Tax avoidance is a practice carried out by taxpayers to reduce, avoid, or delay paying taxes that should be owed. Taxpayers who avoid fulfilling tax obligations will certainly harm state revenues. For this reason, government regulates a series of instruments to prevent tax avoidance practices as an effort to maintain state revenue optimization from a taxation perspective.

According to Government Regulation of the Republic of Indonesia Number 55 of 2022 (PP 55/2022), article 32, paragraph (2), there are 8 (eight) instruments to prevent tax avoidance practices. These provisions specifically apply to transactions between associated enterprise parties, either due to ownership or capital participation, control, or blood/related by marriage relations, resulting in dependence or attachment of 1 (one) party to the other party.

However, if these 8 (eight) instruments are unable to prevent tax avoidance practice, Director General of Taxes (DGT) can redefine the amount of tax that should be owed based on substance over form principle to recognizing economics.

Instruments for preventing tax avoidance practices are as follows:

1. Determine when dividends are received and ascertain the calculation basis of dividends received by domestic taxpayers for equity participation in foreign business entities other than those that sell their shares on the stock exchange;
2. Re-determine the amount of income and deductions as well as determining debt as capital to calculate taxable income amount made by DGT by applying Arm’s Length Principles (ALP);
3. Determine the party who purchases shares or company assets through other parties or a entity established for such purposes as long as there is a pricing irregularity;
4. Determine the party who will sell or transfer intermediary companies share that are established or domiciled in countries that provide tax protection;
5. Re-determine the amount of income earned by domestic individual taxpayers from employer who transfers all or portion of their income in the form of fees or other expenses paid to organizations not based in Indonesia;
6. Recalculate the tax that should be owed based on financial performance comparison with taxpayers in similar business activities (benchmarking) against taxpayers who report operating profits that are too small compared to other taxpayer’s financial performance in similar business fields or report unfair business losses despite taxpayer has made sales commercial for 5 (five) years and report fiscal loss for 3 (three) consecutive years. Benchmarking can be done by comparing certain prices or profit levels at the entity, division or transaction level;
7. Setting limits of loan fees amount that can be charged for tax calculation purposes; and/or
8. Recalculate the amount of tax that should be owed by not imposing payments made by domestic taxpayers to foreign taxpayers as expenses that reduce income resulting from the utilization of differences tax treatment of an instrument or entity that may have more than one characteristic in the country or jurisdiction where taxpayer is domiciled.

Minister Authority to Determine of When Dividends Received from Overseas

One of the instruments for preventing tax avoidance practices which is regulated in more detail in PP 55/2022 is Minister of Finance authority in determining when dividends are received and basis for calculating them for taxpayers. This provision applies to taxpayers, who independently or along with other taxpayers, have at least 50% equity participation in overseas business entities.

Determination of when dividends are received is determined at the end of fourth month after the deadline expiration for submitting Annual Tax Returns for overseas business entities for the relevant tax year. However, if the entity does not have Annual Tax Return submission regulation, or deadline for submitting Annual Tax Return is not set, deadline for receiving dividends is set at the end of the seventh month after the tax year concerned ends. This will be further regulated in a Minister of Finance Regulation.

Determination of Special Purpose Company and Conduit Company

Government can designate certain parties as special purpose companies. In simple terms, a special purpose company is a company established with a specific purpose, such as buying shares or company assets. The establishment of this company can also aim to avoid paying taxes. Due to this reason, determining which party purchases shares or company assets through other parties or entities created for such purposes, as long as there is an irregularity in pricing, is one of the tools used to avoid tax avoidance practices.

Tax avoidance by special purpose companies can take various forms, such as establishing an intermediary company or conduit company in a tax haven country or a double tax avoidance agreement partner. The conduit company itself is formed with a specific purpose, such as buying, selling, or transferring shares. In connection with efforts to prevent tax avoidance practices, the government, in this case, has the authority to determine the party that sells or transfers intermediary companies shares that are established or domiciled in countries that provide tax protection. 

Arm’s Length Principles of Associated Enterprise Transactions

Taxpayers who carry out associated enterprise transactions are required to apply ALP as stated in PP 55/2022, article 1, number 10:

ALP is a principle that applies in sound business practices that are carried out as independent transactions.

Apart from the existence of ownership/equity participation, control, or blood/related by marriage relations, PP 55/2022, article 35, paragraph (2) stipulates that associated enterprise transactions also occur when transactions are carried out between parties who do not have a special relationship but are affiliates of one or both parties determine the counterparty and the transaction price.

If taxpayer does not fulfill ALP in accordance with the applicable provisions, DGT has the authority to re-determine the amount of income and/or the deduction used as the basis for calculating taxable income. The amount of income is re-determined with the transfer price. Determination of transfer price according to ALP is carried out using several methods, namely:

1. Price comparison method between independent parties;
2. Resale price method;
3. Cost-plus method; or
4. Other methods, such as the profit sharing method, transactional net margin method, independent transaction comparison method, the method for valuing tangible assets and/or intangible assets, as well as method for valuing business.