A breakdown of regulations governing Indonesia's tax system

The Indonesian government has set a target tax-to-GDP ratio of 16% by 2019, up from the current average of 12-13%. While ambitious, the goal is not unattainable given that neighbouring countries Vietnam, Malaysia and Thailand have tax-to-GDP ratios averaging of 13% and 17%. However, the target can only be reached by widening and stabilising Indonesia’s narrow tax net.

Facilitating Compliance 

An Indonesian citizen’s tax liability starts at birth and only ends when he or she permanently leaves Indonesia or passes away. Yet, estimates show that out of Indonesia’s 45m working adult taxpayers, only 27m are registered for tax identity numbers, and only about 10m filed tax returns in 2015. The Directorate General of Taxation (DGT) has also stepped up its series of ongoing tax extensification measures.

In line with the DGT’s much-publicised five-year plan to achieve the 2019 tax-to-GDP target, 2015 was designated a year for coaching taxpayers. A widespread social awareness campaign was conducted through social media. The objective was to educate individuals and businesses alike regarding how to register for a tax identity number and how to pay one’s fair share of taxes, as well as emphasising that this should be an ongoing commitment. The widely anticipated 2016 amnesty plan is another of the DGT’s high-profile efforts to widen Indonesia’s tax net and improve coverage of registered taxpayers. The amnesty offers a once-off redemption fee for taxpayers to declare previously undeclared assets, both domestically and offshore. Eligible taxpayers not yet registered will first have to register with the DGT before receiving amnesty. Once their tax amnesty application is approved, taxpayers can move forward without worry of further tax audits from the DGT for the fiscal year ending in 2015.

As part of the government’s efforts to improve the ease of doing business, e-filings and e-payments have been rolled out progressively since 2005. E-payments have been made compulsory in phases since January 2016 and are mandatory across the country as of July 2016. The value-added tax (VAT) system, which is one of Indonesia’s most document-intensive tax compliance obligations, is fully electronic nationwide as of July 2016.

Enhancing Data Collection 

Indonesia is largely a self-assessment tax environment. The DGT recognises that the mere filing, or easier filing, of additional tax returns would not be useful in increasing tax revenues if there is a high degree of error. As a result, better collation and processing of supporting data has been a focus for the DGT in order to facilitate more targeted tax audits.

Since 2013 there has been a system in place for more than 60 government agencies and associations to provide data to the DGT. These agencies include Indonesia’s Land Certification Authority, the Association of Indonesia Automotive Industries, PT Pelabuhan Indonesia, for import and export information, as well as banks for taxpayers’ credit card information. This supplements internal data collected by the DGT through tax filings.

In order to broaden its access to cross-border taxpayer information, Indonesia has committed to using international Exchange of Information (EOI) agreements and further targets implementation of the automatic EOI by 2018.

Indonesia also entered into the Multilateral Competent Authority Agreement on Automatic Exchange of Financial Account Information (MCAA) on June 4, 2015, and the country is committed to applying this using the Common Reporting Standard (CRS) issued by the OECD. This commitment is implemented in domestic regulations that authorise the DGT to automatically provide information to a country partner on tax withholding and/or collection, or information related to the customers of financial institutions. In support of this policy, Indonesia’s Financial Services Authority has issued a regulation that addresses administrative procedures surrounding the determination of foreign customers and financial institutions’ reporting mechanism using the CRS.

Data Analysis 

While data has been available, financial information was previously generally utilised on an ad hoc basis by tax auditor teams. This was due to most DGT departments having limited access to information from other sources and/or departments, constraining their ability to effectively reconcile and compare data. In an attempt to address this issue, the data collected will now be processed by the newly established and specialised Centre for Tax Analysis (CTA), which will have unprecedented access to all of the DGT’s data. The establishment of specialised units, such as CTA and the Department for International Taxation, which is charged with managing cross-border taxation issues, is part of the DGT’s overall transformation.

