The Indonesian Director General of Taxation (DGT) on November 5, 2009, issued two new regulations setting out strict requirements that nonresident persons must meet in order to claim reduced Indonesian withholding tax rates under Indonesia’s tax treaties. (See DGT Regulation No. PER-61/PJ./2009, “Procedure for Implementation of Double Taxation Agreements” (Regulation 61), and DGT Regulation No. PER-62/PJ./2009, “Prevention of Tax Treaty Abuse” (Regulation 62)).
Conditions for Treaty Relief
Under Regulation 61, a withholding tax agent should withhold tax in accordance with the provisions of an applicable tax treaty (i.e., apply a reduced treaty withholding tax rate or exemption), if the following conditions are met:
- The income recipient is not an Indonesian resident tax subject.
- The administrative conditions for applying the provisions of the tax treaty have been fulfilled.
- There is no “abuse” of the tax treaty by the foreign taxpayer as contemplated in provisions regarding the prevention of tax treaty abuse.
If the above three conditions are not all met, the withholding tax agent must withhold or collect the tax payable in accordance with Indonesian domestic tax law, which is 20 percent in the case of interest, dividends and royalties.
Regulation 62 provides that “abuse” of a tax treaty occurs if:
- A transaction that has no economic substance is carried out using a certain structure/scheme solely in order to obtain a benefit from a tax treaty.
- A transaction has a structure/scheme whose legal form is different from its economic substance and is solely in order to obtain a benefit from a tax treaty.
- The income recipient is not the real owner of the economic benefit of the income (the beneficial owner). For this purpose, the real owner of the economic benefit of the income is an income recipient who is not acting as an agent or a nominee, and is not a conduit company.
- The new regulations specifically provide instances where tax treaty “abuse” is not deemed to occur. They are:
- An individual who does not act as an agent or a nominee.
- An organization whose name is mentioned in the tax treaty or has been agreed by the competent authority of Indonesia and the competent authority of the tax treaty partner.
- A foreign taxpayer who receives or earns income through a custodian from a transfer of shares or bonds traded on the Indonesian Stock Exchange, other than interest and dividends, where the foreign taxpayer is not acting as an agent or as a nominee.
- A company whose shares are listed on a stock exchange and traded regularly.
- A bank.
- A company that meets the following conditions:
The company is established in the tax treaty partner country or has a structure/scheme transaction arrangement that is not solely intended to take advantage of a tax treaty benefit.
The company’s operation is managed by the management itself who has sufficient authority to enter into transactions.
The company has employees.
The company has activities or an active business.
The Indonesia-source income is subject to tax in the recipient country.
The company does not use more than 50 percent of its total income to fulfill its obligations to other parties in the form of interest, royalties or other types of compensation (the 50% Test).
These tests relating to a company are quite stringent and are not clear, particularly the 50% Test. For example, if a company has significant bank debt which is totally unrelated to its investment in Indonesia, but the bank debt results in a company paying more than 50 percent of its total income to the bank, does this mean that the company is denied tax treaty benefits? This is not the intent of the new rules, but could technically be the correct result. Hopefully, the Indonesia Tax Department will provide some clarification.
Certificate of Domicile
General Income Recipients (Form-DGT 1)
The Regulations generally require all nonresident persons, other than banks, to provide a “Certificate of Domicile of Non Resident for Indonesia Tax Withholding” (COD) on Form—DGT 1 to the payer of the income, acting as a withholding tax agent, in order to claim treaty relief from Indonesian withholding tax on Indonesia-source income (such as dividends, interest, royalties and income from rendering services).
The income recipient must complete Form—DGT 1 and make a declaration that the information provided is true, correct and complete. It must provide detailed information regarding itself, including whether it has its own management to conduct the business and such management has independent discretion, whether it employs sufficient qualified personnel and whether it engages in the active conduct of a trade or business. It must also provide information regarding the income in respect of which treaty relief is being claimed and, in the case of services, the terms of the engagement. This latter requirement will prove burdensome to professional service firms (e.g., management consulting firms and international law firms).
In addition, the competent authority of the country of residence of the income recipient (the tax treaty partner country) must confirm and certify that, for purposes of tax relief concerning the types of income mentioned in the form, the income recipient is a resident in the tax treaty partner country within the meaning of the tax treaty. The competent authority or his authorized representative must sign the COD and affix its official stamp, if any.
The income recipient apparently is required to provide a separate Form—DGT 1 for each payment of income for which treaty relief is being claimed. The income recipient must submit the COD to the withholding tax agent before the deadline for filing its monthly tax return for the period in which the income is paid (i.e., by the 20th of the following month).
This is a radical departure from prior practice where a COD was only required to be given to an Indonesian withholding agent once a year and, thus, the new requirement will prove to be very burdensome for foreign investors.