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Managing Tax Risks on Outbound Investment

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The Indonesian tax implications of investments overseas by Indonesian tax residents (including expatriates) are not as obvious as you might think.

Unless you have just arrived in Indonesia, you are probably aware from the publicity regarding the tax amnesty program that Indonesia taxes its tax residents on a worldwide basis. That is, once you are an Indonesian tax resident then you should include in your Personal Tax Return your worldwide income, such as income from overseas rental properties, share portfolios, bank deposits and debt securities. The same applies if your company has similar investments overseas. To the extent that foreign tax was assessed and paid on these (e.g. as withholding tax) then, in principle, an income tax credit can be claimed in Indonesia. I write “in principle” because the rules for claiming the tax credits might prevent the full credit being received.

What is less well known is that Indonesia has rules regarding Controlled Foreign Corporations (CFC) that require tax residents to report income on an accrual basis if they invest in overseas non-public companies where, separately or together with other tax residents, they hold at least 50% of the share capital. Until recently the tax resident investors were required to report in their tax return their share of the after-tax profit of that company, as though a dividend had been declared and paid equal to the entire after-tax profit. An adjustment would then be made to the extent that a dividend was eventually declared and paid.

These rules applied whether the equity investment was into a company undertaking active business activities, such as manufacturing, or only passive activities (e.g. holding a property portfolio) and, commencing 2009, equally applied to investments in companies in tax havens compared to higher-taxing jurisdictions.

The issuance of 107/PMK.03/2017 on 26 July 2017 includes indirect equity investments in the definition of CFC if the shareholding in an indirect entity is at least 50%. Therefore, if you held 50% of a Malaysian company that owned 50% of a Singapore company then you should report a deemed dividend equal to 50% of the after-tax profit of the Malaysian company and 25% (50% x 50%) of the after-tax profit of the Singapore company.

Unfortunately, the regulation is silent on important issues, such as how to treat prior year losses which may occur when setting up an overseas business, and whether it is possible to consider losses incurred in an overseas group holding company that has invested into profitable subsidiaries. The absence of provisions regarding losses creates a corporate tax result that would not occur if the business had been established in Indonesia.

Potentially the operation of the deemed dividend rules creates a higher tax burden compared to where a tax resident individual owns shares in an Indonesian company or an Indonesian company owns at least 25% of another Indonesian company. This begs the question as to whether the deemed dividend rules discourage investment overseas even though the Government has indicated that it wants Indonesian companies to become international players so they can leverage their Indonesian products, access new markets and know-how.

We can only hope that the eventual amendment of the Income Tax Law will see a revised CFC regulation that is more consistent with other jurisdictions and does not penalize out-bound investment. In the meantime, tax residents should consider whether any existing equity investments overseas are being properly reported and what steps can be taken to mitigate the implications of the CFC rules for future investments overseas.

KEY POINTS

  • Indonesia has Controlled Foreign Corporation rules.
  • The CFC threshold is a shareholding by Indonesian tax resident(s) of 50% in    an overseas non-public listed company.
  • The CFC rules do not exclude active businesses or non-tax haven jurisdictions.

 

This article has been published at The Jakarta Post, 28 August 2017