The Fall of Constructive Dividends: Why Article 26 Income Tax Corrections are Automatically Cancelled When Transfer Pricing Is Unproven?

Tax Dispute: Secondary Adjustments, Constructive Dividends, and Article 26 Income Tax for PT STLI

Secondary adjustments in the form of constructive dividends are frequently used by tax authorities to impose Article 26 Income Tax on transfer pricing differences deemed unreasonable. In the case of PT STLI, the Respondent reclassified primary adjustments from Corporate Income Tax—covering sales, purchases, and affiliated interest expenses—into Article 26 objects at a 15% treaty rate. This was based on the assumption that profits were shifted to indirect shareholders through transfer pricing mechanisms that failed to comply with the Arm’s Length Principle (ALP).

Core Conflict: PMK-22/2020 Application and Automatic Dividend Characterization

The core of the conflict lies in the application of PMK-22/2020, which the Respondent used to automatically characterize transfer pricing corrections as dividends. The Petitioner strongly refuted this argument, stating that PMK-22/2020 pertains to Advance Pricing Agreements (APA) and cannot serve as the sole legal basis for secondary adjustments during regular tax audits. Furthermore, the Petitioner emphasized that the counterparty was not a direct shareholder, thus failing to meet the dividend criteria under both domestic regulations and international tax treaties.

Judicial Resolution: The Accessory Nature of Secondary Adjustments

The Board of Judges adopted a logical and consistent approach by prioritizing the resolution of the primary dispute. Given that the primary corrections in Corporate Income Tax, which served as the basis for the "excess" profit, had been annulled by a prior court decision, the legal existence of constructive dividends lost its foundation. The Board held that without a final and binding primary correction, there is no object that can be classified as a secondary correction.

Implications: Legal Certainty Regarding the Nexus of Transfer Pricing Corrections

The implications of this decision provide legal certainty for Taxpayers that secondary adjustments are accessory to primary adjustments. If allegations of transfer pricing unfairness are successfully debunked, the tax burden on constructive dividends must automatically be declared nil. This ruling also serves as a critical reminder for tax authorities not to hastily characterize transactions without clear evidence of capital ownership and proper legal grounds outside the APA framework. In conclusion, the Board of Judges annulled all of the Respondent's corrections and granted the Petitioner's appeal in its entirety.

A Comprehensive Analysis and the Tax Court Decision on This Dispute Are Available Here