To understand and appreciate international tax planning by MNEs, one must have a basic knowledge of the elements of international commerce foundation within a country (Scholes, Wolfson, Erickson, Maydew, & Shevlin, 2009). However, before discussing this knowledge, this section will define FDI under Indonesian law and then outline the registration procedures of an FOIC in an Indonesian tax office to lay the foundation for an explanation of how a foreign affiliate becomes a taxpayer in the country.
An MNE consists of a group of companies operating in different countries under the control of a parent company. Foreign MNEs are foreign companies that operate in Indonesia via direct investment, known as ‘FDI firms’ (DGT, 2011, p. 62)22 or, more popularly, FOICs (DGT, 2015a). That is, an FOIC is a company that is established or acquired by an MNE to conduct business in Indonesia; therefore, it is part of a foreign MNE. Given that many of the FOICs included in the dataset used in this thesis were established many decades ago, it is important to trace back the FDI regulations imposed by the government in the first place.
On 10 January 1967, the President of Indonesia signed Foreign Direct Investment Law No. 1/1967.23 According to Article 1 of the Law, FDI encompasses foreign investments in the form of conducting business in Indonesia whereby foreign investors
22 This is consistent with tax literature (e.g. Markusen, 1995, as discussed in Subsection 3.1.2), which uses the terms MNEs and FDI firms interchangeably.
23 Laws and Regulations Establishment Law No. 12 Year 2011 regulates the process of a bill becoming law in Indonesia (previously regulated under Law No. 10 Year 2004 and Law No. 2 Year 1950). Basically, a bill can be filed either by the parliament or the president (Article 43). The bill proposed by the president is prepared by the minister or the head of non-ministerial government in accordance with the scope of duties and responsibilities (Article 47). The bill is then sent to the head of the parliament (Article 50 (1)). If a bill is prepared by the parliament, the head of the parliament is required to send the bill to the president (Article 47 (1)). The parliament or the president (represented by a relevant minister) is required to start discussing the bill within a maximum period of 60 days from the receipt of the bill (Article 49 (2) or Article 50 (3), respectively). If the parliament and the government jointly approve the bill, the head of the parliament is required to send the bill to the president for enactment (Article 72 (1)). Subsequently, the president is required to sign the bill within a maximum period of 30 days from the day the bill was approved (Article 73 (1)). This marks the entry into force of the law.
directly bear the risk of the investments. However, neither the Law nor the lower-level regulations (i.e., government regulation, presidential regulation and presidential decree) specified any ownership limitations. On 16 April 1992, the government issued Government Regulation No. 17/199224 regarding the ownership requirement for FDIs. Some important features of the regulation are: (1) the investment should not be less than USD250,000; (2) domestic investors should possess at least 5% of the total shares at the time the company is established; and (3) domestic investor shares should increase to at least 20% in 10 years and 51% in 20 years. On 19 May 1994, the government revoked Government Regulation No. 17/1992 by imposing Government Regulation No. 20/1994. A key change made in the new regulation was that the government kept feature (2) above and removed features (1) and (3), suggesting that the government relaxed the investment requirements to boost FDI inflow to Indonesia. On 20 July 2000, Presidential Decree No. 96/2000 regarding FDI was made. The new decree differentiated business sectors closed to FDI from sectors open to FDI. The business sectors that are open to FDI were divided into two categories based on maximum ownership by foreign direct investors (i.e., 49% and 95%).
On 26 April 2007, the government and the parliament revoked Law No. 1/1967 and signed new Law No. 25/2007. Article 1 of the new Law redefines FDI as capital investment activity in the form of business in Indonesia by foreign investors either fully using foreign capital or partly using domestic capital. The enforcement of the new Law was followed by several other government regulations (i.e., No. 77/2007, 111/2007, 36/2010 and 39/2014).25 Although these regulations contain broader sectors and a wider
range of ownership limit, they basically follow the two principles in Presidential Decree No. 96/2000: (1) they differentiate sectors that are open for FDI from those that are not; and (2) the ownership limit is more diverse, but still in the range of 49%–95%.
As explained in Section 2.2.1, DOICs and FOICs are resident-company taxpayers and are therefore equally treated for tax purposes in Indonesia. However, there is a minor difference regarding their registration in a tax office because of the presence of foreign investment tax offices (FTOs). Figure 2.1 illustrates the tax registration procedures of an FOIC in Indonesian tax offices.
Figure 2.1
Registration of an FOIC in Indonesian Tax Offices FOIC
No Yes
An FOIC is registered in a small taxpayer office (STO) for the first time. The company’s registration status can be changed to either a regional medium taxpayer office
Regulation No. 111/2007 and Government Regulation No. 39/2014 revoked Government Regulation No. 36/2010), which means that Government Regulation No. 39/2014 is still in force today. Government Regulation No. 39/2014 significantly changes the previous regulations by broadening the ownership range to 30%–100%. However, as the latter regulation came into force on 24 April 2014 and all FOICs included in this thesis were established before that date, the regulation is not relevant to this thesis. Therefore, this thesis uses Government Regulation No. 36/2010.
STO RMTO/FTO Public?Go
PLCTO
(RMTO) or an FTO by a decree of the Director General of Tax. If the company is listed on the stock market (very few are), the Director General of Tax issues another decree to declare the registration change of the company to a public-listed company tax office (PLCTO). FOICs with certain revenue, total assets and total tax paid may be transferred to a large taxpayer office (LTO) by a decree of the Director General of Tax.