The government also hopes to attract new investment through enhanced regulations. Widening the Indonesian tax net is only part of the equation as Indonesia continues to attract foreign direct investment to stimulate economic growth. Conscious of the importance of regulatory and taxation frameworks in today’s competitive business environment, the government has reviewed its policies, both for domestic and international firms.

Domestic Regulations 

Over the past 12 months the government has issued several tax incentives to enhance the Indonesian economy. One prominent incentive is the temporary revamping of the fixed asset revaluation facility, which allows taxpayers to increase the value of their fixed assets by paying a certain amount of final tax on the incremental value. Although this facility has existed for quite a while, the applicable final tax rate for the period between October 2015 and the end of 2016 is much lower, at 3-6%, as opposed to 10% under the existing facility.

Improvements have been made in the investment facilities area, such as income tax allowance and corporate income tax (CIT) reduction facilities, where the government has tried to streamline the process through a one-door policy in order to speed up the application process. The government has also expanded the eligible industries for income tax facilities. In addition, regulatory improvements have been put in place, whereby an investment licence, under certain criteria, can be issued in shorter periods of time. A new regulatory Negative List of Investment has also been released, which is intended to strike a balance between:

• Accelerating both foreign and domestic investments distributed across Indonesia;
• Developing the country’s competitiveness in the international market;
• Protecting national strategic businesses; and
• Nurturing small and medium-sized enterprises.

Several public works, trading, creative economy and health care businesses have been removed from the list, resulting in these business lines being open for 100% foreign ownership. The percentage of foreign ownership in most sectors is being increased, including ownership within the context of ASEAN cooperation. A new comprehensive type of special economic zone, known as Kawasan Ekonomi Khusus (KEK), has been introduced to develop several areas in Indonesia. So far, the tax facilities under this regime are the most complete, as they cover CIT, VAT, luxury goods sales tax (LST), import income tax, import duty and excise facilities. In addition to these tax incentives, this regime provides benefits in other aspects, namely traffic of goods, manpower, immigration, land procurement and licensing. Currently, eight areas have been designated as KEKs.

Furthermore, the government has issued several VAT facilities to boost the transportation sector. This is in line with the country’s Maritime Axis Doctrine. The government is continuing its policy of safeguarding import duty and anti-dumping import duty on certain goods to secure national industrial development. Separately, in order to maintain the stability of the rupiah, the government has put in place several measures, such as requiring the use of rupiah for general onshore transactions. Bank Indonesia has also mandated the reporting of offshore loans for monitoring purposes.

International Tax Treaties 

In the international tax arena, Indonesia has signed or ratified several double-taxation agreements as part of its ongoing efforts to review existing tax treaties. Notably, an additional protocol, still pending ratification, was entered into for the Netherlands-Indonesia tax treaty offering and it stipulates:

• A 5% withholding tax rate on dividends received by companies (other than partnerships) that directly hold at least 25% of capital; and
• A 5% withholding tax rate on interest for loans made for a period of more than two years, or paid in connection with the sale on credit of any industrial, commercial or scientific equipment. New tax treaties have also been entered into with India and Armenia over the past year.

Urgency Of Tax Collection 

It is with efforts like the initiatives introduced in 2015 and early 2016 that the DGT has steadily improved its tax revenue collections from approximately Rp670trn ($48.9bn) in 2011 to Rp1000trn ($73bn) in 2015. However, the rate of actual tax revenue collection is outpaced by the pressures on the DGT to help support rising national needs. On average, Indonesia depends on taxation for 84% of its fiscal budget every year. Reliance on tax revenues continues to increase given the global drop in commodity prices and the slump in the oil and gas sector – two important traditional sources of revenue for the country. Moreover, the Indonesian government’s efforts to develop national infrastructure, education and other key sectors will require substantial funding.

