Paying Shareholder Debt with a Bank Loan: Can the Interest Still Be Deductible? The Tax Court Decision that Overturned the DJP’s Correction

In the context of determining Taxable Income, the deductibility of interest expense frequently becomes a point of dispute between Taxpayers and the Directorate General of Taxes (DJP), especially concerning the criteria for costs incurred to Obtain, Collect, and Maintain Income (3M) as per Article 6 paragraph (1) of the Income Tax Law (UU PPh). The case of PT LMP in Tax Court Decision Number PUT-014667.15/2020/PP/M.IVB Tahun 2025 serves as a crucial study, affirming that the principle of economic substance can prevail over the formality of transactional chains, resulting in the cancellation of the DJP's interest expense correction amounting to Rp. 665,602,343.00 for Corporate Income Tax Year 2016.

The core conflict in this case revolved around the issue of causality. The DJP corrected the interest expense paid by PT LMP to Bank M because the loan was utilized to settle a debt owed to the Shareholder. The DJP argued that the use of funds that did not flow directly into the company’s operational activities (3M) rendered the interest expense a non-deductible expense based on Article 9 paragraph (1) of the UU PPh. The DJP’s position demanded direct proof of funds being transferred straight from the bank loan to working capital accounts.

However, PT LMP successfully counter-argued by presenting evidence that the debt to the Shareholder was originally used to finance the company’s working capital and operational activities. In essence, the Bank M loan functioned as a substitution or refinancing of the debt, the ultimate purpose of which remained the financing of 3M. PT LMP leveraged the appeal process to complete its audit trail, including ledgers and transfer receipts, which strengthened the evidence of this fund usage chain.

The Tax Court Judges rendered a legal opinion that favored economic substance, by assessing the final purpose and initial utilization of the funds. The Panel accepted the additional evidence provided by PT LMP and gained conviction that the Bank M loan funds, although used to repay the Shareholder, were ultimately closely linked to financing the company's 3M activities. The Panel concluded that, pursuant to Article 6 paragraph (1) of the UU PPh, the interest expense must be recognized as a deductible expense. The final decision of the Panel was to fully grant PT LMP’s appeal, thereby cancelling the entire Interest Expense correction and the corresponding administrative sanctions.

The implication of this decision for tax practice is significant. It sets an important precedent for Taxpayers employing chain-financing schemes, such as bridge financing or the refinancing of debt from related parties/affiliates to a bank. This decision underscores that the key to success in interest expense deductibility disputes lies in the Taxpayer's ability to present comprehensive documentation (audit trail) linking every stage of the borrowing to the final goal: financing the company's 3M activities, and not merely focusing on the formality of the final fund transfer.