Evolving environment: Changes to the tax system and regulations for potential investors

The Indonesian tax system continues to evolve but for several years has been mainly based on three primary tax laws: the General Tax Provisions and Procedures Law, the Income Tax Law, and the Value-Added Tax (VAT) and Luxury Sales Tax (LST) Law. These tax laws are routinely amended to accommodate the country’s rapidly changing business environment and support the government objectives of improving the investment climate while increasing tax revenues.

In an effort to reshape and improve Indonesia’s tax environment, tax officers are receiving more and better training, not only in local laws but also in the rules and practices of other jurisdictions. Tax concessions are being offered to taxpayers in particular sectors and/or particular regions, with additional benefits such as tax holidays offered for those in specific pioneer industries.

Indonesia is largely a self-assessment tax environment, and enforcement remains a priority of the tax authorities. The director-general of tax (DGT) is focusing efforts to combat abuse by targeting tax audits on certain industries, professionals and high-net-worth individuals, as well as taxpayers who meet other specified criteria. Transfer pricing audits are on the rise and are a primary area of concern for multinationals.

The key attributes of the Indonesian tax system and main areas of tax developments are summarised below.

Corporate Taxation

Indonesian companies are tax residents by virtue of having their incorporation or place of management in Indonesia. The primary type of company foreign investors use is an Indonesian limited liability company, referred to as a PT company. Only some categories of foreign businesses such as banking and public works can establish an Indonesian branch operation (a permanent establishment, PE).

The general corporate income tax rate is 25%. This tax applies to net taxable profits, which are determined by taking the accounting profits (in line with Indonesian accounting standards, which largely reflect international accounting standards) and making fiscal adjustments where different treatments apply for tax and accounting. For instance, certain provisions and benefits in kind should be accounted for as expenses for accounting purposes but generally are not deductible expenses for tax. Capital assets can also be depreciated differently for tax and accounting purposes. Some categories of companies, such as certain labour-intensive industries, depending on their legal status or type of business, may be subject to different corporate tax rates, reliefs and/or assessment mechanisms.

If a company suffers a loss in a particular year, the tax losses may generally be offset against profits for the next five years, though there are some cases where this can be extended. Carrying back tax losses is not allowed and tax consolidation or group relief among entities is not available. Tax resident firms are taxed on their worldwide income under a self-assessment system. Foreign firms creating a taxable PE in Indonesia are taxed in a similar manner but only on the income attributable to the PE. A PE is also subject to branch profits tax of 20%, which is calculated on the net figure after income tax. The branch profits tax may be reduced under an applicable double-tax treaty.

Specific tax rates, generally referred to as final income tax, apply to certain types of income. Land and building rentals, for instance, are subject to 10% tax on gross rental amounts. Final income tax also applies to construction service fees at 2-6%. Transfers of land and building rights have a final tax at 5% of the gross proceeds.

Withholding Tax (WHT)

A large proportion of income tax is collected through a WHT system, which applies to both resident taxpayers and non-resident taxpayers. For resident taxpayers, WHT mainly applies to payments or accruals for services rendered.

The general WHT rate of 2% applies to fees for many such services, and the tax represents a pre-payment against the service provider’s annual income tax liability. The WHT rate for interest and royalty income received by a domestic taxpayer from an Indonesian firm is 15%.

In principle, dividend income received by a resident taxpayer from a PT company is taxable as ordinary income for the taxpayer receiving the dividend. However, if the dividend recipient is a PT company with a minimum shareholding of 25% in the firm paying the dividend and the dividend is paid out of profits, the income is tax-exempt. Dividends received by individual resident taxpayers are final-taxed at 10%.

The importation of goods into Indonesia is also subject to WHT at 2.5% (if an import licence is held) or in other cases 7.5%. This WHT also represents a pre-payment of the taxpayer’s annual income tax. Dividends, interest, royalties and fees payable to non-residents without treaty relief are generally subject to 20% final WHT.

Double Tax Treaties

For payments to non-residents, a WHT exemption or a WHT rate reduction may be available under an applicable tax treaty. Treaties typically reduce rates on interest, dividends and royalties to 10% or 15%, although some select treaties have more favourable rates. Indonesia has entered into 65 tax treaties (with only two effective in 2014). To enjoy the benefits, the income recipient must provide a certificate of domicile (CoD) by filling out the form prescribed by the DGT (i.e., a Form DGT-1 or DGT-2, as the case may be), which must be certified by the tax authority of the recipient’s home country. Appropriately certified CoDs in a non-prescribed format are accepted only under specific circumstances.