Without the government’s significant priming of the economic pump, the 4.8% GDP growth rate in 2015 was the slowest in the last six years. Accordingly, more tax revenues are needed to finance the government’s plans. Tax collection targets have increased by 89% from Rp698trn ($51bn) in 2011 to Rp1320trn ($96.4bn) in 2016. Despite the DGT’s best efforts in 2015, Indonesia posted a Rp253trn ($18.5bn) revenue shortfall.

It expects to face similar challenges in 2016 given relatively low domestic consumption, the global downturn and a weak resource sector. The first five months of 2016 have seen the government collect less tax revenues compared to the same period in 2015. By June 2016 an Indonesian parliamentary commission had trimmed its annual budget forecast by 2% to approve a revised revenue target of Rp1780trn ($130bn). However, this is still 18% above actual fiscal collection in 2015. The DGT is thus under pressure to enhance the effectiveness of tax collection and identify new revenue sources.

Constraints On Administration 

Improving tax administration is also not without its challenges. Despite an increasing emphasis on technology, the DGT remains relatively under-staffed compared to more advanced economies. Among the DGT’s estimated 38,500 tax officers who handle corporate and personal taxes, only around 5000 officers are assigned to investigate audits. While seeking to upskill its tax officers to manage the lack of manpower, the DGT has been enhancing the effectiveness of its tax enforcement efforts by targeting tax audits on transfer pricing, certain identified industries, sustained loss-making companies and individuals with particular levels of income. Current tax audits are generally supported by better data, as discussed, and are improving in quality.

Notwithstanding this positive evolution, the relative lack of clarity in Indonesia’s tax regulations still creates difficulties for businesses seeking to apply the rules to today’s evolving business environment. In practice, certain tax audit adjustments are, at times, made via a “form over substance” approach and inconsistently applied. Therefore, it is key that taxpayers are adequately prepared beforehand. Disputes are often only resolved in a tax court, but the time-consuming process may take an average of two to three years to complete.

Even if a tax court decision is obtained, the lack of a precedence concept in Indonesia’s tax – a legacy of Dutch colonial rule – means taxpayers do not have legal certainty that a position will be maintained on similar issues across different years during tax audits. There have also been instances where similar cases had received conflicting judgments in tax courts. On the other hand, the success of tax breaks to stimulate investment has been mixed.

In addition, certain high-profile tax incentives, such as tax holidays, have fallen short of expectations. Despite extensive interest from investors, there have been only five approved applicants since its introduction in 2008, mainly due to issues relating to the qualifying criteria and process. With changes to the schemes in 2015, one hopes that this process can be better streamlined so that incentives have the intended impact.

Limits On The Tax System

Indonesia’s complex withholding taxes differ in their rates, whether they are final or non-final in nature, creditable or not, domestic or international, reporting mechanisms and timing of withholding. Due to Indonesia’s self-assessment tax environment, much of the onus is placed on the paying party to act as the withholding and reporting agent for many transactions. Some existing regulations were further expanded in 2015 – specifically, domestic services subject to Article 23, with a rate of 2% of the gross amount, now covers 62 types of services, indicating a potential greater reliance on this withholding mechanism for tax collections.

Non-final withholding or pre-paid tax mechanisms creditable against a taxpayer’s annual CIT liability often result in tax refund situations. Under the current system, any tax refund regardless of amount automatically triggers a tax audit. This system can be inefficient, as the refund may not correlate to the taxpayer’s tax risk profile. It may also systematically result in the same group of taxpayers consistently being audited due to their business models. This does not maximise effective use of the DGT’s limited resources and may be worth streamlining in the future.

Fast-Evolving Regulations 

Practical difficulties in tax compliance and enforcement are aggravated by the speed and pace of change, given the ever-rising tax collection targets. In 2015 alone more than 260 new laws or amendments to Indonesia’s tax and Customs regulations were introduced. This is in addition to the 13 economic packages launched to stimulate the Indonesian economy during that year. Notably, beyond the various tax facilities announced, a regulation on the allowable debt-to-equity ratio for interest deduction purposes was issued, with a ratio of 4:1 to be applied starting in the 2016 fiscal year.

