 Transfer pricing has become one of the main topics in audits, with the Directorate General of Taxes focusing more on tax audits of transfer pricing. Taxpayers tend to engage in tax avoidance through transfer pricing with practices that exceed the principles of fairness and business norms (PKKU). The DGT found that related company transactions continued to increase from 6.48 trillion in 2021 to 10.360 trillion in 2022 (DDTC, 2024). The transfer pricing scheme is conducted through a pricing mechanism contained in a certain division’s product or service that is then transferred to another division within the same company or between companies with a special relationship, where the transfer price given or charged for services or goods from one company to another company that still has a relationship or affiliation with that company will generally be below market price. 2. LITERATURE REVIEW Agency theory is a contractual relationship between the principal (company owner) with an agent (company management) in executing a contract to carry out agreedupon interests, whereby the principal instructs an agent to carry out certain services and entrusts them with some decision-making authority (Meckling, 1976). The principal grants authority to the agent by prioritizing the interests and profits of the company, in this case, optimizing the company's profits by minimizing the tax burden borne by the company through tax avoidance. In the context of taxation, it initially referred to behavior to “circumvent tax laws,” whether legally or illegally (Braithwaite, 2017). This term has evolved along with taxation practices, where illegal tax avoidance is better known as tax evasion, while the term “avoid” is attached to legal tax avoidance, so that currently the practice of tax avoidance is interpreted as all efforts by taxpayers to minimize, reduce, compensate, or even eliminate taxes that must be paid by taking advantage of loopholes in tax law instruments (N. Hashimzade, 2018). Tax avoidance refers to a strategy of avoiding tax that is performed in a safe and legal way for taxpayers as it does not conflict with tax regulations. Tax avoidance techniques are methods approved by tax laws, even though they are detrimental to the state. The OECD Fiscal Affairs Committee explains several types of tax avoidance techniques, including: (1). Utilizing loopholes in legal regulations for various purposes, (2) There are artificial elements that appear to be rules, when in fact they are not. (3) Confidentiality, where consultants reveal methods or tools for tax avoidance as long as taxpayers maintain confidentiality. The advantage when taxpayers engage in tax avoidance is that the company benefits from savings on taxes payable, thereby maximizing profits and providing benefits to managers both directly and indirectly because they receive compensation from owners or shareholders for the tax savings achieved. However, on the other hand, when a company engages in tax avoidance and is subject to a tax audit by the tax authorities, it will result in sanctions, fines, penalties, and damage to the company's reputation. Therefore, when a company intends to engage in tax avoidance practices, it must be carefully considered so as not to harm many parties. Thin capitalization refers to a situation where a company has a disproportionate amount of debt compared to its capital, commonly referred to as “highly leveraged” (OECD, 2022). Thin capitalization is a practice of avoiding tax where a company’s debt structure exceeds its capital structure. Because interest expenses on loans can reduce taxable income, thin capitalization is considered as providing companies with tax incentives (Prayoga, 2019). Taxpayers tend to use debt instruments from additional investment capital or financing for the Company. High debt creates interest expense obligations for the Company. This is one strategy to minimize or eliminate tax expenses through interest expenses that must be paid by the Company. However, the amount of debt that the Company can incur does not exceed the debt to equity ratio of 4:1 in accordance with PMK No. 165/PMK.010/2015 so that the Company is not indicated to be engaging in tax avoidance (Finance, 2015). Transfer pricing indicates transactions carried out between affiliated companies integrated under the same management in terms of determining the price to be paid (OECD, 2022). Transfer pricing is the setting of prices for transactions conducted between parties that share a close or special relationship. Transfer pricing can be described as company transactions of goods or services among divisions. Transfer pricing is conducted through transactions with related companies, and it can also be conducted by multinational companies that transfer services or goods, accounts receivable across national borders. Transfer pricing must adhere to the applicable regulations in the relevant country (Tomkins, 1992). Globalization is among the factors that develop transfer pricing practices, which is not related to business only but also to corporate law along with accounting. Firm size can be determined from the total assets that a company owns which can be used for its operations. Companies with total assets that are large indicate that the company’s prospects are very good in the relatively long term, and also reflect that the company is relatively more stable as well as