Disputes regarding Article 26 withholding tax on secondary adjustments have become a critical issue in Indonesian transfer pricing practice, particularly when tax authorities reclassify transaction discrepancies as constructive dividends. The case of PT MI provides a vital precedent on how the validity of a primary adjustment in Corporate Income Tax is a mandatory prerequisite (conditio sine qua non) for the enforcement of a secondary adjustment in Article 26 Income Tax.
The core conflict arose when the Respondent adjusted MI’s RD&Q service transactions with its Swiss affiliate. The Respondent claimed MI’s mark-up was arm’s length based on single-year (2018) data, reclassifying the difference as a dividend to the affiliate. MI strongly contested this, arguing that the counterparty was not a shareholder, making it legally impossible to receive dividends. MI also criticized the use of single-year data for ignoring economic fluctuations.
The Tax Court emphasized the importance of accuracy in selection of comparables. The Judges rejected the Respondent's approach of using only three comparable companies, as it was deemed statistically insufficient to establish an interquartile range. By applying multiple-year data (2017-2019), it was proven that MI’s profitability level remained within the arm's length range. Consequently, the primary correction was overturned.
The implication of this ruling is clear: since the primary transfer pricing adjustment was unproven, the legal basis for the constructive dividend vanished. This decision reinforces the need for Taxpayers to maintain robust transfer pricing documentation (TP Doc) with multi-year data analysis to mitigate the risk of transaction reclassification into unwarranted withholding tax objects.
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