The income tax law contains specific anti-avoidance provisions. Where the Indonesian DGT considers that transactions have not been conducted at arm’s length due to the existence of a “special relationship” between the parties, the consideration paid may be adjusted. The DGT’s power extends to all domestic and cross border transactions.
In addition to the power of the DGT to adjust transfer prices, there are thin capitalization considerations and controlled foreign company rules. These are summarized below.
Any transaction determined to be “non arm’s length” may be subject to adjustment by the DGT, including:
- Unreasonable selling prices
- Unreasonable purchase prices
- Allocation of overhead costs
- Interest rates applied to inter-company loans
- Payments of commissions, license fees, franchise fees, rentals, royalties and compensation for managerial, technical and other services
- Purchases of a company’s assets by shareholders (owners) or parties having a special relationship at prices that are lower than market prices
- Sale of goods to foreign partners through third parties having no substantive business (such as a dummy company, letter-box company or re-invoicing center).
A special relationship includes:
- A relationship between two or more taxpayers that are under common ownership or control, whether directly or indirectly
- A relationship between a taxpayer that owns 25 percent or more of the capital of another party, or a relationship between a taxpayer that owns 25 percent or more of two or more parties, and the relationship between the two or more parties last mentioned
- A family relationship, either of the same blood or by marriage in one straight descent line and or one degree sideways.
It is important to note that the above transfer pricing rules apply to domestic as well as international transactions. However, amended guidance issued in November 2011 applies in the case of domestic transactions only when the related parties are subject to the application of different tax rates or luxury goods sales tax is involved in the transaction.
The limited regulations/guidelines which have been issued with regard to Transfer Pricing are now largely in line with the 2010 OECD Transfer Pricing Guidelines although guidance to auditors and the rules prior to November 2011 suggest that a hierarchical approach should be taken to the selection of methodology and the limited nature of the guidelines allows for broad interpretations.
The DGT may enter into Advance Pricing Agreements (APA) on prices with companies and other tax jurisdictions. The DGT issued a regulation covering the policies and procedures that will be adopted in establishing such APAs in late 2010.
A permanent establishment (PE) is any establishment that is regularly used to carry on business in Indonesia by an organization not established or domiciled in Indonesia, which might be in the form of: a place of management; branch office; representative office; office building, factory or workshop; a construction, installation or assembly project; a mine or natural resource site; a fishing area, a livestock breeding area, an agricultural area, plantation or forest area; a dependent agent; services rendered by an employee or other person in whatever form for more than 60 days in a 12-month period; an insurance company not established or domiciled in Indonesia receiving insurance premiums or insuring risks in Indonesia; a consulting team; an individual or body acting on behalf of a body not established or domiciled in Indonesia.
An individual or organization, which acts on behalf of a company domiciled abroad, may create a PE in Indonesia for the foreign company if a dependent agency is considered to exist.
In the absence of treaty provisions to the contrary, a PE is taxed on:
- Income from business activities of the PE and from property controlled or owned by the PE
- Income of the head office of the same legal entity where the income is from a business activity or the sale of goods and provision of services in Indonesia of the same type as those carried out by the PE in Indonesia
- Income in the form of dividends, royalties, interest payments and fees for services received by the head office, as long as there is an effective relationship between the PE and the property or operation producing the income.
A PE is therefore taxed on income from its own business activities as well as on certain items of income received by the head office. A PE is also subject to a branch profits tax of 20 percent, unless reduced by a tax treaty.
Where a special relationship exists, interest may be disallowed as a deduction where such charges are considered excessive, such as interest rates in excess of commercial rates. Interest-free loans from shareholders may in certain cases create a risk of deemed interest being imposed, giving rise to withholding tax obligations for the borrower.
The law allows the MOF to issue a decree defining the maximum ratio of debt to equity in determining deductible interest. Such a decree, proposing a maximum 3:1 ratio for all industries, was issued in 1984. However, a subsequent decree postponed its implementation indefinitely. The DGT later issued a draft proposal for a 5:1 ratio, however this has never been finalized. Special rules on tax deductibility of interest apply in the mining, and oil and gas sectors.
Controlled Foreign Company (CFC) Provisions
Effective January 1, 2009, the CFC type rules whereby Indonesian resident shareholders may be subject to tax on deemed dividends have changed. A CFC is now defined as a foreign unlisted corporation in which Indonesian resident individual or corporate shareholders, either individually or as a group, hold 50 percent or more of the total paid in capital. Listed corporations are not CFCs. The Indonesian shareholders shall be deemed to receive dividends within 4 months after filing the tax return, or 7 months after the end of the fiscal year where there is no obligation to file an annual tax return or there is no specific deadline of filing in the country of residence of the CFC.