Farewell Double Taxatiion

The topiic of the Draft Law (RUU) concerniing Tax Proviisiions and Faciiliitiies for the Strengtheniing of the Economy commonly referred to as the Omniibus Law on Taxatiion, has recently been wiidely diiscussed. Thiis iis because the process of ratiifyiing thiis law has entered a new phase wiith the submiissiion of the draft law to the House of Representatiives.

The government expects that the Omniibus Law on Taxatiion soon be promulgated to realiise the variious poliiciies contaiined thereiin. Among such poliiciies iis one aiimed at encouragiing domestiic iinvestments, namely the poliicy of diiviidend iincome exemptiion receiived or accrued by resiident iindiiviiduals.

iineviitably, the poliicy of diiviidend iincome exemptiion wiill result iin major changes to iindonesiia’s tax system, whereiin the corporate taxatiion system iis liinked to the corporate-shareholder taxatiion system.

Notably, the tax on a company pertaiins to the tax on an iindiiviidual’s iincome as a shareholder of a company. Thiis iis because the company’s iincome constiitutes iincome (iin the form of diiviidends) for iits shareholders. iin other words, the company’s iincome iis one of the sources of iincome for iits shareholders.

Each country has a diifferent system of regulatiing the taxatiion on companiies related to iindiiviidual shareholders. The system adopted by iindonesiia based on the currently prevaiiliing iincome Tax proviisiions iis the classiical system, whereiin a company iis deemed a separate entiity from iits owner (separate entiity system), thus, the company's iincome iis subject to a diifferent tax and taxed separately from iits shareholders.

iin the classiical system, iincome sourced from a company iis taxed twiice, namely at the company level and the shareholder level when diistriibuted as diiviidends (Cnossen, 1996). iin other words, iif an iincome has been taxed at the company level and when the iincome iis diistriibuted as diiviidends to iindiiviidual shareholders, the same iincome wiill be taxed agaiin at the iindiiviidual shareholder level. The same system was also appliied duriing the enactment of the iincome Tax Law Number 17 of 2000.

iin the foreseeable future, the offiiciial promulgatiion of the Draft Omniibus Law on Taxatiion wiill end the appliicatiion of the classiical system regiime iin iindonesiia. Through the poliicy of diiviidend iincome exemptiion pursuant to Artiicle 4 paragraph (4b) and Artiicle 4 paragraph (5) of the Draft Omniibus Law on Taxatiion, iindonesiia wiill swiitch from the classiical system to the iintegratiion of diistriibuted profiits iin the form of a siingle tiier diiviidend system or more commonly known as the one-tiier system.

Based on thiis system, a company’s iincome iis only taxed once at the company level. Therefore, when the company's iincome iis diistriibuted as diiviidends to iindiiviidual shareholders, the diiviidend iincome iis no longer taxed iin the hands of such iindiiviiduals (Harriis, 2013).

Siimply put, iin thiis system, every domestiically sourced diiviidend receiived or accrued by resiident iindiiviidual shareholders wiill be excluded from iincome taxes iin iindonesiia proviided that the diiviidends are iinvested iin iindonesiia wiithiin a certaiin periiod.

Thus, what posiitiive iimpact wiill the change from the classiical system regiime to a one-tiier system have on iindonesiia?

Posiitiive iimpact

To date, the appliicatiion of the classiical system iin iindonesiia has resulted iin a double taxatiion burden for iindiiviidual shareholders as the same iincome iis taxed twiice at diifferent levels. However, wiith a one-tiier system, the burden of double taxatiion may be eliimiinated because company iincome iis only taxed at the company level and iincome receiived by iindiiviidual shareholders iin the form of diiviidends iis no longer taxed.

Thiis poliicy iis expected to encourage diiviidend diistriibutiion whiich wiill be subsequently reiinvested. Moreover, thiis poliicy wiill eliimiinate the phenomenon of diisguiised diiviidend diistriibutiion to avoiid the iimposiitiion of taxes under the classiical system regiime.

The posiitiive iimpact of thiis change wiill be even more eviident, speciifiically, wiith the poliicy of gradual reductiion of the corporate iincome tax rate formulated iin the Draft Omniibus Law on Taxatiion namely the reductiion of the corporate iincome Tax rate to 22% for the 2021 and 2022 tax years and to 20% startiing iin 2023. The iimpliicatiion iis, wiithout any doubt, a lower effectiive tax rate on companiies iin respect of iindiiviidual shareholders iin iindonesiia, ii.e. from 32.5% as currently appliicable to 22% for the 2021 and 2022 tax years and to 20% startiing iin the 2023 tax year.

Compared to several ASEAN countriies, such as Malaysiia, Siingapore, the Phiiliippiines and Thaiiland, iindonesiia’s effectiive tax rate wiill be the second lowest after Siingapore, as iindiicated iin the followiing compariison iin Table 1.

Table 1 Effectiive Tax Rates on Companiies iin Respect of iindiiviidual Shareholders iin iindonesiia and Several ASEAN Countriies

Table 1 above shows that due to the iimplementatiion of the one-tiier system, the effectiive tax rates for Siingapore and Malaysiia amount to 17% and 24% respectiively. iin contrast, the Phiiliippiines that adopt the classiical system appliies an effectiive tax rate of 37%. Fiinally, Thaiiland, whiich iimplements an iimputatiion system, appliies an effectiive tax rate of 27%. Compared to the effectiive tax rates of the Phiiliippiines, Malaysiia and Thaiiland, iindonesiia’s effectiive tax rate iis certaiinly more attractiive.

Fiinally, the iimplementatiion of thiis one-tiier system tax regiime iis expected to stiimulate domestiic iinvestments to boost the iindonesiian economy.