Reshaping the environment: An overview of the tax system and regulations for potential investors

The Indonesian tax system is mainly based on three 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. The tax reforms, which started in 2008, covering amendments of the above laws, were completed in 2010. Subsequent to the commencement of the new laws, the government issued a number of implementing regulations which provide clearer guidance on various tax matters. The government is trying to reshape the tax environment and improve the investment climate. Tax concessions are being provided to certain taxpayers in particular sectors and/or particular regions, and further income tax exemptions or reductions will be given to companies in pioneer industries which have met certain criteria.

Internally, the Indonesian Tax Office (ITO) is becoming more professional in its approach to dealing with taxpayers. New tax audit guidelines have been issued, which provide more certainty to taxpayers about the process. In 2011 the ITO is focusing on carrying out tax audits on certain industries and high-wealth individuals, whilst the office also continues its focus on transfer pricing audits.

The key issues covered in the amended tax laws and their implementing regulations are summarised below.

CORPORATE TAXATION: An Indonesian limited liability company, which is commonly referred to as a PT company, is an Indonesian tax resident by virtue of having its incorporation or its place of management in Indonesia. Its income is taxed on a worldwide basis under a self-assessment system. A branch of a foreign company, which constitutes a permanent establishment (PE), is also taxed in the same manner for the income attributable to the PE.

The corporate income tax rate is 25% on net taxable income. This applies to a company’s profits, determined in line with Indonesian accounting standards, which reflect international accounting standards. Fiscal adjustments are required for certain items where different treatments apply for tax and accounting. For instance, provision and benefits in kind should be accounted for as expenses for accounting purposes but generally are not claimable as deductible expenses for tax. Capital assets are also depreciated differently for tax and accounting purposes. If a company suffers a loss in a particular year, it may be offset against profits for the next five years. For a limited category of businesses in certain regions or businesses subject to certain concessions, the period can be extended for up to 10 years.

Carrying back tax losses is not allowed and tax consolidation is not available.

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% final income tax on the 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, however, for transfers of simple houses and apartments the tax rate is 1%.

Only certain categories of business (e.g. banking and public works) can formally establish a branch operation (generally referred to as a PE) in Indonesia. A PE of a foreign company is taxed in the same manner as the income of PT companies.

In addition, a PE is 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.

WITHHOLDING TAX (WHT): A large proportion of income tax is collected through a comprehensive WHT system, which applies to resident taxpayers as well as non-resident taxpayers. For resident taxpayers, WHT mainly applies to services rendered, and it is accounted for by the recipient of the services at the time of invoice accrual or payment, whichever is earlier. A WHT rate of 2% applies to fees for various services. This WHT constitutes a pre-payment of the service provider’s annual income tax liability.

The WHT rate for interest and royalty income received by a domestic taxpayer from an Indonesian company is 15%. Dividends received by individual taxpayers from an Indonesian company 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 represents a pre-payment of the taxpayer’s annual income tax.

Dividends, interest, royalties and fees payable to nonresidents are subject to 20% final WHT. A WHT exemption or a WHT rate reduction may be available under an applicable tax treaty. Treaties generally reduce rates on interest, dividends and royalties to 10% or 15%.

Indonesia has entered into 62 tax treaties. To enjoy the benefits, the income recipient must provide a certificate of domicile (CoD) by filling out the form of CoD prescribed by the Director General of Tax (DGT), which must be certified by the tax authority of the recipient’s home country.

In the case of dividends, interest and royalties, the recipient must be the beneficial owner of that income; an entity benefitting from a tax treaty cannot be a pass-through entity. To support the beneficial ownership position the CoD form also requires a number of declarations to be made by the recipient that acknowledge that the use of the treaty jurisdiction has not been done merely to obtain the benefit of the treaty. In most situations beneficial ownership is determined under a series of tests, all of which must be met. In broad terms, these tests require the recipient entity to have substance and not be a pass-through entity.

Where a treaty does not have a beneficial ownership requirement, the test requires that the recipient entity was not set up to take advantage of the tax treaty and or that the transaction was not undertaken to take advantage of the tax treaty.

DIVIDEND TAX: 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%.

WHT ON SALE OF SHARES: The sale of shares in a nonlisted Indonesian company by a non-resident is subject to a final 5% WHT based on the transaction value. Where the seller and the buyer are non-residents, the WHT must be accounted for by the Indonesian company whose shares are being sold. 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 PE is treated as if it were the sale of PT company shares or the sale of 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 AND 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 graduated. The highest marginal tax rate is 30% and applies to income above Rp500m ($60,000) per year. Employment income, a type of individual income, is taxed through withholding by the employer.

VAT AND LST: VAT is due on virtually all transactions involving transfers of taxable goods or the provision of taxable services in the Indonesian Customs Area. Under the VAT and LST Law, 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 standard VAT rate is 10% and 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. Most goods and business-related services are categorised as taxable goods or taxable services. Those categorised as non-taxable include unprocessed mining or drilling products, gold bars, securities, banking, insurance and finance leasing services.

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. 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 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 the 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 alcoholic beverages, certain household appliances and certain sporting equipment. 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 Rp6000 ($0.72) for each document stamped.

