In the absence of a general anti-tax avoidance rule, numerous cross-border transactions in Indonesia are structured to minimise Indonesian tax. There are various specific anti-tax avoidance rules such as CFC and thin capitalisation, but the tax authorities are apparently worried that treaty abusive practices still occur. Back in 2005, the Indonesian tax authority commenced its efforts to combat those practices by issuing circular letters on beneficial ownership and a unilateral increase of withholding tax on interests paid to Dutch tax residents from 0% to 10%. As part of the reform process, the 2008 income tax law also explicitly defines a beneficial owner. A large number of those measures are considered less than successful, as there were many international tax disputes that were verified in court and decided in favour of the taxpayer.
On November 5 2009, the Director General of Taxation surprisingly slammed foreign investors by issuing two regulations that will take effect January 1 2010. Regulation 61 revokes an earlier circular letter on tax treaty application and requires all non-residents to provide a new model certificate of residence (COR) that if they wish to enjoy tax treaty benefits entered into by Indonesia and their resident country. Such a non-tax resident shall also not abuse the treaty and be the recipient of the income. The COR shall be attached to the monthly tax return of the resident payer and contain various declarations including the six abusive of treaty tests that are explained by Regulation 62 below.
Regulation 62 clearly prohibits any application of the tax treaty if there is abuse, which is indicated by the following:
- A transaction is without economic substance and is used merely to obtain a benefit from a tax treaty.
- There is a difference between the economic substance of a transaction and the legal form of its structure, and it is used merely to obtain a benefit from a tax treaty.
- The recipient of the income is not the beneficial owner (an agent, nominee or conduit company).
If the non-resident is a company other than a bank or public company, it must meet the following requirements:
- The company is not established in the jurisdiction of the relevant treaty's counterparty merely to obtain the treaty benefits, and the transaction itself is not structured solely to take advantage of the treaty benefits.
- The company has independent management with sufficient authority to conduct its business.
- The company has employees.
- The company has an active operation or business.
- The company is subject to tax in its jurisdiction of residence on the Indonesia-sourced income.
- 50% or more of the company's income is not used to satisfy an obligation to another party in a form of interest, royalty or other reward.
Those two regulations immediately became the focus of attention for all foreign investors in Indonesia. Bondholders, lessors, shareholders, lenders, permanent establishments, and other non-residents must carefully monitor and anticipate the effects of those regulations. They should start by considering restructuring their existing investment or future proposed investment. Utilisation of mutual funds, commercial banks and other types of vehicles deemed appropriate, or derivative products in the structure, become an option to avoid unnecessary tax exposures.
Oene Marseille and Freddy Karyadi