Tax authorities are increasingly aggressive in applying secondary adjustment instruments by reclassifying transfer pricing differences as constructive dividends subject to Article 26 Income Tax. Under Article 18 paragraph (3) of the Income Tax Law, any excess payment to an affiliate that fails to meet the Arm's Length Principle (ALP) can be deemed a disguised distribution of profit. The case of PT JP highlights how adjustments to distributor margins, considered too low, trigger additional withholding tax obligations on the value of the difference paid to a non-resident taxpayer.
The dispute originated from the purchase of High Speed Diesel (HSD) by PT JP from BP Singapore Pte. Limited. The Respondent initiated a primary adjustment in the Corporate Income Tax because PT JP was characterized as a Limited Risk Distributor with a Gross Profit Margin (GPM) of only 1.00%, significantly below the comparable median of 5.28%. Consequently, the Respondent applied a secondary adjustment, designating the difference as a dividend subject to 10% Article 26 Income Tax under the Indonesia-Singapore Tax Treaty. PT JP contested this, arguing that BP Singapore was not a direct shareholder and that the Respondent's method was inaccurate due to limited comparable data.
In its deliberation, the Board of Judges emphasized that the existence of a special relationship is not solely determined by direct ownership but also by control through management or technology within a business group. The Judges agreed with the use of the Resale Price Method (RPM) since PT JP functioned as a distributor without significant value-added. As the transaction was deemed non-arm's length, the excess payment flowing to the group was considered an economic benefit meeting the definition of a dividend as stipulated in the Elucidation of Article 4 paragraph (1) letter g of the Income Tax Law. Accordingly, the Board of Judges rejected the taxpayer's appeal and upheld the entire Article 26 Income Tax base correction.
This ruling sends a strong signal to taxpayers that transfer pricing documentation must not only focus on Corporate Income Tax but also mitigate the risks of secondary adjustments. The implication is that any unfairness in purchase or sales prices with foreign affiliates potentially creates a double tax burden: expense/income adjustments at the corporate level and withholding tax on constructive dividends. Multinational companies are advised to conduct regular benchmarking and ensure that pricing policies are aligned with the functional risk profile performed.
A Comprehensive Analysis and the Tax Court Decision on This Dispute Are Available Here
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