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Tax Court judgement serves as lesson to all taxpayers with litigation cases
The Tax Court rejected the appeal on the basis of the provision in paragraph 4 of article 1983 (General Taxation Provision & Procedures Law), which was added when this Law was amended in 2007. The provision states that “Financial accounts, notes, data, or other information disclosed by taxpayers in the objection process that are not disclosed during the audit process, with the exception of data and information that are not possessed by the taxpayer during the audit process, are not to be considered in the objection decision”.
In 2009, a MNC FF annual income tax return for fiscal year 2007 was audited by the Director General of Taxes. Based on the audit report, there was a royalty fee on know-how on the payment of Technical Assistance Fee & Royalty (TARO) to an affiliate company. The auditors requested the company to provide the supporting data and documents to prove that such royalty fee payment had been made in accordance with the arm’s length principle.
The taxpayer was not able to provide the necessary data and transfer pricing documentation required to test whether the royalty payment complied with the arm’s length principle during the audit process and instead submitted the trademark and license agreement between the company and the affiliated entity concerning the obligation to pay the royalty annually at the amount of 2% of net sales.
The reason that the taxpayer was unable to submit the TP documentation was that in the previous tax audit for the 2008 tax year, such expenses had not been corrected. In 2007 there had been no obligation for companies to prepare the transfer pricing documentation. Companies were only obliged to prepare the transfer pricing documentation from fiscal year 2009, pursuant to Director General of Taxes Regulation No. PER 34/PJ/2009.
Since the expenses could not be deducted from gross income unless their arm’s length nature was duly supported, an assessment letter for underpaid corporate income tax for tax year 2007 was issued, which led to the objection (mentioned above) being filed by the company on 9 June 2009.
However, during the objection process, the company still failed to provide the documents, data and information that had been required by the auditors. Instead, the company submitted research report results (Technology License Royalty Search) conducted by two independent parties, namely Ernst & Young, Netherlands and Price Waterhouse Coopers, Netherlands, which confirmed that the royalty payment had been made at arm’s length, which unfortunately could not be considered as supporting documents since they were submitted during the final stage of the objection process.
Further to the above-mentioned Paragraph (4) of Article 26 A of Law No. 28 of 2007 which applies to objections filed after 31 December 2007, the Director General of Taxes rejected the company’s objection, in respect of which the taxpayer filed an appeal at the Tax Court.
The appeal process
During the examination of the appeal case at the Court, the judges were of the opinion that:
- During the audit process, the company did not submit the documents required by the auditors, and instead provided the Know-how License Agreement which stated the company’s obligation to pay an annual 2% royalty fee from net sales;
- The taxpayer did not provide the transfer pricing documentation relating to the royalty payment to its affiliate in 2007 because such obligation to prepare for transfer pricing documentation (stipulated in DGT Decree No. PER-34/PJ/2009) was only effective starting fiscal year 2009.
- The taxpayer submitted during the review of the objection process the result of two research studies (Technology License Royalty Search) conducted by two independent companies;
- The judges of the Tax Court are of the opinion that it is common for a company to pay royalties to its affiliates. Without the royalty fee on know-how, it will be impossible for a company to operate in Indonesia. As such, these expenses should be deducted from the company’s gross income.
- However, the Director General of Taxes and the judges at the Tax Court used the same legal reference, i.e. Paragraph (4) of Article 26 A of Law No. 28 of 2007 on the fourth amendment to Law No. 6 of 1983 and GR No. 80 of 2007, which took effect in 2008.
In its decision, the Tax Court referred to Paragraph (4) stating that the data and documents that were not disclosed during the audit could not be considered in the objection or the appeal process. Thus, the Tax Court rejected the company’s appeal and upheld the Director General of Taxes’ decision.
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In this case, the taxpayer did not realise that based on the transitional provision and that as of 1 January 2008, the provision in Paragraph (4) had been effective.
Because of that, even if the said royalty payment to the affiliate was made at arm’s length so the company can operate in Indonesia, such negligence resulted in the company’s appeal being rejected by the Tax Court.
Taxand Indonesia believes that the provision in Paragraph (4) should have not been applied by the Tax Court in this case since legally the provision in Paragraph (4) does not bind the Tax Court because the Tax Court has its own Procedural Law.
The Tax Court should have decided on the tax dispute based on following principles:
- Either the taxpayer or the DGT can interpret the tax laws. However, in the case of a dispute it will be the Tax Court judge who will issue the decision as to which interpretation of the tax laws is correct.
- Judges as the enforcers of laws must explore, follow and understand the value of life in society. The judges should seek material truth.
The rejection of PT Frisian Flag Indonesia’s appeal at the Tax Court based on the reason that the legal basis was not satisfied should serve as a lesson to all taxpayers with litigation cases.