Victory in Tax Court: Why Unpaid Interest Cannot Be Subject to Article 26 Withholding Tax?

Dispute on Article 26 Income Tax Withholding: Domestic Accrual vs. Tax Treaty Payment Criterion

Disputes over the withholding of Article 26 Income Tax on loan interest often become a crucial point in tax audits, especially when there is a difference in interpretation between domestic regulations and Double Taxation Avoidance Agreements (DTAA/Tax Treaty). This case originated from a correction to the Article 26 Income Tax Base for the December 2020 period by the Respondent against PT. KKM amounting to IDR 1,248,883,333.00. The Respondent applied the correction arguing that interest expenses on debt to KIC (South Korea) had matured and were recorded on an accrual basis, thus the obligation to withhold tax arose pursuant to Article 26 paragraph (1) of the Income Tax Law.

The Applicant's Argument: Prioritizing the "Paid" Terminology

The Applicant firmly rejected the correction by prioritizing tax treaty provisions. The focus of the Applicant's argument lay in the interpretation of Article 11 of the Indonesia-South Korea Tax Treaty, which uses the terminology "paid". The Applicant argued that as long as there is no actual transfer of funds or cash payment to the foreign tax subject, the taxing rights of the source state cannot be executed, even if the expense has been recognized for accounting purposes or has contractually matured.

Judicial Considerations: Tax Treaty as Lex Specialis

The Tax Court Judges, in their legal considerations, provided a confirmation regarding the status of the Tax Treaty as lex specialis over domestic law. The Panel assessed that the requirement for taxing interest under the Indonesia-South Korea Tax Treaty is the occurrence of payment. Since the Respondent was unable to prove the realization of interest payments during the disputed period and facts showed the Applicant was experiencing liquidity constraints, the Judges held that the "due date" criterion in the Income Tax Law cannot override the "paid" criterion in the Tax Treaty.

Implications: Real Payment as the Determining Factor

This decision has significant implications for businesses with cross-border affiliated transactions. Legally, this ruling strengthens the certainty that in applying withholding tax on interest to residents of Treaty partner countries, the moment of real payment is the determining factor for tax liability. This provides protection for Taxpayers from tax burdens on expenses that are merely accounting recognitions without any actual cash outflow. In conclusion, strengthening arguments based on treaty overriding is key to winning similar disputes.