Beware of Deemed Dividends! Why Transfer Pricing Differences Lead to Article 23 Tax Corrections?

Tax Dispute Analysis: PT KI and the Authority of Secondary Adjustment Corrections on Non-Arm's Length Affiliate Transactions

Article 18, paragraph (3) of the Income Tax Law authorizes the Director General of Taxes to redefine the amount of income and deductions and to determine debt as equity to calculate Taxable Income for taxpayers with related party relationships. In the dispute of PT KI, the Respondent established a secondary adjustment correction of IDR 2,646,578,736 as a deemed dividend following a primary adjustment on sales transactions to affiliates deemed non-arm's length.

The Core Conflict: TNMM Analysis, MOTC Indicators, and the Impact of the COVID-19 Pandemic on Profitability

The core of the conflict originated from the Transfer Pricing analysis conducted by the Respondent using the Transactional Net Margin Method (TNMM) with the Markup on Total Cost (MOTC) indicator, where KI's margin of -14.97% fell significantly below the arm's length range of 0.55% to 3.03%. KI argued that the loss was purely due to the impact of the COVID-19 pandemic, which drastically reduced turnover, and rejected the dividend classification because the counterparty was not a direct shareholder. However, the Respondent maintained that the difference constituted an economic benefit flowing to the corporate group (affiliates), thus meeting the criteria for dividends as regulated in Article 22, paragraph (8) of PMK-22/PMK.03/2020.

Judicial Considerations: Validity of Single-Year 2020 Data and the Substance of Deemed Dividends

In its legal considerations, the Board of Judges emphasized that using single-year 2020 comparison data was appropriate to accurately capture the extraordinary economic conditions caused by the pandemic compared to using multiple years. Regarding the secondary adjustment aspect, the Board opined that any unreasonable expenditure or difference paid to a related party is, in substance, an indirect distribution of profit. Therefore, KI's claim that the counterparty was not a shareholder could not invalidate the "dividend" nature within the broader context of related party relationships.

Strategic Implications: Corporate Double Tax Burden and the Reinforcement of TP Documentation

The implications of this decision confirm that taxpayers must be extremely careful in documenting the impact of the pandemic on financial statements and comparability analyses. This ruling strengthens the tax authority's position in applying secondary adjustments automatically (case-by-case) to Transfer Pricing corrections, resulting in a double tax burden: Corporate Income Tax (via sales correction) and Article 23 Income Tax (on deemed dividends). In conclusion, strengthening TP Documentation and supporting evidence regarding economic anomalies is crucial to avoid these chain corrections.