Article 26 Income Tax corrections on constructive dividends often serve as a "domino effect" from transfer pricing disputes in Indonesian tax audits. Based on Tax Court Decision Number PUT-010774.13/2023/PP/M.VB Year 2024, the Board of Judges has provided legal certainty that the secondary adjustment mechanism cannot stand alone if the primary correction in Corporate Income Tax has been legally annulled. This dispute originated from the Respondent's move to recharacterize the difference in affiliated transaction values at PT FI as a disguised profit distribution to a foreign tax subject, which was subsequently subjected to Article 26 Income Tax withholding amounting to IDR 268,837,415.00.
The core conflict centered on the Respondent's argument applying Article 18 paragraph (3) of the Income Tax Law to establish a constructive dividend as a consequence of the revenue correction. The Respondent considered PT FI’s transactions to be inconsistent with the Arm's Length Principle (ALP), thus treating the discrepancy as a fund flow that must be taxed as a dividend. Conversely, the Petitioner (PT FI) strongly refuted this by demonstrating that their profitability profile, measured through a Mark-up on Total Cost (MTC) of 9.45%, fell within the arm's length interquartile range of comparable companies. Furthermore, the Petitioner emphasized that the transactions were conducted with a sister company, therefore not meeting the criteria for a dividend distribution, which should be directed to a direct shareholder.
Legal resolution was provided by the Board of Judges through a systematic and interconnected approach. The Judges referred to the decision on PT FI’s Corporate Income Tax dispute for the same fiscal year, where the Board had already annulled the primary correction on revenue. This annulment was based on the finding that the Respondent performed a flawed comparability analysis, comparing PT FI, a limited-risk manufacturer, with fully-fledged manufacturers without appropriate adjustments. Since the affiliated transactions were materially declared arm's length and the revenue correction was removed, the tax base for the secondary adjustment (Article 26 Income Tax) automatically became legally groundless and was dismissed.
The analysis and impact of this decision emphasize the importance of consistency in resolving derivative tax disputes. This ruling serves as a reminder to tax authorities that the determination of constructive dividends must be rooted in a solid primary correction that is materially proven to violate the ALP. For Taxpayers, this victory demonstrates that robust transfer pricing documentation (TP Doc) and accurate functional analysis are the primary keys to dismantling transaction recharacterization arguments. In conclusion, the Board of Judges granted the Petitioner’s appeal in its entirety and canceled the Article 26 Income Tax correction for the July 2020 tax period.
A Comprehensive Analysis and the Tax Court Decision on This Dispute Are Available Here
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