Tax breaks for special economic zones in Indonesia

Indonesia has pledged to make special economic zones (SEZs) a policy priority. The zones are seen as a way to boost industrial activity and job creation, particularly in more remote, less developed regions. The goal is to draw more than $50bn in investment into SEZs over the next decade, and methods include enhancing the incentives available and allowing public and private sector entities to propose SEZ plans.

The strategy is seen as a timely one, as it aims to capitalise on supply-chain readjustments in the region at a time when increased global protectionism and the Covid-19 pandemic has multinational entities reconsidering the locations of their production bases. In a statement in which he instructed his Cabinet do more to take advantage of strained trading relations between the US and China, President Joko Widodo noted that of 33 firms moving out of China since trade frictions began, 23 picked Vietnam as their alternative destination. Indonesia’s strict labour laws – which could be subject to change if a major omnibus bill put forward in February 2020 is passed – are frequently cited as a disincentive to investors.

Strategy Synergy

SEZ-oriented manufacturing is guided by two long-term strategies: the Master Plan of National Industry Development 2015-35 and Making Indonesia 4.0. The former aims to foster upstream and intermediate industries as a way of strengthening sector GDP, while the latter seeks to diversify economic activity by de-emphasising exports of natural resources and developing high-tech export industries.

Indonesia currently has 17 designated SEZs, 13 of which are operational. In 2019 these attracted $1.5bn in investment, or about 25% of the country’s total capital investment, according to Luhut Pandjaitan, coordinating minister for maritime affairs and investment. Cumulative investment in SEZs was valued at $6.3bn at end-2019 – less than other countries in the region, including Thailand. While generally focused on industry or specific industries, SEZs in Indonesia are also services-oriented, such as the Likupang SEZ on the island of Sulawesi, which was created to attract tourism. Three new SEZs were inaugurated in 2019, and before the Covid-19 pandemic there were plans to launch another seven in 2020.

The rules governing SEZs are not found in any one law or set of regulations but are spread across several. A plan to progressively lower corporate tax rates from 30% to 20% as of 2021 could boost SEZ attractiveness if implemented. The headline rate is currently the highest in the region, alongside the Philippines. Specific reforms to the SEZ landscape include a regulation signed by the president in January 2020, which states that SEZs can be proposed by entities other than the federal government, including state-owned enterprises, regional governments and private investors. The National Council will conduct a review of any written SEZ proposals within 45 days. In 2019 draft amendments to the tax regime for SEZs were proposed in order to expand and simplify incentives. Under the proposals, a minimum investment of Rp20bn ($1.4m) would receive a 50% tax exemption for five years, followed by 25% for another two years. At levels above Rp20trn ($1.4bn), the tax break would last for 20 years.

Geographic Diversity

In setting up SEZs, the government has worked to diversify activity away from Java, where most of the population lives and where the bulk of economic activity occurs. The three SEZs inaugurated in 2019 are located in East Kalimantan, North Sulawesi and North Maluku. In the Maloy Batuta Trans Kalimantan SEZ, the state secured an investment in a 24,000-barrel-per-day crude oil refinery from Kilang Kaltim Continental, a subsidiary of Canada’s Continental Energy Corporation. Another SEZ tied to the availability of a resource is the Galang Batang SEZ in the Riau Islands province, which is located between Sumatra and Singapore. The plan for this SEZ is to develop a supply chain of bauxite, with an investment commitment valued at Rp36.3trn ($2.6bn) by 2023.