Affiliated Service Expenses Disallowed by the DJP? Beware of Hidden Dividends and Getting Hit by Income Tax 26 Twice!

Transfer Pricing Disputes: Analysis of Intragroup Services Correction and Income Tax Article 26 Secondary Adjustment

Enforcement of the Arm's Length Principle and Cross-Border Consequences

Within the framework of enforcing the Arm's Length Principle in Indonesia, this Tax Court decision provides an important case study regarding the consequences of transfer pricing corrections that lead to an Income Tax Article 26 secondary adjustment. This dispute centers on the correction of affiliated service expenses (Intragroup Services - IGS) paid by the Applicant (PT SB and FI) to a related party in Singapore, which the tax authority reclassified as hidden dividends and subjected to Income Tax Article 26. The enforcement of Article 18 paragraph (3) of the Income Tax Law became the primary focus, where the Panel of Judges had to balance the authority of the tax office in redetermining the amount of income against the Taxpayer's right to benefits under the Double Taxation Avoidance Agreement (P3B).

Core Conflict (Arguments of the DJP & WP)

The Directorate General of Taxes (DJP) as the Respondent argued that the Applicant was unable to prove the actual benefits (benefit test) and the substantial existence of the paid affiliated services. Consequently, the Respondent disallowed the expense (primary adjustment) and, in accordance with the Elucidation of Article 18 paragraph (3) of the Income Tax Law, this non-arm's length discrepancy was automatically deemed a hidden dividend (deemed dividend). On this dividend, the DJP imposed Income Tax Article 26 at the domestic rate of 20%. On the other hand, the Applicant firmly maintained that under corporate law (the Limited Liability Company Law), a company cannot distribute dividends while experiencing financial losses. Furthermore, the Applicant emphasized that the recipient was not a direct shareholder, and most importantly, the Applicant demanded its right to apply the 10% preferential rate under the Indonesia-Singapore Tax Treaty.

Resolution (Legal Opinion of the Panel)

The Panel of Judges took a pragmatic and jurisprudential stance. First, the Panel upheld the substance of the primary adjustment on the grounds that the burden of proof rests on the Taxpayer, and the Applicant failed to convince the Panel regarding the substance of the services received. Therefore, the reclassification into hidden dividends (secondary adjustment) was considered legally valid, prioritizing the anti-abuse function within tax legislation (Elucidation of Article 18 paragraph (3) of the Income Tax Law) over the formal provisions of the Limited Liability Company Law. Second, the Panel of Judges granted the Taxpayer's objection regarding the withholding tax rate. Since the income recipient was domiciled in a tax treaty partner country and the Applicant could prove its eligibility for treaty benefits, the Income Tax Article 26 rate had to be reduced from 20% to 10% in accordance with Article 10 paragraph (2) of the Indonesia-Singapore Tax Treaty. This case concluded with a Partially Granted verdict.

Analysis and Impact (Implications of the Decision)

The implications of this ruling are highly significant for multinational enterprises engaged in intragroup service transactions. The decision confirms that double taxation penalties (expense disallowance in Corporate Income Tax and the imposition of Income Tax Article 26 on deemed dividends) are very likely to occur if transfer pricing documentation, particularly the benefit test for affiliated services, is weak. However, this ruling also serves as a strong foundation establishing that even if a secondary adjustment is maintained, the Taxpayer still retains the right to a lower tax treaty rate, provided all formal requirements (including the Certificate of Domicile) are met. This limits the financial losses of the Taxpayer in transfer pricing disputes that involve international elements.

Conclusion

This Tax Court Decision sends a clear signal: comprehensive transfer pricing documentation is the primary line of defense. If this defense crumbles, the battle must shift to maintaining a lower tax treaty rate to minimize the financial impact of the Income Tax Article 26 secondary adjustment. Taxpayers must make satisfying the benefit test and formal tax treaty compliance a top priority in tax risk management.