Taxpayer Wins Part of the Battle in Tax Court: The Key to Overturning DGT's Transfer Pricing Correction Lies in Proving Factual Marketing Expenses

The implementation of Article 18 paragraph (3) of the Income Tax Law fundamentally requires compliance with the arm's length principle in related-party transactions.

Transfer pricing (TP) disputes frequently shift from transaction pricing to the validity of operating profit determinations, particularly when the tax authority applies the Transactional Net Margin Method (TNMM) and challenges the segmentation of financial statements. Tax Court Decision Number PUT-015804.15/2020/PP/M.VIA Year 2025 serves as a crucial case study on how the Panel of Judges addresses fundamental differences in operating expense (OPEX) allocation between the Taxpayer (Appellant) and the Directorate General of Taxes (Respondent). In this case, the Respondent executed a significant correction to the net income of the Appellant—who operates a dual role as a Contract Manufacturer and an affiliated Distributor—because the authority deemed the operating profit of the affiliated segment to be un-arm's-length after applying a proportional overhead allocation based on sales ratios.

The core conflict within this case is the opposition between the proportional allocation method promoted by the Respondent and the functional segmentation based on actual data defended by the Appellant.

The Respondent reasoned that the Taxpayer failed to maintain adequate accounting books, thereby compelling the auditor to utilize a proportional allocation method to divide general expenses across all operational segments. The Appellant firmly refuted this stance, presenting factual evidence that significant expense items, such as Marketing Service Fees, sales and marketing salaries, and travel expenses, were inherently connected only to the domestic independent sales segment (non-affiliated) and were entirely irrelevant to export sales made to related parties under centralized orders. The Appellant argued that the incorrect proportional allocation artificially suppressed the profit margin of the affiliated segment, making it appear un-arm's-length.

The resolution of this dispute was achieved through a balanced approach by the Panel of Judges, resulting in a "partially granted" verdict.

The Panel of Judges adhered to the principle that the true burden of proof rests upon the Taxpayer. Consequently, the Panel overturned the Respondent's adjustments on expense items that the Appellant successfully proved were strictly related to the independent segment. This included expenses specific to marketing and sales functions. Conversely, the Panel sustained the Respondent's proportional allocation for expenses proven to be general overhead or shared services (such as IT, finance, and professional fees). The Panel then executed a recalculation of the TNMM based on the verified and approved expense segmentation, ultimately overturning a total correction amount of Rp13,628,555,923.00.

An analysis of this ruling highlights crucial implications for transfer pricing litigation.

It emphasizes that in TP disputes utilizing the TNMM framework, Taxpayers must prepare highly detailed and fact-based segmentation documentation rather than relying merely on a general profit and loss statement. The Taxpayer's partial victory demonstrates that functional segmentation arguments and the rejection of irrelevant cost allocations are acceptable before the Court, provided they are backed by solid and detailed supporting evidence (such as detailed job descriptions, logical cost drivers, and service agreements). By implication, a taxpayer's tax litigation strategy must focus closely on auditing the cost allocation assumptions applied by tax examiners.

A Comprehensive Analysis and the Tax Court Decision on This Dispute Are Available Here'