capable of generating profits (Barli, 2018). Company size is an internal factor that reflects the amount of resources a company has, is considered to influence tax compliance and the potential for tax avoidance. Company size can indicate a company's ability and stability in carrying out its economic activities (Masrullah, 2018). Therefore, the larger the company size, the lower the tax burden and the company is able to make good plans using its resources, and vice versa. The larger the company, the “Thin Capitalization and Transfer Pricing on Tax Avoidance: The Moderating of Firm Size” 4807 Yati Mulyati1, IJMEI Volume 11 Issue 11 November 2025 more likely it is to have many subsidiaries/branches both domestically and across countries, so that it can engage in transfer pricing as a form of tax avoidance. In addition, large companies with large and healthy resources can obtain external funding by borrowing money or incurring debt. The debt incurred by the company has the consequence of large interest payments, enabling the company to utilize thin capitalization to reduce taxes as a tax avoidance practice (Rego, 2003). From the above description, the research hypotheses are as follows: H1: Thin capitalization affects tax avoidance. H2: Transfer pricing affects tax avoidance. H3: Company size moderates the effect of thin capitalization on tax avoidance. H4: Company size moderates the effect of transfer pricing on tax avoidance. 3. RESEARCH METHOD Quantitative study is the method implemented for this research, with the use of secondary data sourced from the financial reports of the companies in this study. The mining companies that are on the IDX list during 2018–2022 had a population of 74 companies. Using purposive sampling with criteria requiring companies that published their financial reports for 5 consecutive years and used the rupiah currency in their reporting, only 23 companies met the criteria. A total of 115 data samples were collected. Table 1. Concept and Measurement of Operational Variable Variable Research Variable Meaurement Dependent Variable Tax Avoidance (TA) ETR = Tax Expense devided by Profit before tax Independent Variable Thin Capitalization (Thin_Cap) Total liabilities divided by total assets (Wibowo, 2018), (Melmusi, 2016) Transfer Pricing (TP) Related receivables devided by total receivables (Isnalita, 2020) Moderating Variable Firm Size (size) Ln Total Asset Source: compiled Data processing in this study used EViews 13. Classical assumption testing was conducted first by testing data normality using Jarque-Bera, followed by autocorrelation testing using Durbin-Watson, and multicollinearity testing using the variance inflation factor (VIF) value and Harvey's test for heteroscedasticity detection. In selecting the Moderated Regression Analysis model, the Chow, Hausman, along with Lagrange multiplier tests were first conducted to determine the model that is appropriate between the Common Effect Model (CEM), Fixed Effect Model (FEM), as well as Random Effect Model (REM). The regression analysis in this study is panel data regression with the Moderated Regression Analysis (MRA) model. MRA is a specific panel data regression in which interaction terms, or multiplication of two or more independent variables, are included. The MRA equation model to be formed is as the following: Y = a + β1Thin_Cap + β2TP+ β3Size + β4Thin_Cap *Size+ β5TP*Size + e The next step is to test the hypothetical variables using the t-test. The coefficient of determination is tested in order to examine the extent to which thin capitalization, transfer pricing, and firm size can explain tax avoidance by identifying the R2 value. IV. RESULT AND DISCUSSION 4.1 Result The results shown in Table 2 present a statistical summary that comprises the mean, median, minimum, maximum, along with standard deviation of the variables Thin Capitalization, Transfer Pricing, Company Size, as well as Tax Avoidance. For Thin Capitalization, the values obtained are 1.04 for mean, 1.07 for median, 20.33 for maximum, -43.09 for minimum, with a standard deviation of 5.95. For Transfer Pricing, the values obtained are 0.27 for mean, 0.09 for median, 1.00 for maximum, 0.00 for minimum, with a standard deviation of 0.31. For Company Size, the values obtained are 28.25 for mean, 27.98 for median, 31.45 for maximum, 24.95 for minimum, and a standard deviation of 1.62. Lastly, for Tax Avoidance, the values obtained are -0.42 for mean, -0.21 for median, 2.01 for “Thin Capitalization and Transfer Pricing on Tax Avoidance: The Moderating of Firm Size” 4808 Yati Mulyati1, IJMEI Volume 11 Issue 11 November 2025 maximum, -28.16 for minimum, with a standard deviation of 2.66. In conducting classical assumption tests, starting with normality, autocorrelation, multicollinearity, along with heteroscedasticity tests, the classical assumption test requirements have been met. Furthermore, in determining the appropriate regression model for this study, the researcher utilized the Chow, Hausman, along with Langrange Multiplier tests. The steps taken first were to estimate the Common Effect Model (CEM), Fixed Effect Model (FEM), as well as Random Effect Model (REM). From the Chow and Hausman test results, it was determined that the Fixed Effect Method was the model that is appropriate for regression, so this study used the FEM approach. From the regression model results, the Moderated Regression Analysis (MRA) obtained is as below: Tax_Avoid = 47.79701 - 16.15461Thin_Cap + 17.26152TP - 1.730906Size + 0.597690X1*Z - 0.585479X2*Z The following is the interpretation of the equation above: 1. Thin Capitalization, Transfer Pricing, Company Size, Company Size moderates Thin Capitalization, and Company Size moderates Transfer Pricing are equal to zero (0), then Tax Avoidance will be equal to 47.79701 units. 