Secondary Transfer Pricing Fails! Tax Court Voids Billions in Article 26 Income Tax, The Key Victory: Counterparty Was Not a Shareholder

The transfer pricing dispute case once again highlights the complexity of applying the Arm’s Length Principle, specifically concerning the mechanism of secondary adjustments in the form of constructive dividends regulated under Article 22 paragraph (8) of PMK Number 22/PMK.03/2020. Tax Court Decision Number PUT-006748.13/2023/PP/M.XA Year 2025 serves as a critical precedent by rejecting the imposition of Income Tax (PPh) Article 26 on the difference resulting from an abnormal affiliated transaction, setting a firm legal boundary for imposing tax on constructive dividends directed at non-shareholder entities.

The Tax Court heard the appeal filed by PT JSGI against a correction of the Article 26 Income Tax Base (DPP) amounting to over Rp. 248 billion. This correction originated from a primary adjustment (Cost of Goods Sold/HPP correction) made by the Tax Authority (DJP) on PT JSGI's raw material purchase transactions with its Japanese affiliate, JFE Shoji Trade Corporation (JSTC), which was subsequently reclassified as a constructive dividend.

The core conflict in this dispute hinges on two aspects. On one side, DJP argued that any abnormal difference in affiliated transactions, according to domestic Transfer Pricing Ministerial Regulations, must be treated as a profit distribution subject to PPh Article 26 since it involves a Foreign Taxpayer (WPLN). This view is driven by the economic principle of preventing tax base erosion through profit shifting. On the other side, PT JSGI firmly maintained that imposing the constructive dividend concept on JSTC violated core tax law principles. PT JSGI proved that JSTC merely acted as an affiliated supplier and was legally not a shareholder of the company.

In the hearing of this dispute, the Tax Court Panel did not solely focus on debating the primary correction to the Cost of Goods Sold (HPP), but also scrutinized the legal foundation of the secondary adjustment. The crucial point that determined the Panel's decision was that the concept of a Constructive Dividend, which serves as the object of PPh Article 26, inherently requires a shareholder relationship between the paying party (PT JSGI) and the income-receiving party (JSTC), as stipulated in Article 4 paragraph (1) letter g of the Indonesian Income Tax Law and its Elucidation.

Upon examining the presented facts and analyzing the legal status of both parties, the Panel affirmed that JSTC, the affiliated entity acting as the raw material supplier in Japan, was factually and legally not a shareholder of PT JSGI.

Due to the absence of this shareholder relationship, the Panel ruled that the abnormal HPP difference—even if indicative of profit shifting—could not be legally classified as a dividend. Consequently, the object required for PPh Article 26 was not met. Therefore, the secondary PPh Article 26 correction established by the DJP could not be sustained. This ruling clearly limits the authority of the tax authorities, confirming that a secondary adjustment in the form of a constructive dividend can only be applied to an affiliated entity that clearly holds the legal status of a shareholder.

As we can see from the analysis and resolution of the dispute, the Panel of Judges adopted a dualistic view. The Panel initially upheld DJP’s argument regarding the primary adjustment (HPP correction) because PT JSGI was deemed to have failed to provide sufficient evidence to support the factual adjustments claimed (e.g., idle capacity). However, when addressing the secondary adjustment, the Panel provided a crucial legal consideration. This means that the cancellation of the secondary correction (PPh Article 26) is not based on the primary correction (HPP) being rejected, but rather on the legal flaw in the application of the secondary correction itself.

The Panel of Judges explicitly referred to the provisions of Article 4 paragraph (1) letter g of the Indonesian Income Tax Law and its Elucidation. The Judges ruled that the concept of a dividend, including a constructive dividend, is inherently linked to a shareholder relationship. Since JSTC was factually and legally not a shareholder of PT JSGI, the abnormal HPP difference could not be classified as a dividend. Consequently, there was no object for PPh Article 26, even though the HPP correction (profit transfer) was economically justified.

The implication of this decision has a significant impact on tax practices in Indonesia. This ruling serves as an important reference that limits the tax authorities' power to apply secondary adjustments in the form of dividends. Multinational Taxpayers now possess a strong legal argument, confirmed by the Tax Court, that the constructive dividend concept is applicable only in the context of transactions between a company and a party with a clear shareholder status. This provides greater legal certainty and assists Taxpayers in formulating strategies to mitigate transfer pricing disputes, where a strict separation between the functions of affiliated suppliers/service providers and shareholders becomes critical.

A comprehensive analysis and the Tax Court Decision on This Dispute Are Available Here