Testing Indonesia's Readiness to Adopt 2 Pillars of Global Tax Architecture

Zulhanief Matsani, Monday, 25 October 2021

Testing Indonesia's Readiness to Adopt 2 Pillars of Global Tax Architecture

Testing Indonesia's Readiness to Adopt 2 Pillars of Global Tax Architecture

To dampen Base Erosion and Profit Shifting (BEPS) actions as many as 134 countries support international tax reform. Especially related to the implementation of the two pillar solution in facing the challenges and dynamics of the digital economy starting in 2023.

The global consensus initiated by the 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 global agreement in Pillar One. First, the taxation rights for the jurisdiction or source country or marketing location.
In this case, every multinational company that has a global revenue of more than 20 billion euros must reallocate more than 25% of its profits to be distributed to the jurisdiction where its customers or service users are located.

Second, increasing 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 and other relevant taxes.

Fourth, the simplification of the rules of application of the arm's length principle in certain circumstances, especially focusing on low-capacity countries.

Pillar 2: Global Minimum Tax

Then in Pillar 2, there are some key points that the G20 and OECD countries have agreed to.

First, issuing the Global Anti-Base Erosion (GloBE) regulation which requires the application of corporate income tax (PPh) with a minimum rate of 15%. The minimum tax targets all multinational companies with a revenue of more than 750 million Euros a year.

Second, it requires all jurisdictions—where the corporate income tax rate on interest, royalties, and other payments is less than 9%—to comply with tax rule (Subject to Tax Rule). This compliance must be outlined in bilateral agreements with developing countries that are members of the Inclusive Framework so as not to be abused.

Third, accommodate tax incentives only for substantial business activities.

Indonesia's response

This global consensus is a success of multilateral diplomacy in overcoming the practice of BEPS and an unfair race to the bottom.

Indonesia is one of the 134 supporting countries that are certainly affected by this global tax reform. Moreover, Indonesia is one of the largest goods and services markets in the world that gets the allocation of taxing right on the investment of the income of multinational companies.

The question is, how does Indonesia adapt to the international tax architecture and its implications for domestic regulations?

Regarding pillar 1, Indonesia's main focus is to address the digital tax consensus globally.
In the VAT aspect, to create an equal level of playing field between domestic and foreign businesses, the tax targets the delivery of intangible taxable service and taxable goods through trade through electronic systems (PMSE) such as streaming music and films, online advertising, and online marketplaces.

Indonesia's digital VAT policy is not in breach of international consensus. This is because the collection of VAT only targets goods and services that are consumed domestically regardless of where the goods and/or services come from (destination principle). This policy also provides equality for providers of intangible taxable goods or domestic taxable services who are previously subject to VAT.

Meanwhile, from the income tax aspect, Indonesia is committed to imposing taxes on electronic transactions in accordance to the level of the playing field. 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 if consensus and technical guidance on implementation is available, Indonesia will follow a multilateralism approach. Technically, Indonesia will adopt the best practices resulting from the global consensus.

But if consensus cannot be reached, a unilateral approach would be an alternative scenario. That is, Indonesia will impose an electronic transaction tax (PTE) unilaterally using domestic regulations that have been prepared.

In fact, the OECD still makes room for any tax authority to enact unilateral policies. For example, 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 digital service tax (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 being based on physical presence.

Related to pillar 2, the discussion focused on reducing the Indonesian corporate income tax 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 also begun to revise the Double Taxation Avoidance Agreement (P3B) for the implementation of the Multilateral Instrument on Tax Treaty (MLI). Among other things, by initiating a principal purpose test, the latest principle that will be included in the tax treaty of Indonesia and the UAE and is planned to be applied to tax treaty 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 and applied and documented with the identification data of multinational companies which will 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 the process of resolving tax disputes in international arbitration that is easy and efficient, 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. However, 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 remain focused on the substance of value creation.

In general, the implementation of global consensus requires commitment from each member country, with a strict implementation time limit according to the schedule that has been prepared. Indonesia seems prepared to adapt and implement it.

On 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 VAT according to the principle of destinations that do not violate international agreements. For the income tax aspect, as an anticipation of the international consensus is failure to achieve, Indonesia has prepared regulations related to Electronic Transaction Tax 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%. Even in the Harmonized Tax Law (HPP Law), Indonesia canceled 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 the field.


*The article was published in Kumparan, on 25 October 2021



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