Indonesia

Jul Seventa Tarigan
PB Taxand
Indonesia

Growth of the Indonesian economy is having an impact on taxpayers in a number of ways, explains Jul Seventa Tarigan, tax manager of PB Taxand.

The government predicts that the Indonesian economy will grow 6.5% in 2011 and 6.5%-6.9% in 2012. The country's robust economic growth has led the tax authority to improve and to keep on increasing the tax revenue without sacrificing the investment climate and to provide certainty for taxpayers. Another big challenge is the low ratio of taxpayers filing annual income tax returns (tax coverage), that is, only 7.73% of the total population in 2010, which the government is targeting to increase to 20% in the next five years.

The developments in the Indonesian tax system cannot be dissociated from global trends. As an investment destination, Indonesia has become the home of investment for multinational companies which use transfer pricing transactions and tax planning strategies in order to achieve tax efficiency. The following discusses the major developments in Indonesia, with regards to the transfer pricing regulations and anti-tax avoidance regulations that were recently issued by the tax administration, in achieving Indonesia's economic objectives.

Developments in transfer pricing regulations

New transfer pricing rules

Indonesia has finally realised that transactions between related parties must be governed by a clear and specific regulation that adopts the internationally accepted principles in order to provide certainty and uniformity in applying the arm's-length principle (ALP). The tax authority issued the Director General of Taxes (DGT) Regulation No. PER-43/PJ/2010 to provide guidance in applying the ALP and to set out the transfer pricing (TP) documentation requirements. Hopefully, it may usher in a new era of certainty for TP practices in Indonesia.

The highlights of the rules are:

It covers all transaction between related parties, including cost contribution arrangement, intra-group services and intangible properties.
All aspects regarding comparability analysis and TP methods mainly adopt the OECD Transfer Pricing Guidelines. However, the application of TP methods being used is based on a hierarchy (Comparable Uncontrolled Price, Resale Price/Cost Plus, Profit Split, and finally Transactional Net Margin).
The arm's-length price or profit may be a single amount or a range of prices or profits (ranging between the first and third quartile).
It specifies the minimum documentation requirements and the taxpayer is also allowed to maintain other documents to support the determined arm's-length price/profit.
The appropriate application of ALP is validated by implementing the following four steps:

Step 1: Conducting the comparability analysis;
Step 2: Applying the appropriate TP method;
Step 3: Determining the arm's-length price/profit; and
Step 4: Preparing the TP documentation.

Safe harbour: transactions between related parties amounting to IDR10 million ($1,170) and below are not obliged to implement the abovementioned four steps.

The tax authority is authorized to make adjustments on any related-party transactions if the taxpayer fails to implement the four steps or to present the supporting documents.

New procedures in implementing the Mutual Agreement Procedure (MAP)

The Indonesian tax authority traditionally implemented MAPs in an ad hoc manner and mostly applied MAPs to settle inappropriate application of the tax treaty. The issuance of the DGT Regulation No.PER-48/PJ/2010 provides a clear guidance for taxpayers to make an MAP request to the tax authorities as it also provides the procedures for the tax authority to follow up the MAP request from the tax treaty partners. It is expected that transfer pricing disputes may also utilise the MAP as an avenue for dispute resolutions.

For the effectiveness of tax treaty implementation, finally the Indonesian tax administration has set up three important pillars of the Indonesian tax treaty:

Procedures to implement relief-at-source and anti-treaty abuse (PER-61/PJ/2009 and PER-62/PJ/2009);
Procedures to implement refund for non-residents (PER-40/PJ/2010); and
Procedures to implement the MAP (PER-48/PJ/2010).

The unique feature in this procedure is that the tax authority will decline MAP requests from a taxpayer or a treaty partner if the related domestic taxpayer pursues a domestic dispute settlement (objection or appeal) on the related case. This situation actually reduces the effectiveness of the MAP and undermines the investment climate, as it will increase the risk of double taxation.

New procedures for applying the advance pricing agreement (APA)

The issuance of APA procedures under the DGT Regulation No.PER-69/PJ/2010 is one of the significant breakthroughs in tax administration in Indonesia. Now, the taxpayer, in order to manage the risks of transfer pricing, can request the tax authority to enter into a transfer pricing agreement unilaterally or bilaterally.

The APA procedure has these five stages:

a. Pre-lodgment meeting

The taxpayer will submit a request for pre-lodgment meeting, including supporting documents to be reviewed by the tax authority. Evaluation and time scheduling is then set up. The tax authority will make a decision within three months on whether or not to continue the discussion with the taxpayer.

b. Formal application

When the tax authority decides to continue the discussion, the taxpayer will submit the formal application, supporting documents and critical assumptions.

c. Discussion

This stage is to discuss the coverage of the APA, comparability analysis, TP method, relevant factors and the conditions and whether there is a necessity to enter into an agreement with other countries. No specific time limit is set out in the procedures.

d. Issuance of the agreement

The tax authority must issue the agreement within 20 days and this must be signed by the DGT and the taxpayer. The agreement will be valid for three consecutive years. There is a possibility that it may be applied retroactively in certain conditions.

e. Implementation and evaluation

The taxpayer must submit a compliance report annually. The tax authority has the power to revise or terminate the agreement in the following cases: the taxpayer fails to comply with the agreement; submits incorrect information; fails to submit the required compliance report; or committed tax fraud, including changes of critical factors.

