An overview of Indonesia's tax environment

Indonesia has posted positive economic growth in the last few years, even in the face of the recent global economic slowdown. The country recorded a GDP growth rate of 5% in 2016, on par with the previous two years. Tax income is a key component to this growth, allowing the state to invest in various sectors of the economy and contribute to the continued building of infrastructure.

CURRENT STATE: The government has set the tax revenue target for 2017 at Rp1472.7trn ($111bn), and the country managed to collect 46.8% of that figure in the first seven months of the year. The government is targeting tax revenue of Rp1609.4trn ($121.3bn) in its annual budget plan for 2018, which would represent 86% of the entire state revenue.

The government has set an ambitious target of a tax-to-GDP ratio of 16% by 2019, up from the current ratio of 10.3%. Policy and administrative reforms will be necessary to close the gap; tax laws will be amended accordingly to support this target and to accommodate the rapidly changing business environment. Amendments to the three primary tax laws – the General Tax Provisions and Procedures Law (Ketentuan Umum dan Tata Cara Perpajakan), the Income Tax Law, and the Value-Added Tax (VAT) and Luxury Sales Tax (LST) Law – will be discussed by Parliament over the next five years.

Indonesia has also completed its first tax amnesty programme, which aimed to enable fairer tax reforms through an expanded tax base, provide a comprehensive and integrated tax database and increase voluntary compliance. As part of the programme, taxpayers disclosed a large number of previously unreported assets amounting to Rp4881trn ($367.9bn). The programme yielded redemption money of Rp114trn ($8.6bn) for the government and other tax revenue of Rp21trn ($1.6bn). This achievement has been recognised as one of the most successful tax amnesty programmes in the world.

EFFORTS TO INCREASE TAX COMPLIANCE: Indonesia has updated its Certificate of Domicile (CoD) provisions for foreign and domestic tax residents. In the CoD disclosure form for foreign taxpayers, a requirement that the earned income be subject to tax in the domicile country is removed from the beneficial ownership test. The new form does, however, add a set of general residency tests that should be fulfilled by non-individual taxpayers for them to be able to enjoy tax-treaty benefits.

In the past year the Directorate General of Tax (DGT) has continued to develop its numerous electronic systems to facilitate the ease of tax compliance. In addition to making the electronic VAT system mandatory nationwide in July 2016, the DGT has introduced a full electronic Article 23/26 withholding tax system, which will be introduced gradually beginning in September 2017.

Indonesia is largely a self-assessment tax environment, therefore enforcement remains a priority for tax authorities. Through the enhanced tax audit procedures, the DGT continues to step up its efforts to monitor compliance. Targets of tax audits are transfer pricing, taxpayers operating in certain industries and taxpayers that did not take advantage of the tax amnesty programme. The DGT is enhancing its capabilities to trace property of taxpayers in order to identify any undisclosed income or assets INFORMATION OPENNESS: The August 2017 enactment of the Law on Financial Information Access for Tax Purposes introduces more information openness in Indonesia, provides the DGT access to detailed data from financial institutions and enables the DGT to fulfil Indonesia’s Automatic Exchange of Financial Account Information (AEOI) reporting obligations. Financial accounts in the name of individuals with balances exceeding Rp1bn ($75,400) as of December 31 of each reporting year are subject to this provision. The data collected will be processed by a specialised Centre for Tax Analysis, which will have access to all data from the DGT.

CONTROLLED FOREIGN COMPANY RULES: Indonesia has also updated the Controlled Foreign Company (CFC) rules that adopt some of the recommendations from the OECD/G20 Base Erosion and Profit Sharing (BEPS) project. The rules expand the definition of a CFC to include indirectly owned CFCs, and introduces the concept of transparent entities. Once an actual dividend is paid by the CFC, this amount can be offset (therefore non-taxable) against deemed dividends reported in the past five years. If the actual dividends are higher than the deemed dividends reported in that period, the difference should be reported as taxable income on the Indonesian taxpayer’s corporate income tax return.

TRANSFER PRICING DOCUMENTATION: Indonesia launched a new standard for transfer pricing documentation in FY 2016, affecting the Master File, Local File and Country-by-Country (CbC) Report, a move broadly in line with the OECD/G20 BEPS project. This new provision was followed by the signing of the Multilateral Competent Authority Agreement on the Exchange of CbC Reports on January 26, 2017, where Indonesia agreed to increase international tax transparency through the automatic exchange of annual CbC Reports among tax jurisdictions in which multinational operating groups conduct activity.

INTERNATIONAL TAX DEVELOPMENTS: On June 7, 2017 Indonesia, together with 67 other jurisdictions, made a notable international tax commitment by signing the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (the Multilateral Instrument, MLI). By signing the MLI, Indonesia agrees to include results from the OECD/ G20 BEPS project into its tax treaties to ensure consistency in the implementation of the BEPS project, while also providing flexibility to accommodate specific tax-treaty policies.

By July 2017 Indonesia had signed bilateral agreements with Hong Kong and Switzerland to implement the AEOI starting in 2018, with the first data transmission taking place in 2019. Singapore has also included Indonesia as one of the partner jurisdictions for AEOI purposes.

The new protocol to the 2002 tax treaty between Indonesia and the Netherlands entered into force on August 1, 2017 and shall be effective for amounts paid or credited beginning on October 1, 2017 for both countries. This protocol provides attractive features, such as the 5% withholding tax rate for dividends and interest. Indonesia has also ratified the second protocol to the 1991 tax treaty with Malaysia, which updates articles in the tax treaty regarding the AEOI to be in line with current international tax standards.

