WINNING THE BATTLE AGAINST HIDDEN DIVIDENDS: PPh ARTICLE 26 CORRECTION CANCELLED AFTER SUCCESSFUL TRANSFER PRICING DISPUTE IN THE COVID-19 ERA

Domestic and international transfer pricing regulations explicitly allow tax authorities to impose secondary adjustments, which in Indonesian tax practice often manifest as the imposition of Withholding Tax Article 26 (PPh Article 26) on the corrected differential, reclassified as a constructive dividend. The case of PT OE (hereinafter referred to as PT OE) highlights how the validity of this secondary adjustment is absolutely dependent on the strength of the primary correction argument. In the appeal dispute regarding the PPh Article 26 Underpayment Tax Assessment Letter for the December 2020 Tax Period, the Tax Court Panel fundamentally rejected the Directorate General of Taxes' (DGT) correction, confirming that if the basis for the Corporate Income Tax (CIT) transfer pricing correction cannot be sustained, the resulting PPh Article 26 consequence is automatically nullified.

The Core Conflict and PT OE's Rebuttal

The core conflict in this case was the DGT's action to reclassify the non-arm's length transfer pricing differential of Rp7.8 million into a constructive dividend, subsequently imposing PPh Article 26 at a 10% rate in accordance with the applicable Tax Treaty (P3B). The DGT argued that the positive fiscal adjustment made to the Taxpayer's profit, deemed to violate the Arm's Length Principle (ALP), must be categorized as a hidden profit transfer to a foreign affiliate, in line with Article 22 paragraph (8) of PMK 22/PMK.03/2020. PT OE vehemently rebutted this, stating that the primary correction was flawed because it disregarded the extraordinary condition of the COVID-19 Pandemic, which materially caused losses in 2020. Furthermore, PT OE challenged the formal aspect of PPh Article 26, asserting that a purely fiscal correction does not meet the requirements of income paid, provided for payment, or due for payment, which is a mandatory prerequisite for withholding tax.

Legal Consideration of the Tax Court Panel

The legal consideration of the Tax Court Panel effectively adopted the principle of legal dependence (mutatis mutandis). After examining the related but separate CIT transfer pricing dispute file, the Panel had concluded that the DGT's argument regarding the non-arm's length nature of the transfer price (primary correction) was not strong enough to be upheld. Consequently, because the basis for the CIT correction was defeated, the reclassification of the differential into a dividend and the imposition of PPh Article 26, which constitutes a secondary adjustment, must also be revoked. The Panel concluded that the DGT's correction of the PPh Article 26 Object was unfounded, leading to the full grant of the Taxpayer's appeal request.

Implications for Transfer Pricing Practice

This decision carries significant implications for transfer pricing practice in Indonesia. This Tax Court decision sets a precedent emphasizing the importance of sustaining the primary correction with a very strong basis, both in substance (comprehensive ALP analysis, including external factors) and in form (compliance with PMK 213/2016 and PER-22/PJ/2013). For Taxpayers, this victory is a crucial reminder to challenge not only the substance of the TP correction but also the formal legality of PPh Article 26: a fiscal correction cannot be automatically converted into a dividend due if there is no evidence of an actual distribution of profit. PT OE's persistence in presenting the facts of the COVID-19 impact and challenging the formal legality of PPh Article 26 were key to the success of this litigation.