The Issue Of Beneficial Ownership

In the case of dividends, interest and royalties, the recipient must be the beneficial owner of that income. This means that the entity receiving the income and benefitting from a tax treaty cannot be a pass-through entity. To support the beneficial ownership position, the CoD form requires a number of declarations to be made by the recipient that the use of the treaty jurisdiction has not been done merely to obtain the benefit of the treaty and to prove “substance”. In most situations, beneficial ownership is determined under a series of tests outlined in the form, all of which must be met. In broad terms, these tests require the recipient entity to be, in substance, the economic owner of the income and not a pass-through entity. Where a treaty does not have a beneficial ownership requirement, the relevant test requires that the recipient entity was not established and the transactions were not undertaken primarily to take advantage of the tax treaty.

WHT On Sale Of Shares

The sale of shares in a non-listed Indonesian company by a non-resident is subject to a final 5% WHT based on the transaction value (or if higher, market value for a related party transaction). Where the seller and buyer are non-residents, the WHT must be accounted for by the Indonesian company whose shares are being sold. This tax may be exempted under most of Indonesia’s tax treaties with a few notable exceptions. If the buyer is Indonesian, then the buyer is responsible for the payment of the tax. Gains on the sale of non-listed shares sold by an Indonesian company are taxed under normal principles.

The 5% WHT also applies to the sale of shares in a conduit company domiciled in a tax haven country and used to escape Indonesian tax. In this respect, the sale of shares in the conduit company interposed between the actual shareholder and the Indonesian PT company (or foreign company with an Indonesian PE) is treated as a direct sale of the PT company shares (or the Indonesian PE). Sales of shares in an Indonesian listed company are subject to a 0.1% final tax based on sale proceeds (see further comment below).

Payroll Tax & Personal Income Tax

Individual tax residents are liable for tax on their global income.

An individual is regarded as an Indonesian tax resident if he/she stays in Indonesia for more than 183 days in any 12-month period or intends to stay permanently in Indonesia. Individual tax rates are progressive. The highest marginal tax rate is 30% and applies to income over Rp500m ($50,000) per year. Employment income is taxed through a monthly withholding system.

VAT & LST

VAT is due on all transactions involving transfers of taxable goods or the provision of taxable services in Indonesia. Most goods- and business-related services are categorised as taxable goods or services. Those categorised as non-taxable include unprocessed mining or drilling products, natural gas, certain books, gold bars, securities, banking, insurance and finance leasing services. The standard VAT rate is 10% and is calculated by applying the rate to a relevant tax base. In most cases, the tax base is the transaction value agreed between the parties concerned.

The rate applicable to exported goods is 0%. Certain exported services, such as toll manufacturing, repair and maintenance, and construction services are also subject to 0% VAT. The VAT must be collected at the time of delivery when risk and ownership of goods have been transferred or when income from a service delivery can be reliably estimated or measured.

The VAT system operates on an input-output model. In most cases the supplier of goods or services is responsible for collecting VAT from the buyer. The tax collected constitutes output VAT for the vendor and input VAT for the buyer. Firms liable for VAT are required to account for VAT on a monthly basis.

The minister of finance recently introduced an electronic VAT (e-FP) invoice system to make it easier for VAT-able taxpayers to collect VAT. An e-FP will be mandatory for certain VAT-able taxpayers that fulfil the stipulated criteria. Non-compliance will result in the affected taxpayers being deemed not to have issued a VAT invoice and an administrative sanction of 2% from the VAT imposition base will be imposed on the taxpayer.

A paper-based VAT invoice is still applicable for all other taxpayers and on export-oriented transactions.

A payment must be made to the extent that output tax exceeds input tax, and the taxpayer is entitled to a refund of the excess where the input tax exceeds output tax. Refund applications can be made at the end of a book year. It can take up to 12 months or more for companies to receive VAT refunds, after going through a VAT audit. However, taxpayers meeting certain compliance criteria may obtain pre-audit refunds. Monthly refunds are possible for certain taxpayers, e.g. exporters of goods or services, suppliers to VAT collectors, companies in pre-production stage and suppliers of goods or services for which VAT is not collected.