BUSINESS TRANSACTIONS: The transfer of assets as part of a business merger, consolidation, expansion or acquisition should be reported for tax purposes at fair market value. However, the transfer of assets at book value may be permissible for certain qualifying business transactions.

The scope of a business merger and consolidation has been expanded to include an inbound cross-border merger and consolidation, i.e., a merger or consolidation that results in the domestic corporate taxpayer being the surviving entity and the offshore entity that is merged or consolidated with the domestic corporate taxpayer must be dissolved. While included in the overall definition, cross-border merger or consolidation activity is not yet supported by a legal regulatory framework.

The definition of a business acquisition now specifically includes the merger of a permanent establishment (PE) of a foreign bank with a domestic corporate taxpayer by way of transferring all of the PE’s assets and liabilities to the domestic corporate taxpayer and dissolving the PE.

Criteria such as the business purpose test must be met and a specific approval must be obtained from the DGT. If the merging companies are VAT-eligible entrepreneurs (i.e., taxpayers subject to VAT), the transfer of goods between the merging firms is VAT-exempt. Furthermore, a sharia business unit has been added to fulfil a business spin-off obligation as required by law. No initial public offering is required for this type of sharia spin-off transaction.

VAT FOR ESSENTIAL PRODUCTS: VAT is generally in place on the consumption of goods and services in Indonesia. There are certain types of goods that are exempt from VAT due to their nature, such as basic-necessity goods that are in high demand. To restrict what is defined as “basic-necessity goods that are highly required by the public”, the government has issued an updated list of goods that would fall under this category.

If VAT is incurred on the purchase of goods or services in the process of producing these basic-necessity goods, then this input VAT on the acquired goods or services cannot be credited and will become an additional production cost.

CORPORATE INCOME TAX: The government may provide an avenue for the reduction of 10-100% of corporate income tax due for five to 15 years from the start of commercial production. For example, a maximum reduction of 50% may be granted to firms in the telecommunications and information industries with new capital investment plans valued between Rp500bn ($37.7m) and Rp1trn ($75.4m). The period can be extended to up to 20 years if the state deems it necessary for the national interest.

This facility is provided to firms in pioneer industries that have a wide range of connections, provide additional value and high externalities, introduce new technologies and offer strategic value to the national economy. Currently, this facility is available for the following business sectors:

• Upstream metal;

• Oil refinery industry or infrastructure, including those activities under the public-private partnership (PPP) scheme;

• Base organic chemicals sourced from oil and gas;

• Machinery;

• Telecommunications and information;

• Sea transportation;

• Industrial processing of agriculture, forestry and fishery products; and

• Economic infrastructure other than those under the PPP scheme. An application to receive a reduction in corporate income tax must be submitted to the Investment Coordinating Board (BKPM). A proposal for approval from the Ministry of Finance (MoF) will be made by the BKPM chairman after carrying out research on the applicant and the investment plan. A proposal can be submitted to the MoF until August 15, 2018.

INBOUND INVESTMENT INCENTIVES: In addition, the MoF may provide the following tax concessions to investors in certain designated areas or regions:

• A reduction in tax on net income of up to 30% of the amount invested, prorated at 5% for six years of commercial production, provided that the assets invested are not transferred out of the country within six years;

• Accelerated depreciation and/or amortisation deductions;

• Extension of tax losses carried forward from five years to up to 10 years; and

• A reduction of the withholding tax rate on dividends paid to non-residents to 10% (or lower if treaty relief is available). The applicant must meet one of the following criteria to be eligible for the above tax facilities:

• High investment value or investment for export purposes;

• High absorption of manpower; or

• High local content. Recommendation from the BKPM chairman, together with the application for investment approval, must be obtained before MoF approval for the tax facilities can be sought.

ZONE-BASED CONCESSIONS: Indonesia has a number of zone-based incentive schemes on offer, which are outlined below. Industrial Zone (KI): The determination and licensing of a KI is granted by the government. The applicable tax facilities depend on the classification of the Industrial Development Area (WPI) of the KI, namely:

• Advanced (WPIM);

• Developing (WPIB);

• Potential I (WPIP I); and

• Potential II (WPIP II). The chart to the right shows the available tax facilities for each type of WPI. Special Economic Zone (KEK): A corporate income tax reduction facility may be granted to new taxpayers with capital invested in the production chain of the main activities of a KEK, as outlined in the chart on the preceding page. Taxpayers rejected for the corporate income tax reduction facility and taxpayers conducting other activities in a KEK may apply for similar inbound investment incentives under the income tax concessions. In addition to the chart’s income tax facilities, taxpayers in a KEK are also entitled to the following:

• Non-collection of VAT and LST on the import of certain goods;

• Non-collection of Article 22 income tax on the import of certain goods;

• Postponement of import duty on capital goods and equipment, and goods and materials for processing;

• Exemption of excise tax on the import of goods to be used to produce non-excisable goods; and

• Non-collection of VAT and LST on the domestic purchases of certain goods. Bonded Logistic Centre (PLB): A PLB is intended to store both imported goods from outside the Indonesia Customs Area and goods from other places within the Indonesia Customs Area that can be processed with one or more simple activities within three years. The tax facilities in these areas are as follows:

• Non-collection of VAT and LST on the import of certain goods;

• Non-collection of Article 22 income tax on the import of certain goods;

• Postponement of import duty on certain goods;

• Exemption of excise tax on the import of certain goods; and

• Non-collection of VAT and LST on the domestic purchase of certain goods.