To curb Base Erosion and Profit Shifting (BEPS) actions, as many as 134 countries support international tax reform. The reform is especially related to the implementation of a two-pillar solution in facing the challenges and dynamics of the digital economy starting in 2023.
The global consensus initiated by the Organisation for Economic Co-operation and Development (OECD) and the G20 is contained in a report entitled Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalization of the Economy, published in October 2021.
Pillar 1: Taxing Rights
There are four points of a global agreement in Pillar 1.
First, the taxation rights for the source jurisdiction or country, or the marketing location. In this case, every multinational company that has a global revenue of more than €20 billion must reallocate more than 25% of its profits to be distributed to the jurisdiction where its customers or service users are located.
Second, the increase of tax certainty through mandatory and binding dispute resolution with an elective regime to accommodate low-capacity countries.
Third, the abolition and termination of Digital Services Taxes (DST) and other relevant taxes.
Fourth, the simplification of the rules for applying the arm's length principle in certain circumstances, especially focusing on low-capacity countries.
Pillar 2: Global Minimum Tax
In Pillar 2, some key points were agreed upon by G20 and OECD countries.
First, issuing the Global Anti-Base Erosion (GloBE) regulation which requires the application of corporate income tax (CIT) with a minimum rate of 15%. The minimum tax targets all multinational companies with a revenue of more than €750 million a year.
Second, requiring all jurisdictions—where the CIT rate on interest, royalties, and other payments is less than 9%—to be subject to tax rule. To avoid any misuse, the compliance must be outlined in bilateral agreements with developing countries that are the members of the Inclusive Framework.
Third, accommodating tax incentives only for substantial business activities.
The global consensus appears as a success of multilateral diplomacy in overcoming the practice of BEPS and an unfair tax rate war (race to the bottom).
As one of the 134 countries, Indonesia is certainly affected by global tax reform. All the more, Indonesia is one of the largest markets for goods and services in the world, with the right of tax allocation on the income of multinational companies.
The question is, how will Indonesia adapt the international tax architecture, and what are the implications for domestic regulations?
Regarding Pillar 1, Indonesia's main focus is to address the digital tax consensus globally.
In the Value Added Tax (VAT) aspect, to create an equal level of playing field between domestic and foreign businesses, the tax targets the delivery of intangible taxable services and goods via trade through electronic systems (perdagangan melalui sistem elektronik/PMSE) such as music and films streaming, online advertising, and online marketplaces.
Indonesia's digital VAT policy does not breach the international consensus. After all, the collection of VAT only targets goods and services consumed domestically regardless of where the goods and/or services come from (destination principle). This policy also provides equality for providers of domestic intangible taxable goods or services as they are subject to VAT earlier.
From the income tax aspect, Indonesia is committed to imposing taxes on electronic transactions in accordance with the level of playing field principle. However, its implementation still has to wait for the global consensus schedule (2023).
At least, the Government of Indonesia has prepared two scenarios of taxation on the income of global digital companies to be delivered at the G20 Presidential Meeting in 2022.
The first scenario is that once the consensus is reached and the technical guidance on the implementation is available, Indonesia will follow a multilateralism approach. Technically, Indonesia will adopt the best practices resulting from the global consensus.
If otherwise occurred, however, a unilateral approach would be an alternative scenario. Under this scenario, Indonesia will unilaterally impose an electronic transaction tax (pajak transaksi elektronik/PTE) using domestic regulations that have been prepared.
The OECD still makes room for any tax authority to enact unilateral policies, indeed. For example, policies based on the principle of significant economic presence imposed by Indonesia and Israel, equalization levy in India, diverted profit tax in the UK and Australia, and DST in the European Union (EU), Canada, Mexico, Brazil, and Turkey.
In its development, the OECD finally issued a proposal for a unified approach—with the hope that a global consensus could be reached as soon as possible—to give new taxing authorities and rights to market countries without relying on physical presence.
Related to Pillar 2, the discussion focused on reducing the Indonesian CIT rate from 25% to 22%. The rate position is quite competitive and still above the globally agreed minimum rate limit (15%).
Similarly with the Subject to Tax Rule, Indonesia is not in a position to apply a rate below the consensus. In fact, Indonesia has started to revise the Tax Treaty (Perjanjian Penghindaran Pajak Berganda/P3B) for the implementation of the Multilateral Instrument on Tax Treaty (MLI). Among other things, the revision starts by initiating a principal purpose test, the latest principle that will be included in the tax treaty of Indonesia and the United Arab Emirates (UAE) and is planned to be applied to tax treaties with other countries.
Lastly, for the implementation of Pillars 1 and 2 to work well, there are at least three recommendations that must be considered (N. Altenburg & K. Schlucke, 2021).
First, the regulations related to sourcing rules must be clear, as well as applied and documented with the identification data of multinational companies to be taxed.
Second, the risk of double taxation must be reduced to a minimum with clear and easy-to-implement rules for taxpayers and tax authorities. For example, rules regarding withholding taxes and calculating income on counterparties on the same type of income.
Third, to create legal certainty, a clear commitment from participating countries is needed regarding an easy and efficient process of resolving tax disputes in international arbitration, including a commitment period for settlement.
Then, the G20/OECD stated that value creation replaces physical presence as a proxy for economic links for each jurisdiction to be able to impose taxes. The issue, however, is how to ensure that the principle of income inclusion rules does not hinder the sovereignty of each country in providing incentives to attract investment and staying focused on the substance of value creation.
In general, the implementation of global consensus requires commitment from each country member, with a strict implementation time limit according to the schedule that has been prepared. For this, Indonesia seems ready to adapt and implement it.
Regarding Pillar 1, Indonesia has adopted the application of a digital tax that will follow the global consensus. On the other hand, Indonesia has also imposed a VAT according to the destination principle that does not violate international agreements. For the income tax aspect, as anticipation that the international consensus cannot be achieved, Indonesia has prepared regulations related to PTE since 2020.
Regarding Pillar 2, Indonesia has adapted by lowering the income tax rate to 22% or still above the global minimum standard of 15%. More so, in the Harmonized Tax Law (HPP Law), Indonesia will cancel the planned reduction of the second phase of Income tax rates to 20% starting in 2022.
We just have to wait and see how the implementation will look like in reality.
*The article was published in Kumparan, on 25 October 2021