Concurrently, the DGT is undergoing a review of domestic tax regulations given Indonesia’s support of the OECD’s work on its base erosion and profit-shifting project globally. Given the short time available to introduce the changes, adoption of new initiatives may also be limited. This unnecessarily constrains the government’s efforts to reform the system and prepare taxpayers’ for change.

Opportunities For Improvements 

Studies have shown there is ample evidence that taxpayer compliance largely depends on having a favourable attitude towards the tax system, and in particular considering on the whole that it is a fair and equitable system. Acceptance of the fairness of taxation may derive from an identification with the state and a general confidence that its tax system treats all Indonesian citizens equitably.

Furthermore, there is evidence that such a generalised acceptance is undermined in a period of rapid social change, especially in times of globalisation, which may dilute an individual’s sense of nationhood. In these circumstances, tax authorities must seek more refined means of maintaining or re-establishing taxpayers’ confidence in the system and its integrity. An important aspect of this is certainly procedural fairness: compliance is more likely if taxpayers feel they have been treated respectfully, honestly and impartially.

The lack of certainty and feeling of unfairness in the tax environment, particularly when some taxpayers are targeted for tax audits due to pre-paid tax credits, is an increasing source of concern for both existing and prospective business players. This will undermine trust in the domestic tax system and is counterproductive to the government’s efforts to attract investment. In this regard, more can be done by the government to provide taxpayers with a stable and predictable tax system to encourage better compliance. With the introduction of tax amnesty and other schemes, taxpayers who were incompliant previously could have the opportunity to reset and move forward with a fair and clean slate. This is very welcome. Reforms should be evolving, taking into account feedback from taxpayers and the business community, and public education should be ongoing, while dispute and withholding tax processes must be streamlined. Hopefully, with such enhancements, the government and taxpayers can build mutual trust. The Indonesian tax system can then evolve in a more stable manner and contribute its part to the country’s next phase of growth.

CIT Reduction 

The CIT reductions scheme is provided to certain companies that are in pioneer industries and incorporated in Indonesia no earlier than August 15, 2011. These companies must also:

• Have a legalised new capital investment plan of at least Rp1trn ($73m), or Rp500bn ($36.5m) for telecommunications and information industries;
• Commit to deposit a minimum of 10% of their planned investment value in banks located in Indonesia; and
• Meet a debt-to-equity ratio of 4:1.

​The facility covers a rate reduction of 10-100% for CIT due between five and 15 years from the start of commercial production. A maximum reduction of 50% may be provided to telecommunications and information industries, with a new capital investment plan of Rp500bn-1trn ($36.5m-73bn). The period can be extended to 20 years if it is deemed necessary for the national interest.

Taxpayers being rejected for the CIT reduction scheme and taxpayers carrying out other activities in KEK may apply for similar income tax allowances as mentioned previously. Taxpayers in KEK are also entitled to the following tax facilities:

• Non-collection of VAT and LST on the import or domestic purchases of certain goods;
• Non-collection of VAT and LST on the delivery of certain goods between taxpayers in KEK;
• Non-collection of Article 22 Income Tax (PPH 22) on imports;
• Postponement of import duty on capital goods and equipment, and goods and material for processing; and
• Exemption of excise on goods to be used to produce non-excisable goods.

On top of these tax incentives, this regime also provides investment incentives in other ways. The government has also offered companies operating in a KEK benefits related to traffic of goods, manpower, immigration, land procurement and licensing.

Debt-To-Equity Ratio

After having been stipulated in the Income Tax Law for over three decades, the government finally determined a debt-to-equity ratio for the purposes of calculating tax, starting from the 2016 fiscal year. A single ratio of 4:1 is generally applicable, which means that the amount of debt allowed in order to obtain full deductibility of the financing cost is limited to four times the equity amount. Some taxpayers may apply for exemption in certain circumstances.

