Beware! Transfer Pricing Adjustments Can Lead to Double Taxation of Constructive Dividends under Article 26 Income Tax

Corrections to the Arm's Length Nature of Purchase Prices and Domino Effects

Corrections to the arm's length nature of purchase prices from affiliated parties during Corporate Income Tax (CIT) audits frequently trigger a domino effect in the form of secondary adjustments categorized as constructive dividends. Based on the Tax Court Decision Number PUT-012164.13/2022/PP/M.XB of 2024, the Board of Judges emphasized that any disparity regarding the unreasonableness of affiliated transaction prices upheld in CIT disputes automatically becomes an object of Article 26 Income Tax withholding for foreign taxpayers. This case originated from the Respondent's move to perform ex-officio financial statement segmentation because PT K failed to present segmented data between its distribution and service divisions, subsequently leading to the finding that the purchase price of goods from affiliates exceeded the fair range.

The Core Conflict in Comparability Analysis and Segmentation Obligations

The core conflict in this dispute lies in the differences in comparability analysis methods and the obligation for financial statement segmentation. The Respondent utilized the Transactional Net Margin Method (TNMM), distributing the annual correction equally into the December 2019 tax period, referencing Article 18 paragraph (3) of the Income Tax Law which permits the reclassification of excess payments as dividends. Conversely, PT K argued that they are a simple distributor that should be tested using the Resale Price Method (RPM) and rejected the dividend classification because the transactions were conducted with various common-control entities, not just the direct shareholder. However, the absence of valid segmentation evidence from the Taxpayer's side weakened the rebuttal against the profit-per-division analysis conducted by the tax authorities.

The Board of Judges Legal Consideration on Mandatory Segmented Financial Statements

The Board of Judges, in their legal consideration, stated that the obligation to present segmented financial statements is mandatory for companies with different business characteristics according to PMK-213/2016. Since the correction on CIT (Cost of Goods Sold) was upheld, legally, the value of the difference is considered an outflow of wealth to foreign affiliates meeting the criteria of dividends in a broad sense as regulated in Article 4 paragraph (1) letter g of the Income Tax Law. The Board held that the economic substance of the excess purchase price constitutes a disguised profit distribution; therefore, the Article 26 Income Tax correction made by the Respondent complied with the prevailing regulations.

The Implications of This Decision on Withholding Tax Disputes

The implications of this decision are highly significant for multinational companies operating in Indonesia. This ruling confirms that transfer pricing disputes do not end with profit and loss adjustments alone but can extend to withholding tax disputes, drastically increasing the effective tax burden. Taxpayers are expected not to underestimate the preparation of Local File documents that include accurate financial statement segmentation. The main conclusion is that consistency between functional data and financial reporting is a critical determinant in mitigating the risk of secondary adjustments, which are difficult to refute in court if the primary dispute (CIT) is not successfully won.

A Comprehensive Analysis and the Tax Court Decision on This Dispute Are Available Here