In addition to VAT, deliveries or imports of goods categorised as luxuries are also subject to LST. These goods include certain alcoholic beverages, household appliances and sporting equipment. After the government recently revisited the LST rules in 2013, LST no longer applies to many products. Where applicable, LST is due either upon import or upon delivery by the manufacturer to another party, and the rates currently range from 10% to 75%.

Other Taxes

Stamp duty is nominal. The amount is generally Rp6000 ($0.60) for each document stamped. Land and property tax is due every year. The effective property tax is either 0.1% or 0.2% of the official value of the land and buildings (a predetermined proportion of a deemed sales value determined by the government). The value is updated every one to three years by the government in light of market values. The transfer of land and building rights is subject to a 5% duty based on the official value or the transaction value, whichever is higher. The duty is payable by the purchaser.

Tax Payment & Reporting

Corporate income tax returns must be submitted to the DGT on an annual basis. Monthly instalments of corporate income tax must be made based on the firm’s prior year tax liability. Any tax payable after taking into account the monthly instalments and tax withheld by third parties must be settled before filing the annual corporate income tax return. The annual filing must occur within four months of the book year-end. The time may be extended up to two months by notifying the DGT in writing together with a provisional tax calculation. Final settlement of the tax payable must be made before the end of the fourth month. For extension requests, the tax payable per the provisional calculation must be settled before submission of the extension notification. Payments of tax beyond the deadline will trigger an interest penalty of 2% per month with a maximum of 48%.

VAT, LST and WHT must be accounted for on a monthly basis. A VAT return for a particular month must be filed by the end of the following month, whereas a WHT return for a particular month must be filed by the 20th of the following month. VAT and LST payment deadlines are before the reporting date, but WHT taxes must be settled by the 10th of the following month.

Accounting For Tax

PT companies generally must maintain their books in rupiah and in Indonesian. The records must be kept in Indonesia. The tax year must coincide with the book year, which may be the calendar year or any 12-month period ending on a specified date, but consistency must be maintained.

Based on specific DGT approval, foreign-owned Indonesian companies, PEs and taxpayers presenting their financial statements in their functional currency of US dollars in accordance with the financial accounting standards applicable in Indonesia, can maintain their books in US dollars and in English. An approval application must be filed with the DGT no less than three months before the commencement of the US dollar accounting year. The DGT must issue a decision on the application within a month. If no decision is made within a month, the application is considered approved.

Tax Audit Selection Develops

Indonesia continues to focus efforts on promoting foreign investment, capital accumulation, and the export of goods other than oil and gas, in an effort to expedite economic development and to become internationally competitive. As a result, a broad range of deregulatory measures has been implemented and additional changes can be expected to further enhance the investment climate.

For one of these measures, the DGT has developed a benchmarking methodology for reviewing taxpayers’ compliance, the benchmark behavioural model (BBM). Previously, the DGT used the total benchmarking ratio (TBR) as its benchmarking methodology. Most of the financial ratios used in the TBR are also adopted in the BBM (e.g., gross profit margin and corporate tax to turnover ratio). The BBM is intended to be used only as a supporting tool in assessing the tax compliance level of a taxpayer, and a discrepancy in respect to any particular ratio does not in itself prove non-compliance by a taxpayer. The discrepancy may prompt a follow up from the account representative for further explanation. If the review of the discrepancy reveals noncompliance with the tax law, the account representative may request an amendment of the tax return or recommend that the taxpayer be subject to a tax audit.

This change in tax audit methodology is evidence of the government’s continued commitment to tax administration reform, which aims to increase reliance on taxpayer compliance and to improve good governance in tax administration by strengthening transparency and accountability mechanisms.

Tax Audits & Tax Assessments

The DGT may perform a tax audit on a particular taxpayer for various reasons. A request for a tax refund will trigger a tax audit. The below factors may also trigger a tax audit:

• Declaring continual tax losses in the tax returns;

• Failure to file a return after a DGT reminder;

• Change in fiscal year;

• Change in book-keeping method;