Recently, no taxpayers have submitted an APA request yet as they wait and see what will happen. Taxpayers are still measuring the risks, whether they can satisfy the tax authority just by preparing the required TP documentation.

Development on anti-tax avoidance rules

Indonesia has moved toward being a country that combats tax avoidance through several special anti-tax avoidance rules. The modification of 1995 controlled foreign companies (CFC) rules to stricter rules, introduction of anti-stepping measures in the amendment of the Income Tax Law in 2008, the application of income assignment doctrine and new procedure to apply the tax treaty, including the implementation of anti-treaty shopping in 2009, demonstrated its significant development. It is perceived that certainty is improved; but, as a consequence it requires taxpayers to increase awareness on the effect of those rules.

Stricter CFC rules

In 2008, the minister of finance issued regulation no 256/PMK.03/2008 (PMK-256) and revoked the anti CFC regulation of 1995. The main difference between the old and new rules is that there are no more negative or black-listed countries. Previously, there were 32 countries considered as tax havens. This means that wherever a CFC is situated, even in a high-tax jurisdiction, the Indonesian resident taxpayers must recognise dividend income from subsidiaries.

Furthermore, in 2010 the DGT issued regulation no. PER-59/PJ/2010 that provides the calculation basis for recognised dividends. The net income of a CFC must be calculated by applying the generally accepted accounting standards in the country of the CFC. This may substantially affect the recognised dividend when a CFC is functioning as an investment holding and has applied the consolidation method.

The CFC rules will be applied when a resident taxpayer owns at least 50% of the CFC shares, individually or collectively with other resident taxpayers. No CFC income is exempt.

The stricter CFC rule may significantly affect the outbound investment of Indonesian residents as they are exposed to higher income tax. For a resident taxpayer who utilises an offshore special purpose vehicle (SPV) to obtain financing, meticulous attention is needed to mitigate the effect of this regulation.

Limited anti-stepping rules

The Minister of Finance issued regulation no. 140/PMK.03/2010 (PMK-140) that may authorise the tax authority to collapse the transaction conducted by a special purpose company (SPC). The coverage of this rule is the acquisition by an SPC of assets or shares owned by an Indonesian company (the seller). The SPC is established or used by the true buyer to acquire the assets or shares.

The tax authority may collapse the transaction of SPC provided all these conditions are met:

The SPC and the true buyer are related parties.
The value of the transaction between the seller and the SPC does not reflect the fair value of assets or shares.
The asset or share is initially provided by the true buyer as collateral or loan to the seller.

If all the above conditions are met, the tax authority may restructure the acquisition of assets or shares as a transaction between the seller and the true buyer. It seems no tax exposure will be raised from this adjustment; however it may have a significant impact on capital gains tax that must be borne by the true buyer when the assets or shares are transferred to other parties in the future.

Application of Income Assignment Doctrine

The Minister of Finance issued regulation no.139/PMK.03/2010 that may give rise to tax exposures for expatriate workers in Indonesia, as well as employers who act as the withholding tax agents.

The tax authority is authorized to recalculate the amount of the expatriate employee's income paid by the employer provided all these conditions are fulfilled:

The Indonesian employer remits the income of the expatriate worker to the non-resident company overseas, wholly or partly, in the form of management fees, technical fees or other service fees.
The employer and the overseas company are affiliated.
The expatriate worker is an employee of the overseas company.

This rule actually provides certainty on the criteria that may fall into the category of tax avoidance. However, it may cause the employer to be exposed to the risk of withholding tax, since any adjustment by the DGT will result in the underpayment of withholding tax, including penalty, and this will be a source of burden to the employer.

Anticipated regulations

Tax holiday facility

The government is now preparing the regulations to provide a tax holiday facility, as has been stipulated in the Investment Law of 2007. However, some questions arise such as for how long it will be provided, what sectors will be covered, and how effective it will be in attracting investors to Indonesia since it is essentially a subsidy enjoyed by the home country.

Implementation of the Indonesia-Hong Kong tax treaty

Both governments signed the treaty on March 23 2010. This treaty is not effective yet since the Government of Indonesia has not finished the ratification process while Hong Kong ratified it domestically on June 22 2010.

Investors are eagerly looking forward for this treaty to be effective as soon as possible as it can provide a better channel for inbound investments to Indonesia than the traditional channel of Singapore.

Implementation of several TIEAs

As one of the G20, Indonesia has implemented measures to promote tax transparency by negotiating tax information exchange agreements (TIEA) with some jurisdictions such as Guernsey, Jersey, the Isle of Man, and Bermuda. Those treaties are in the process of being signed or ratified and they are expected to be effective soon. It is predicted that Indonesia will expand its TIEA network with more jurisdictions to enable the tax administration to enforce the domestic tax laws and to increase revenue.

Jul Seventa Tarigan (jul.st@pbtaxand.com) is a tax manager of PB Taxand of Taxand Indonesia.