Winning Transfer Pricing Disputes: Why Berry Ratio Trumps Return on Sales for Limited Risk Entities?

Legal Dispute: Berry Ratio Validity and Secondary Adjustments (PT NSDI)

The Directorate General of Taxes (DGT) frequently implements secondary adjustments by reclassifying transfer pricing discrepancies as disguised dividends subject to Income Tax Article 26. This dispute originated when the Respondent adjusted PT NSDI's Income Tax Article 26 base for December 2020 by IDR 32,647,996,884, based on the assumption of indirect profit distribution to overseas affiliates due to alleged operational profit irregularities.

The Methodology Conflict: ROS vs. Berry Ratio

The core conflict in this case lies in the methodology used for testing the arm's length principle. The Respondent utilized the Transactional Net Margin Method (TNMM) with Return on Sales (ROS) as the Profit Level Indicator (PLI). Conversely, the Petitioner argued that as a limited risk procurer whose sales are entirely to affiliated parties, using ROS as a denominator is unreliable. The Petitioner emphasized that the Berry Ratio is a far more appropriate indicator as it compares gross profit to independent operating expenses.

Judicial Review: Neutralizing Related-Party Bias

The Board of Judges, in its legal considerations, agreed with the Petitioner's arguments. The Court affirmed that if the total sales value is derived from affiliated transactions, such sales cannot serve as a reliable base (denominator) for fairness testing due to inherent transfer pricing bias. The Court validated the use of the Berry Ratio as a more accurate instrument for measuring the functions of a limited risk intermediary.

Implications: Substance Over Form in Secondary Adjustments

PT NSDI's victory reinforces that secondary adjustments cannot be automatically applied without a proper functional analysis and the selection of an appropriate PLI. The Board of Judges demonstrated consistency in applying the "substance over form" principle, requiring that the existence of dividends be materially proven rather than merely assumed from primary Corporate Income Tax adjustments.

Conclusion: The key to navigating transfer pricing corrections leading to Article 26 withholding tax is precision in defining the functional profile and selecting comparable benchmarks. Robust Transfer Pricing Documentation (TP Doc) regarding methodology selection remains the primary defense.