The world is being hit by a new type of Corona virus pandemic, Covid-19. In Indonesia, various policies to mitigate the spread of the virus are pursued by all parties, including the government, corporations, down to families. What is the taxation implication of corporate social responsibility?
The government has chosen the Large-Scale Social Restrictions (Pembatasan Sosial Berskala Besar/PSBB) option to prevent the spread of Covid-19, which until Monday 6 April 2020 recorded 2,491 positive cases of Covid-19, with 192 patients recovering and 209 patients died. In its implementation, the government began to restrict access to human traffic to and from an area, poured out economic stimulus, urged people to keep their distance from each other to prohibit events that involve many people (social and physical distancing).
At the corporate level, one of the simple social concerns that some companies do is to share free sanitation and medical items, such as masks, hand sanitizers, and disinfectants, both to employees and the surrounding community around the working environment.
While the Covid-19 pandemic is not my competence, I will focus on the tax implications of the examples of corporate social responsibility instead. In this case, the Value Added Tax (VAT) of Free Gift categorized as Taxable Goods or Services (Barang Kena Pajak/BKP) by companies as VAT-Registered Persons (Pengusaha Kena Pajak/PKP).
As regulated in VAT Law, included in the VAT objects are Taxable Goods or Services for personal use and/or as a free gift. For the personal use and free gift, each is subject to a VAT of 10% of the selling price or replacement value after deducting the gross profit. This provision is further governed by Government Regulation Number 1 Year 2012.
"Personal use" is defined as the use of Taxable Goods or Services for the benefit of entrepreneurs, managers, or employees, both in the form of self-produced goods and those that are not. The VAT is exempted from the use of Taxable Goods or Services for productive purposes or those related to the production, distribution, marketing, and management activities of a company. This means that the VAT is only imposed on the consumptive "personal use" of Taxable Goods or Services or the use of Taxable Goods or Services with no relation to the company's business activities.
Meanwhile, the "free gift" is gift given without payment, either the self-produced goods or those that are not. In fact, providing samples of goods for promotion to a relation or buyer is also included in the free gift VAT calculation. The latter is going to be the topic of our further discussion.
The Essence of Value Added
Before we start, perhaps we should reinterpret the philosophy of "value-added" as the base of VAT imposition. Alan A. Tait in his legendary book “Value Added Tax: International Practice and Problems (1988; 4)” states that the value-added gets its name from the value added by manufacturers to raw materials or their purchases (other than labor) before selling the products or services. In other words, value-added can be seen from the additive side (the difference between costs and wages plus profits) or from the subtractive side (output minus input).
Adam Smith in Rosdiana and Tarigan (Perpajakan : Teori dan Aplikasi, 2005: 215) defines VAT as the difference between sales and purchases made by a company within a particular accounting period.
In this case, going with the general assumption, I would define value-added as the difference between the price of the product or service produced (output) and the costs used up during the production process of the goods and services (input). In the VAT mechanism adopted in Indonesia, the output can be treated the same as an output tax, while the input as a deduction can be assumed as an input tax which is the tax credit (deduction) of the output tax. Thus, the essence of VAT is the output tax minus input tax.
If we take a closer look to the case above, the sanitary and medical equipment shared freely are neither output nor end product/service sold by the company—except for pharmaceutical companies. Assuming that the transaction is made with an independent party, there is no value-added obtained by the taxpayer from distributing free items. Instead, it would be an additional cost for the company as they must buy external products.
Similar to sharing sample products for free to potential customers or providing supplements/merchandises such as calendars, umbrellas, hats, or other promotional items in the context of product marketing by companies. In marketing strategies, sharing promotional items for free is common for every company to popularize the brand, which is expected to positively impact the sales target.
The question is then, are the medical equipment and promotional items/merchandise shared for free by companies are included in the category of output? This issue becomes relevant to be discussed considering that not all products freely distributed are included in the category of output produced and sold by companies.
In the context of providing product samples, even if they meet the output category, the cost of procurement of supplements or promotional items is actually taken into account when setting the selling price of the main product (output). It means that, despite the value-added in the free gift of the supplement or the promotion, the real VAT has been borne by customers based on the price of the main product or service sales package.
The next question is whether the supplement or promotion items provided are free in the output category? the answer is absolutely no. Then, why does the company still have to bear more VAT on the free gift of supplements or promotional items? Thus, the imposition of VAT on free gift has precisely come out of the theory of Value Added Tax. In addition, this problem is exactly counter-productive with Indonesia's spirit of improving business ease ranking and creating a friendly investment climate.
The Momentum of Omnibus Law
In the context of taxing the price assessment regarding the free gift of Taxable Goods or Services, especially for transactions with the parties under the company’s control (employees, shareholders, or affiliated companies), the tax has been regulated in Article 2 of the VAT Law, emphasizing on the value of a reasonable market price (arm's length). Thus, affiliate transactions using an arm’s length price—even if the free items are the main products or services sold (output), should not be subject to VAT under the proposition of free gift. This affirmation is important so that the application of VAT on the free gift (Article 1 letter d of VAT Law) does not conflict with the terms of transfer pricing (Article 2 of VAT Law).
It is time for all parties to sit together and straighten up the value-added principle, especially regarding the application of VAT on free gifts. Moreover, the government and the parliament are spurring a discussion of amendments to some taxation provisions using the Omnibus Law scheme. At the very least, the Covid-19 outbreak - which forced all parties to keep their distance - gave the government and the parliament time to breathe for a moment and re-observe the points of the amendment to the Tax Law in the pause of social distancing. We surely do not want the revision of the policies that are imposed hurriedly leaves crucial "homework" in the field of taxation.
*This article has been published on Investor Daily, Tuesday, April 7th, 2020