Revaluation Of Fixed Assets 

The excess of the fair market value over the tax book value of revalued assets is subject to a final income tax rate of 10%. There is a special programme available on revaluation of fixed assets for the submission period of October 20, 2015 through December 31, 2016, which is subject to different rules. Below are the defining features of this special programme:

• Lower final income tax rate, at 3%, 4% and 6%, applies for applications submitted in 2015, the first half of 2016 and the second half of 2016, respectively; and
• Revaluation can be conducted on some or all of the tangible fixed assets owned by the taxpayer. Additional eligible taxpayers include the following:
• Corporate taxpayers who maintain English bookkeeping and US dollars;
• Corporate taxpayers who have not passed five years since their last asset revaluation; and
• Individual taxpayers who maintain bookkeeping.

Goods Subject To PPH 22

Certain consumer goods such as household appliances and electronic devices are no longer considered luxury goods, and therefore have been excluded as LST objects. With no more LST levy on the cost components, it is expected that the sale price of these consumer goods will drop, and thus the goal of boosting purchasing power can be achieved.

In accordance with regulations on PPH 22, the import of these goods is now taxable at 10%. Previously, the rate was 2.5% when using an importer identification number (angka pengenal impor, API), or 7.5% when not using an API.

This PPH 22 is taxed on import value and becomes a tax credit for importers when calculating their annual income tax due. The following transactions are now subject to PPH 22: upstream metal; oil refinery; base organic chemicals sourced from oil and gas; machinery; telecommunications and information services; maritime transportation; processing industry for agricultural, forestry and fishery products; processing industries in KEK; and economic infrastructure other than under the Government Cooperation with Business Entities. An application must be submitted to the chairman of the Indonesia Investment Coordinating Board (BKPM). A proposal for approval from the Ministry of Finance will be made by the BKPM chairman after investigating the applicant. The proposal can be submitted to the ministry until August 15, 2018.

Income Tax Allowance

This allowance is now open to 143 types of investment, up from the previous 129 eligible types of investment either in designated business sectors and/or regions. Key new targets include the construction of smelters for mining products, as well as the manufacturing of communication devices, motor vehicles and ships. The income tax allowance now covers all forms of investment, including investment in intangible assets. As such, this will add accelerated amortisation of intangible assets to the tax break. Other main features of the new incentive include the option to extend the tax loss carry forward incentive, as well as eliminate some requirements perceived as difficult for investors to demonstrate.

Zone-Based Concessions 

A CIT reduction facility may be granted to new taxpayers with new capital invested in the production chain of the main activities in KEK, as described below. The government has reclassified raw skins and raw material of silver craft as strategic goods exempted from VAT. Anode slime is also considered a strategic good, and VAT is not-collected on deliveries of this product to be further processed in producing gold bars.

VAT Base 

VAT is calculated by applying the VAT rate to a relevant tax base. In most cases the tax base is the transaction value agreed on between the parties concerned. For certain events, other values must be used as the tax base. Below are recent changes to the list of other tax bases.

VAT For Transport 

The government has changed VAT treatment for imports and the delivery of certain means of transport and services related to it from VAT exempt to VAT not collected so that importers or producers in these areas can now credit their input VAT. This will reduce production costs and is expected to strengthen the national transportation industry. This is in line with the country’s Maritime Axis Doctrine. In regard to maritime transport companies that serve international routes, they are exempt from VAT for certain port services utilised by them. Furthermore, VAT is not collected on deliveries of certain fuels for these international route ships.

Pension Benefit Programme

In addition to the existing social security benefits, such as accident insurance, death insurance and retirement, the Social Security Agency for Workers’ Social Security also covers pension benefits for all citizens at rates of 1% and 2% of regular salaries, which is borne by employees and employers, respectively.