• Performed fixed-asset revaluation; and

• Business restructuring, including acquisitions, mergers and liquidations. The DGT may also select a taxpayer to be audited based on risk-based selection criteria. Effective February 2013, tax audit timelines are now split into the examination and discussion phase. Field audits should be done within six-eight months and office audits within four-six months. The subsequent discussion phase should be done within two months. Further extensions are only allowed in limited circumstances. Based on tax audit (or a similar tax verification process) findings, the DGT will issue a tax assessment letter. Under the General Tax Provisions and Procedures Law, a tax assessment letter for a particular period or year may only be issued within five years of the end of the tax period or year in question (reduced from 10 years previously). Under the transitional provisions, any assessment letters for fiscal years 2003 to 2008 must be issued no later than 2013. In view of these provisions, the tax audit focus in 2013-14 will include taxpayers showing a tax loss position and/or filing VAT returns with overpayment compensations. Tax audits in Indonesia can prove to be a difficult and protracted process. As such, all taxpayers are advised to be prepared in advance. This includes making sure that relevant documentation is ready for delivery to the tax auditors within a month of request. Under the one-month rule, any documents delivered beyond a month from the request date can be ignored by the DGT. In addition, a new tax “e-Audit” technique was introduced by the DGT in May 2013. To be conducted by specially assigned and trained e-auditors, the process is designed to understand a taxpayer’s organisation, business process, electronic systems as well as data collection and conversion process to support the tax audit process. As one of the e-Audit processes involve allowing the DGT limited access to taxpayer’s IT systems to read and download data, taxpayers with extensive IT systems should be ready in the event of an e-Audit. A coordinated approach may also be taken for concurrent tax audits of group companies. Group tax audit procedures were issued in 2013 to set out the procedures, document templates and coordinating protocols for use between the relevant regional tax offices and tax service offices prior to the formal audit findings.

Tax Dispute Resolution

A taxpayer who does not agree with a tax assessment letter can file an objection with the DGT within three months of the issue of the assessment letter. The DGT has to issue an objection decision within 12 months of the objection being filed. If no decision is issued within this time frame, the objection is deemed to be accepted. Under the General Tax Provisions and Procedures Law, taxpayers can elect to pay the amount of tax they consider due and contest the balance in the objection. However, if the objection decision is unsuccessful, a 50% penalty applies on the unpaid tax. This amount increases to 100% if the objection decision is appealed in the Tax Court and the court’s decision is unfavourable. A taxpayer who does not accept an objection decision can file an appeal with the Tax Court within three months of the receipt of the objection decision. To the extent that the objection decision calls for a payment of tax due, according to the Tax Court Law, at least 50% of the tax due must be settled before filing the appeal. As set out in the General Tax Provisions and Procedures Law, the taxpayer is only required to pay an amount agreed in the tax audit closing conference. This creates a mismatch and taxpayers are generally advised to pay the 50% amount to ensure the Tax Court accepts the case. However, recently the Tax Courts have interpreted that the tax due refers to the amount agreed by the taxpayer as stated in the objection or appeal, which was already paid in full, and hence no additional tax in dispute needs to be paid. The Tax Court should decide on an appeal within 12 months. In certain circumstances its decisions can be submitted for a judicial review to the Supreme Court. Supreme Court decisions are closed hearings with no representations made apart from the submission of a written review request.

Previously, there was only one Tax Court in Jakarta to hear cases from taxpayers across Indonesia. However from 2013, taxpayers with their tax identities’ registered in Surabaya, Medan or Yogyakarta should have their cases heard at the Tax Courts in the respective major cities.

Transfer Pricing

By law, transactions between related parties must be conducted at arm’s length; otherwise the DGT has the right to re-determine the transactions accordingly. Under the General Tax Provisions and Procedures Law, the government requires taxpayers to maintain specific transfer pricing documentation to prove adherence to the arm’s length principle.

The number of tax audits with transfer pricing as the key focus area has significantly increased following the issue of regulations related to transfer pricing in recent years. The DGT has issued detailed guidelines which, broadly stated, typically follow OECD principles. Transactions under particularly close scrutiny include payments of royalties and technical or management services fees, intercompany services, financing transactions and exports to related parties. New transfer pricing audit regulations and technical guidelines have also been issued to provide greater certainty to taxpayers on the approach, basis and nature of documents to be adopted by the DGT during the audit process.