Land and building (property) tax is due every year. The effective property tax at present 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 AND 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 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 and 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. Final settlement of the tax payable must be made before the end of the fourth month. Payments of tax beyond the deadline will trigger an interest penalty, which is 2% per month. 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 20th of the following month. VAT and LST payment deadlines are before the reporting date while for WHT, the tax settlement must be made 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 and PEs 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 AUDITS AND TAX ASSESSMENTS: The DGT may perform a tax audit on a particular PT company for various reasons. A request for a tax refund will trigger a tax audit. Declaring continual tax losses in tax returns, failure to file a return after a DGT reminder, and business restructuring including acquisitions, mergers and liquidations, may also trigger a tax audit. The DGT may also select a taxpayer to be audited based on risk-based selection criteria. Based on tax audit 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 tax years up to 2007 must be issued no later than 2013.

Tax audits in Indonesia can prove to be a difficult and protracted process and all taxpayers are well 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 the request date. Under the one-month rule, any documents delivered to the tax auditors beyond a month of the request date can be ignored by the auditors.

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 properly due and contest the balance in the objection. However, if the objection decision is unsuccessful, a 50% penalty applies on the unpaid tax. This 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 Tax Court decisions can be appealed in the Supreme Court. Supreme Court decisions are closed hearings with no representations made apart from the submission of a written appeal.

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 new regulations relating to transfer pricing. The DGT issued detailed transfer-pricing guidelines in 2010 which, broadly stated, generally follow OECD principles. Transactions under particularly close scrutiny include payments of royalties and technical or management service fees, intercompany services, royalty and financing transactions, and exports to related parties.

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 ITO during an audit is being strictly 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 ITO may terminate the MAP process if certain conditions exist, such as the Indonesian resident taxpayer making the request for MAP submits an objection letter to the DGT or an appeal to the Tax Court.

The tax law authorises the DGT to enter into advance pricing agreements (APAs) with taxpayers and/or another tax 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. More than 2000 companies currently enjoy this facility.

INCOME TAX CONCESSIONS: The Income Tax Law provides various facilities and incentives, such as a package of concessions available for companies that invest in certain qualifying business 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%).

Small enterprises, i.e. corporate taxpayers with an annual turnover of not more than Rp50bn ($6m), are entitled to a tax discount of 50% off the standard rate which is imposed proportionally on taxable income of the part of gross turnover up to Rp4.8bn ($576,000).

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. Founder 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 withholding tax 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 HOLIDAY: On 15 August 2011, tax facilities in the form of an income tax exemption (tax holiday) or reduction were announced by the Indonesian government. The tax facilities are provided 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. Currently five business sectors may enjoy the tax exemption. These are the industries of base metal, oil refinery and/or base organic chemicals sourced from oil and gas, renewable energy, machinery and telecommunication.

Eligible taxpayers may enjoy the income tax exemption for a period of five to 10 years from the start of commercial production. After the end of the tax holiday period, the taxpayers are given a 50% income tax reduction for a further two tax years.

Only Indonesian legal entities with a minimum investment value of Rp1trn ($120m) will be eligible for the facilities. Eligible taxpayers will also be required to deposit 10% of their planned investment value in a bank or banks located in Indonesia.

Once the facilities are granted, taxpayers should submit periodic reports on the realisation of their investment plans and the use of the funds deposited in the Indonesian bank or banks. Failure to realise the investment plan and to submit the above periodic report will cause in a termination of the tax facilities.

CONTINUOUS DEVELOPMENT: Indonesia continues its serious effort to promote foreign investment, capital accumulation and the export of goods other than oil and gas, to expedite economic development and to become internationally competitive. A broad range of deregulatory measures has been implemented and additional measures can be expected to further enhance the investment climate.

The government is also committed to continuing tax administration reform, which aims to increase taxpayer compliance by increasing the efficiency and effectiveness of the DGT, and to improve good governance in tax administration by strengthening transparency and accountability mechanisms.

The ITO has introduced profitability benchmarking based on taxpayer industries. The benchmarking is based on analysis conducted internally by the DGT and is intended to be used in assessing the risk profile of Indonesian corporate taxpayers as a tool in its audit selection process. Taxpayers with profitability that falls below the DGT benchmarks for their industry may be asked for further information, asked to amend a tax return, or possibly be subject to an audit.

The benchmarking contains a range of profitability ratios for the industries examined, including gross profit margin, operating profit margin and corporate tax to turnover for 2005, 2006 and 2007.

Up to now, the ITO has released benchmarking guidelines for 115 industries. Further benchmarking regulations are likely to be issued in the future to cover additional industries.

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. This will apply where it results in no gain or loss on the transfer. 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 companies is VAT exempt. Merging companies can also apply for a 50% reduction of duty on the acquisition of land and building rights.

Facilities for foreign companies operating through their branches in Indonesia are also available. PEs may be exempted from the imposition of branch profit tax if they reinvest their after-tax profits in Indonesia in one of the following forms: 1)Capital participation in a newly established Indonesian company as a founder or participant founder; 2)Capital participation in an established Indonesian company as a shareholder; or 3)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. PEs must also fulfil certain administrative requirements with regard to their reinvestment.