Service Fees Transferred Priced, Charged 20% Dividend Tax: The Threat of Constructive Dividends in Tax Court Decisions

The application of Secondary Adjustments by tax authorities on affiliated transactions is becoming increasingly common and receives strong justification from the Tax Court. The difference in transaction value that does not comply with the Arm's Length Principle (ALP), and has been corrected in the primary Corporate Income Tax (CIT) adjustment, is automatically recharacterized as a constructive dividend according to the mandate of Article 4 paragraph (1) letter g of the Income Tax Law (UU PPh). Tax Court Decision Number PUT-009964.13/2022/PP/M.IIB confirms this consequence, particularly in the context of intergroup service payments where the economic benefit could not be proven.

The core conflict stems from the primary CIT adjustment on service fees paid by the Domestic Taxpayer (WP) to its foreign affiliate. The Directorate General of Taxes (DJP) argues that the lack of adequate evidence regarding the existence of the services (true services) and the actual economic benefit renders the payment non-arm's length. Consequently, the excess payment is deemed repatriated to the domestic taxpayer as profit. The DJP then proceeds with the secondary adjustment, imposing PPh Article 26 (Withholding Tax) on the profit recharacterized as a constructive dividend, at a rate of 20% or the applicable tax treaty rate.

The Appellant, PT NBI, challenged this correction, arguing the payment was for legitimate services and rejecting the dividend recharacterization because the recipient was not formally a shareholder. However, the Panel of Judges rejected this challenge. The Panel was consistent with the previous decision (the CIT dispute) which upheld the primary adjustment. Juridically, the Panel relied on Article 4 paragraph (1) letter g of the UU PPh which defines dividends to include "distribution of profits directly or indirectly." This recharacterization is further supported by the Minister of Finance Regulation governing Transfer Pricing, which confirms that excessive, non-arm’s length payments can be treated as constructive dividends.

The implication of this decision is significant.

The Tax Court provides strong legitimacy to the application of PPh Article 26 on Constructive Dividends as an effort to counter Base Erosion and Profit Shifting (BEPS). Taxpayers now face a dual risk: not only losing the expense in CIT but also being required to withhold PPh Article 26 on the adjustment, which is often final and risks triggering international double taxation if the treaty partner country does not provide a Corresponding Adjustment.

Going forward, taxpayers must focus on documentation proving the cash flow does not exceed ALP and ensure the availability of repatriation mechanisms to mitigate the Secondary Adjustment risk under current regulations.