PT PK manufacturing Ltd was a contract manufacturer of cabins for excavators for the Japanese parent, Press Kogyo Co. Ltd. Japan, and paid royalties for “use of IP”.
Following an audit, the tax authorities issued an assessment where deductions for royalty payments were disallowed due to lack of documentation for ownership to said IP.
Furthermore, the tax authorities did not see any economic benefit for the contract manufacturer in paying the royalties, as it had been continuously loss making.
The Company disagreed and brought the case to court.
The Tax Court ruled in favor of the tax authorities. According to a decision issued 4 December 2019 the existence and ownership to the Intellectual Property in question had not been sufficiently documented.
An request for review was then filed with the Supreme Court.
Judgement of the Supreme Court
The Supreme Court dismissed the request and upheld the decision of the Tax court.
“(…) Therefore, the object of the dispute in the form of tax credit correction on the Utilisation of Intangible Taxable Goods (BKP) from Outside the Customs Area (in connection with royalty fees) amounting to Rp39,776,916.00 which has been considered based on facts, evidence and application of law and decided with the conclusion that it is maintained by the Panel of Judges is correct and correct. Thus, the Panel of Judges of the Supreme Court is convinced and determined to reaffirm the decision a quo because in this case the issuance of the decision of the Appellant now the Review Respondent has been carried out based on the authority, procedure and legal substance in a measurable manner (rechtmatigheid van bestuur and presumption iustae causa) in the framework of the implementation of the General Principles of Good Government (AAUPB), especially the principle of legal certainty and the principle of accuracy because the input tax that can be calculated (FPN-JLN) amounting to Rp31.988,772.00 on the grounds that the existence and utilisation of the IP cannot be proven by the current Appellant and there is no economic benefit for the payment of royalties to the current Appellant, considering that the royalty payments were made by the current Appellant to Press Kogyo Co. Ltd (PK) of Japan which is a shareholder (65%) of the current Appellant (Affiliated Party). Moreover, royalty payments are essentially part of a financial instrument for the payment of a quo which is essentially a service, while in a legal instrument it is a position on Intellectual Property Rights (IPR). The OECD Transfer Pricing Guidelines state that to test the existence of royalty payment transactions on intangibles between related parties, it is necessary to test the willing to pay test (par 6.14), economic benefit test (par 6.15), product lifecycle consideration (par 1.50), identify contractual and arrangement for transfer of IP (par 6.16-6.19). In other words, the OECD Transfer Pricing Guidelines where in testing the existence of royalty payment transactions on intangibles between related parties must be carried out:
a) Willing to pay test (Par 6.14),
b) Economic benefit test (Par 6.15),
c) Product life cycle consideration (Par 1.50),
d) Identify contractual and arrangements for transfer of IP (Par 6.16- 6.19);
That based on the OECD Guidelines a quo, there are five comparability factors in an effort to obtain reliable comparables, namely: (i) terms and conditions in the contract; (ii) FAR (function, asset and risk) analysis; (iii) products or services transacted; (iv) business strategy; and (v) economic situation;
That in the application of the arm’s length principle to royalty transactions on intangible property, the OECD TP Guideline provides the following guidance:
6.23 “In establishing arm’s length pricing in the case of a sale or licence of intangible property, it is possible to use the CUP method where the same owner has transferred or licensed comparable intangible property under comparable circumstances to independent enterprises. The amount of consideration charged in comparable transactions between independent enterprises in the same industry can also be guided, where this information is available, and a range of pricing may be appropriate.” Based on the aforementioned considerations, the Panel of Supreme Court Justices concluded that whether or not the payment of royalties is justified, the real issue in the dispute is an evidentiary dispute, which is related to the existence of the IP and its beneficial value to the Reconsideration Applicant formerly the Appellant. In addition, the real recognition of the applicant which contradicts the fact that since the examination process until the commencement of the trial process, the Review Applicant could not show that the IP (intangible property) was recorded in the financial statements of Press Kogyo Co. Ltd. Japan (PK Japan), which can prove that Press Kogyo Co. Ltd. Japan (PK Japan) recognised the intangible asset. Moreover, in casu has a legal relationship with the decision of the tax court body that has Permanent Legal Force (BHT) in case register Number PUT-115599.15/2014/PP/M.XIIIB Year 2019 which was pronounced on Tuesday 19 February 2019 with the verdict “rejecting the Appellant’s appeal”. This means that the positive correction of royalty fees is maintained, so that royalty fees cannot be charged as a deduction from gross income in the calculation of Corporate Income Tax for 2014, Therefore, the Panel of Judges of the Supreme Court determined that the correction in this case is maintained and can have immediate tax consequences on VAT obligations and therefore the correction of the Appellant (now the Respondent for Judicial Review) in the case a quo is maintained because it is in accordance with the provisions of the applicable laws and regulations as stipulated in Article 29 along with the Explanation of Article 29 paragraph (2) of the Third Paragraph of the Law on General Provisions and Tax Procedures juncto Article 4 paragraph (1), Article 6 paragraph (1) and Article 18 paragraph (3) and paragraph (4) of the Income Tax Law juncto Article 9 paragraph (8) letter b of the Value Added Tax Law juncto Article 69 paragraph (1) letter e and Article 78 and Article 84 paragraph (1) letter h of the Tax Court Law juncto OECD Guidelines;
b. Thus, the reasons for the petition of the Petitioner for Reconsideration cannot be justified because they are opinions that are not decisive because there is no decision of the Tax Court that is clearly contrary to the applicable laws and regulations as stipulated in Article 91 letter e of Law Number 14 of 2002 concerning the Tax Court;
Based on the above considerations, the request for reconsideration filed by the Applicant for Reconsideration is unwarranted and must be rejected;”
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Indonesia vs PT PK Manufacturing Indonesia March 2021 Supreme Court