According to Scholes, et al. (2009), there are three elements of international commerce foundation. The first element is the ways in which foreign income is taxed. The tax literature groups countries by taxation of foreign income into two broad categories: territorial and worldwide systems (Markle, 2015). Countries that adopt the territorial system exempt foreign income from income tax calculations. In contrast, countries that adopt the worldwide system tax foreign income at their domestic rates and allow credits for tax paid on foreign income to avoid double taxation. As discussed in Section 2.2.1, ITL Article 4 (1) states that all income from Indonesia and outside Indonesia are subject to Indonesian income tax, suggesting that the country has adopted the worldwide income system.
Markle (2015) finds that, on average, MNEs subject to territorial tax systems shift more profits than those subject to worldwide tax systems when the parent country is involved, and the two groups appear to shift equally among their foreign affiliates. Different from Markle (2015), Scholes et al. (2009) suggest that MNEs in countries that impose worldwide tax systems may have incentive to shift profits as those in countries that impose territorial tax regimes. The reason for this is that, while most countries with worldwide tax systems allow resident taxpayers to claim tax paid in foreign countries as
Indonesian foreign income tax offset policy is discussed in more detail at the end of this section.
The second element is the ways in which foreign operations can be structured by MNEs. As Scholes et al. (2009) suggest, MNEs can choose to operate their foreign affiliate as a branch, a partnership or a subsidiary company because most countries impose income tax on branches, partnerships and subsidiaries differently. This is also true in the case of Indonesia. For example, profit distribution received by partners in a partnership is exempted from income tax. In contrast, income distributed to shareholders in a subsidiary will be taxed as dividend income. Under ITL Article 2(5), MNE branches are categorised as permanent establishments. Further, ITL Article 2(1a) states that permanent establishments are treated as resident company taxpayers for tax purposes. For instance, permanent establishments are required to lodge an annual tax return, similarly to domestic companies. Nonetheless, permanent establishments are different from subsidiaries because permanent establishments are required to report income derived from Indonesia only. In contrast, subsidiaries are required to report worldwide income in their Indonesian annual tax returns.
The focus of this thesis is foreign MNEs that operate their affiliates in Indonesia in the form of subsidiaries (i.e., FOICs). There are several reasons for focusing on subsidiaries: (1) subsidiaries are usually larger: they have larger capacity in terms of production, sales and technology; (2) FDI inflow to Indonesia mostly takes the form of establishing or acquiring subsidiaries; and (3) more importantly, subsidiaries as separate legal entities are more suitable for complex transactions designed to shift profits.
The third and most important element of international commerce foundation is how foreign tax credits can be structured by MNEs. As explained earlier, Indonesia has adopted the worldwide tax system. This means that all income received from Indonesia
and outside Indonesia is assessable income under Indonesian tax law. However, losses incurred outside Indonesia cannot be used to offset against assessable income.
To avoid double taxation of foreign income, ITL Article 24 allows tax already paid offshore by resident taxpayers to be credited in the same year against tax payable in Indonesia as long as it does not exceed a certain level. The foreign tax credit (FTC) limit or foreign income tax offset (FITO) limit is intended to prevent taxpayers from obtaining tax relief in excess of the domestic tax payable on the foreign income. Indonesian Finance Minister Decree No. 165/2002 specifies that the FITO limit is calculated as follows:
FITO limit = income from overseas
global TI X total tax payable
In addition, the decree requires that the FITO limit calculation be performed for each country if the foreign income is derived from several countries.
According to ITL Article 24, the tax paid overseas that can be claimed as FITO is the tax directly imposed on income obtained by Indonesian taxpayers from overseas. Therefore, tax paid overseas may not be eligible to be claimed as FITO if the income after tax is not transferred to the Indonesian taxpayer. The income tax imposed on the income transferred to the Indonesian taxpayer is the tax that can be considered FITO. An example is presented below to explain how much FITO can be claimed for the tax paid overseas.26
Indonesian Company A is the sole shareholder of X Inc. in Country U. The income- and tax-related information of X Inc. in 2013 is as follows:
(1) TI of X Inc. Rp20,000,000,000
(2) Corporate income tax (25%) 5,000,000,000 (3) Income after tax (paid out as dividends) 15,000,000,000
(5) Dividends received by Company A 12,000,000,000
Suppose that the TI of Company A’s Indonesia operations in 2013 is Rp50,000,000,000. The tax payable is computed as follows:
(6) TI from Indonesia operations Rp50,000,000,000 (7) Dividends (before withholding tax) 15,000,000,000
(8) Total TI 65,000,000,000
(9) Tax payable (25%) 16,250,000,000
FITO limit = 15,000,000,000
65,000,000,000 × 16,250,000,000 = Rp3,750,000,000
Given that the amount of withholding tax paid in Country U (Rp3,000,000,000) is less than the FITO limit (Rp3,750,000,000), Company A can claim the withholding tax Rp3,000,000,000 on the dividends received as FITO. Therefore, in 2013, Company A’s final tax liability (liability after including FITO) is Rp16,250,000,000 − Rp3,000,000,000 = Rp13,250,000,000.