Severance Pay, Leave Compensation, and Final Article 21 Income Tax: What the Tax Authority Often Gets Wrong

Disputes over Final Article 21 Income Tax often do not revolve around whether an item constitutes a taxable object, but rather around how tax rates and statutory thresholds are applied. This issue lay at the heart of the dispute between PT HIM and the Directorate General of Taxes (DGT), where the tax authority treated payments in the form of severance pay for contract employees and compensation for unused five-year leave entitlements as Final Article 21 Income Tax objects that automatically resulted in tax payable.

The core issue in this case extended beyond the mere classification of taxable objects. It touched upon a deeper question concerning the substance of income and the proper application of final income tax rates. The DGT adopted a broad approach, asserting that any payments related to termination of employment and employee benefits should, without exception, be subject to Final Article 21 Income Tax. As a result, the DGT assessed income tax payable on the full amount of such payments.

In contrast, PT HIM presented a defense grounded in substance rather than form. While PT HIM did not dispute that severance pay for contract employees could be classified as an object of Final Article 21 Income Tax, it emphasized that Government Regulation No. 68 of 2009 explicitly provides a 0% tax rate for severance payments up to a certain threshold. Accordingly, even where such payments qualify as taxable objects, they do not necessarily give rise to tax payable. Furthermore, PT HIM argued that compensation for unused five-year leave entitlements does not fall within the category of income subject to Final Article 21 Income Tax, as it does not share the same characteristics as severance pay, pension benefits, or other similar payments that are exhaustively regulated under Indonesian tax law.

In its legal considerations, the Panel of Judges adopted a balanced position. The Court agreed with the DGT that severance pay for contract employees constitutes an object of Final Article 21 Income Tax. However, the Panel firmly affirmed that the 0% tax rate prescribed under Government Regulation No. 68 of 2009 must be respected, rendering the DGT’s correction—which resulted in tax payable on such severance—unsustainable. Moreover, the Court rejected the DGT’s correction related to compensation for unused five-year leave, concluding that such payments do not qualify as objects of Final Article 21 Income Tax.

Ultimately, the Court partially granted PT HIM’s appeal. This decision serves as an important precedent, underscoring that in disputes involving Final Article 21 Income Tax, the determination of taxable objects cannot be detached from applicable tax rates and statutory limitations. It also reinforces the principle that tax adjustments which disregard the substantive nature of income are vulnerable to being overturned at the appellate level.

Comprehensive Analysis and Tax Court Decision on This Dispute is Available Here