Where a taxpayer has no documentation available to substantiate these transactions, there is a high risk that deductions for the payments will be denied in full. In this regard, the one-month-rule time limit within which a taxpayer must produce any documentation requested by the DGT during an audit is being enforced. Transfer pricing disputes may be resolved through the domestic objection and appeal process, or, where the dispute involves a transaction with a related party in a country that is one of Indonesia’s tax treaty partners, the parties may request double tax relief under the Mutual Agreement Procedures (MAP) article of the relevant tax treaty. The domestic dispute resolution includes applying for a tax objection, appealing to the Tax Court, and requesting a reduction or cancellation of administrative sanctions. There is a restriction that a MAP application shall be discontinued if an appeal decision is declared by the Tax Court prior to the finalisation of the MAP. However if a MAP agreement is reached prior to the finalisation of the tax objection process, the MAP result will be taken into consideration. If a party is not satisfied with the Tax Court decision, a judicial review by the Supreme Court is allowed.

The tax law authorises the DGT to enter into advance pricing agreements (APAs) with taxpayers and/or another country’s tax authority on the future application of the arm’s length principle to transactions between related parties. The process may or may not involve cooperation with foreign tax authorities. Once agreed, an APA will typically be valid for a maximum of three tax years after the tax year in which the APA is agreed. The APA can also be applied to tax years before it was agreed if certain conditions are met, such as the tax year has not been audited and there is no indication of tax crime. However, the rollback of an APA to prior years is not automatic and will be subject to agreement between the taxpayer and the DGT.

Bonded Zones

Bonded zone status can be granted by the minister of finance to qualifying companies that are export-oriented, upon their making a specific request. Import duty and VAT concessions are provided to companies with bonded zone status. This entails that no VAT or import duty is payable provided the underlying goods are exported (prior to August 26, 2013). It is worth noting that effective August 26, 2013, the facilities restriction in bonded zones for domestic products has been relaxed. Moving forward, more economic areas are expected to be designated bonded zones. More than 2000 companies enjoy this facility.

Capital Market-Related Incentives

A gain from the sale of shares traded on the Indonesian Stock Exchange is not taxable in the normal fashion, nor is any loss claimable as a deduction.

The sale of listed shares is subject to final WHT of 0.1%, which is based on the transaction value. Founding shareholders are required to pay 0.5% tax at the time of listing based on the listing price. If this tax is not paid, those shareholders are taxed on any subsequent gains based on normal principles. Interest income on Indonesian bonds is subject to final WHT of 15%. A 5% corporate tax cut is granted to public companies that satisfy three conditions: a minimum public listing of 40%; a minimum number of 300 public shareholders, each holding no more than 5% of the company’s shares; and the maintenance of the first two conditions for at least 183 days in the relevant year.

Tax-Free Merger & Acquisition

The transfer of assets in a business merger, consolidation or expansion must be accounted for at market value. However, the transfer of assets at book value may be allowed for certain qualifying mergers, consolidations or expansions. Certain criteria such as the business purpose test must be met and specific approval must be obtained from the DGT. If the merging companies are VAT entrepreneurs (i.e. taxpayers subject to VAT), the transfer of VAT-able goods between the merging firms is VAT-exempt. Merging companies can apply for a 50% reduction of duty on the acquisition of land/building rights.

Incentives For PEs

Facilities for foreign companies operating through their branches in Indonesia are also available. PEs may be exempted from the imposition of branch profit tax (BPT) if they reinvest their after-tax profits in Indonesia in one of the following forms: capital participation in a newly established Indonesian company as a founder or participant founder; capital participation in an established Indonesian company as a shareholder; or acquisition of a fixed asset or investment of intangible asset used by the PE to conduct its business or activities in Indonesia. The above forms of reinvestment must be executed no later than at the end of the tax year following the year when the income subject to BPT is earned by the PE.

Income Tax Concessions

The Income Tax Law provides various facilities and incentives, such as a package of concessions available for firms that invest in certain qualifying sectors and/or regions. The main concession is a 30% investment allowance based on the amount of the investment (which essentially applies to investment in fixed assets), claimable over six years at 5% per year. The other concessions include accelerated depreciation of fixed assets (twice as fast as the normal rate), a longer tax loss carry-forward period (extended from five years up to 10 years depending on certain criteria) and a reduction of WHT on dividends paid to foreign shareholders (from 20% to 10%).

Tax Holiday

The government provides tax facilities in the form of income tax exemption (tax holiday) or reduction to firms in pioneer industries which have a wide range of connections, provide additional value and high externalities, introduce new technologies and have strategic value for the national economy.

Five economic sectors currently enjoy this type of tax exemption: base metals, oil refineries and/or base organic chemicals sourced from oil and gas, renewable energy, machinery and telecommunications.