The Force of Attraction Trap: Why Trillions of Rupiah in Turnover from a South Korean Head Office Were Attributed to a Representative Office in Jakarta and Subjected to Final PPh?

Tax Dispute Case Regarding Permanent Establishment Status and Force of Attraction Rule of PIC

The tax dispute case involving the South Korean entity,PIC, once again highlights the complexities of determining Permanent Establishment (PE) status and applying the Force of Attraction Rule in Indonesia. This Tax Court decision affirms that activities conducted by a representative office, even if it claims to be limited to a preparatory and auxiliary character as stipulated in Article 5 of the Indonesia–Korea DTA, can be classified as a PE if the substance of its activities is deemed essential and income-generating. The core of this Corporate Income Tax (PPh Badan) dispute for the 2018 Tax Year is the correction of the Head Office's turnover, amounting to Rp4.1 Trillion, which was pulled into the Indonesian PE and subjected to PPh Final Article 15.

Conflict of Functions and Differing Interpretations

The conflict arises from differing interpretations of the Representative Office’s function. The Appellant persistently argued that its office solely functioned for market intelligence and as a liaison, without commercial decision-making authority. However, the Respondent argued otherwise. Based on a thorough examination, including confirmation with customers, the Respondent proved that the Representative Office carried out business development functions and actively participated in the Head Office’s sales process to customers in Indonesia, from offering products to handling claims. This fact, supported by a long operating period (almost 18 years) and a significant number of employees, invalidates the claim of preparatory or auxiliary status.

Judicial Resolution and Application of the Force of Attraction Rule

In its resolution, the Panel of Judges aligned with the Respondent's arguments. The Panel adhered to the principle of substance over form, stating that the activities performed by the Appellant in Indonesia exceeded the scope of the PE exception. With the PE status proven, the Force of Attraction Rule under Article 5 paragraph (1) letter b of the Income Tax Law was automatically applied. This principle allows the tax authority to attribute all income earned by the Head Office from similar activities conducted by the PE in Indonesia. The attributed income of Rp4.1 Trillion was then subjected to Final Income Tax (PPh Final) Article 15 (1% of the gross export value) based on the specific Net Income Calculation Norm for Trade Representative Offices.

Significant Implications and Non-Deductible Expenses

The implications of this decision are highly significant. Firstly, it strengthens the precedent that a representative office’s documentation and administrative permits must align with the actual functions performed. Secondly, the imposition of PPh Final Article 15 resulted in the correction of Other Operating Expenses amounting to Rp38.2 Billion as non-deductible, as these costs were assumed to be incurred to generate income subject to final tax. This decision serves as a stern warning to Foreign Taxpayers to periodically review the functional framework of their Representative Offices to avoid PE status determination and the risk of the Force of Attraction Rule, which potentially multiplies the tax base.