2. Thin Capitalization increases by one unit and other variables remain constant, then Tax Avoidance will decrease by 16.15461 units. 3. Transfer Pricing increases by one unit and other variables remain constant, then Tax Avoidance will increase by 17.26152 units. 4. If Company Size increases by one unit and other variables remain constant, Tax Avoidance will decrease by 1.730906 units. 5. If Thin Capitalization is moderated by Company Size and shows a one unit increase, with the assumption that other variables remain constant, Tax Avoidance will increase by 0.597690 units. Thin Capitalization’s effect on Tax Avoidance is smaller than after being moderated by Company Size, which is -16.15461. This is an indication that Company Size can strengthen Thin Capitalization’s effect on Tax Avoidance. 6. If Transfer Pricing is moderated by Company Size increases by one unit and other variables remain constant, Tax Avoidance will show a 0.585479 units decrease. Transfer Pricing’s effect on Tax Avoidance is greater than when moderated by Firm Size, which is 17.26152. This indicates that Firm Size weakens Transfer Pricing’s effect on Tax Avoidance. The ability of Thin Capitalization, Transfer Pricing, along with Firm Size to explain Tax Avoidance simultaneously is shown in the coefficient of determination value. The coefficient of determination R2 value obtained from the model used is 0.873206 or 87.32%. This indicates that the variables of Thin Capitalization and Transfer Pricing on Tax Avoidance with a moderating variable which is Company Size are able to explain 87.32%. Furthermore, the first hypothesis test results show thin capitalization’s effect on tax avoidance with a significance probability value of less than 0.05, indicating that tax avoidance is affected by thin capitalization. The second hypothesis with a significance probability value of 0.1509, which exceeds 0.05, indicates that tax avoidance is not affected by transfer pricing. The third hypothesis with a significance probability value of 0.0000, which falls below 0.05, indicating that company size is able to moderate the effect of thin capitalization on tax avoidance. Furthermore, the fourth hypothesis, where the significance probability value obtained a result of 0.1669, can be concluded that company size does not moderate transfer pricing’s effect on tax avoidance. 4.2 Discussion Thin capitalization, proxied by the debt-equity ratio, shows an influence on tax avoidance in mining companies during the 2018-2022 period. The thin capitalization value in the research sample shows a fairly high figure, indicating that companies have debts that are greater than their equity. High debt values tend to indicate that companies are engaging in tax avoidance on the grounds that interest expenses on debt can be deducted from income, thereby minimizing taxes. Large interest expenses, especially those originating from loans from affiliated companies and those with special relationships, constitute tax avoidance practices. This study’s results are backed by the Thin Capitalization theory, whereby the higher the company's debt “Thin Capitalization and Transfer Pricing on Tax Avoidance: The Moderating of Firm Size” 4809 Yati Mulyati1, IJMEI Volume 11 Issue 11 November 2025 for financing the company, the higher the interest expenses will be, resulting in higher tax avoidance practices by the company (OECD, 2017). Therefore, the application of Thin Capitalization has a macro impact on the country, because the more companies reduce their tax burden, the more the state's revenue through taxes will decrease. This study’s results are an indication that tax avoidance is not affected by transfer pricing. Transfer pricing is proxied by the company's receivables in relation to total receivables. In the research sample, companies are less likely to have receivables from affiliated companies, which indicates that companies tend not to engage in tax avoidance. Companies consider the risk of audit when conducting transfer pricing by determining unreasonable prices for related companies, which could also damage the company's reputation. The high cost of transfer pricing is also a reason why companies do not engage in transfer pricing. This study’s results show that company size moderates thin capitalization’s effect on tax avoidance, where the larger the scale or size of the company, the easier it is for them to obtain funding sources because it has greater flexibility and the ability to obtain larger funds than small companies. Companies that obtain funding through a relatively high level of debt compared to equity will incur higher interest expenses, which will result in higher tax avoidance by the company. Furthermore, this study shows that company size does not moderate transfer pricing’s effect on tax avoidance, proving that both large and small companies do not engage in transfer pricing for the purpose of tax avoidance. 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