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Jakarta, Ideatax -- In the previous article, we have discussed a lot about the basic principles of international taxation, one of which is the domicile principle and the source principle. The domicile principle implies that income tax is imposed in the country of domicile on income derived from domestic as well as income derived from abroad (world-wide income). Meanwhile, the source principle implies that income tax is imposed in the place where the source of income is located.
The different taxation principles adopted have the potential to cause double taxation. The effect of double taxation is greatly affected by multi-national companies that establish several controlled companies in different countries (Controlled Foreign Enterprise). Therefore, through this article, we will specifically discuss the Controlled Foreign Enterprise (CFC) rules in Indonesia so that taxpayers can avoid any actions that can be categorized as tax avoidance related to CFC ownership.
In general, OECD (2023) defines a CFC as a foreign enterprise that is directly or indirectly controlled by a domestic taxpayer. Another definition mentions that a CFC is a business entity registered and operating in a different jurisdiction from the entity that controls it (Chen, 2022). Tax authorities may apply different criteria to determine the nature of control. However, OECD (2023) itself claims that CFC rules are derived from BEPS action 3 report on Controlled Foreign Enterprise.
In Indonesia, the CFC rules are clearly regulated in the Income Tax Law and its derivative rules. Article 18 paragraph (2) of the Income Tax Law, among others, regulates that:
The Minister of Finance is authorized to regulate when dividends are earned by a domestic taxpayer on equity participation in an overseas business entity other than a business entity that sells its shares on the stock exchange, with the following regulations:
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The amount of capital participation of the domestic taxpayer is at least 50% (fifty percent) of the total paid-up shares; or
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Together with other domestic taxpayers has equity participation of at least 50% (fifty percent) of the total paid-up shares.
In its explanation, it is stated that this regulation is necessary to avoid tax avoidance from domestic taxpayers who invest their shares abroad. Therefore, a regulation is needed regarding the time when a dividend is payable.
For example, PT ABC and PT DEF together invest 30% of their shares in XYZ Ltd. XYZ Ltd shares are not traded on the stock exchange and in 2018 XYZ Ltd earned a profit of 10 billion rupiah. For this condition, the government can determine when the dividend is obtained and the basis for its calculation.
The provisions on CFC rules are further regulated in Minister of Finance Regulation Number 256/PMK.03/2008 on the Stipulation of the Time of Dividend Acquisition by Domestic Taxpayers on Capital Investment in Foreign Business Entities Other than Business Entities Selling Their Shares on the Stock Exchange as amended lastly by PMK 107/PMK.03/2017 and 93/PMK.03/2019.
Through these stipulations, the government regulates that a domestic taxpayer is considered to have direct control over a foreign business entity if it meets two criteria: First, having direct capital participation of at least 50% (fifty percent) of the total paid-up shares in non-stock exchange foreign enterprise; or second, together with other domestic taxpayers having direct capital participation of at least 50% (fifty percent) of the total paid-up shares in non-stock exchange foreign enterprise in which the percentage is determined at the end of the year.
The taxpayers designated as having direct control as mentioned above are deemed to obtain deemed dividend on capital investment in non-stock exchange foreign enterprise. Deemed dividend is a dividend that is determined to be obtained by a domestic taxpayer on equity participation in a directly controlled non-stock exchange foreign enterprise.
There are five types of deemed dividend regulated in PMK 93 of 2019, including certain income received by the foreign company that is not the controlling shareholder on the exchange of:
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Dividends, except dividends that are received and/or earned from controlled non-stock exchange foreign enterprise;
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Interest, except for interest that is received and/or earned by a controlled non-stock exchange foreign enterprise owned by a domestic taxpayer with a bank business license;
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Rent in the form of: (1) rent that is received and/or obtained by a controlled non-stock exchange foreign enterprise in connection with the use of land and/or building; and (2) rent other than rent as referred to in point 1) that is received and/or obtained by a controlled non-stock exchange foreign enterprise derived from transactions with parties that have a special relationship with the controlled non-stock exchange foreign enterprise;
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Royalties; and
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Gains due to sale or transfer of assets.
Based on the above description, it can be understood that if an overseas subsidiary, in this case a non-exchange foreign business entity with direct or indirect control, obtains income from royalties or profits from the sale of transferred assets, then the income is considered as deemed dividend to the parent entity which is a domestic taxpayer even though the overseas subsidiary does not explicitly state that the income is a dividend.
Payable Time
PMK 107/2017 in conjunction with PMK 93/2019 regulates that deemed dividend is deemed to be earned at the end of the fourth month after the expiration of the deadline for filing the Annual Tax Return for directly controlled non-stock exchange foreign enterprise. For instance, if in country X a directly controlled non-stock exchange foreign enterprise has an obligation to submit its Annual Tax Return by the end of April, the deemed dividend is deemed to be earned at the end of September or the end of the fourth month after April.
However, PMK 107/2017 in conjunction with PMK 93/2019 also regulates that in the event that a directly controlled foreign enterprise does not have an obligation to file an annual tax return in its home country, the deemed dividend is deemed to be earned in the seventh month after the end of the relevant tax year.
Calculation Method
Deemed dividend is calculated by multiplying the percentage of ownership of a Resident Taxpayer in a non-exchange foreign enterprise that has direct control with the dividend imposition base in the form of net amount of certain income from the foreign enterprise.
In the event that a taxpayer has direct and indirect control over a non-exchange foreign enterprise, two provisions apply: first, for a non-exchange foreign enterprise with direct control, the tax imposition base on the deemed dividend is the net amount after tax of certain income of the foreign enterprise. Second, for a foreign enterprise with indirect control, the tax base is calculated by multiplying the percentage of participation of the directly controlled foreign enterprise in the indirect foreign enterprise by the net after-tax amount of certain income of a foreign enterprise.
It should be noted that an indirectly controlled non-stock exchange foreign enterprise is controlled by a domestic taxpayer through a directly controlled non-stock exchange foreign enterprise with an equity investment of 50% or more.
For example, PT ABC owns XYZ Ltd which is located in country X with 65% ownership. The shares of XYZ Ltd are not traded on the stock exchange and in the 2019 tax year, XYZ Ltd earned certain income of USD 100,000; expenses related to certain income of USD 30,000 and income tax of USD 5,000. The prevailing exchange rate on September 30 was Rp 14.500/USD.
Based on the example above, the amount of deemed dividend is 65% *(USD 100,000 - 30,000 - 5,000) = USD 42,250. Because the prevailing exchange rate at that time was IDR 14.500, PT ABC must recognize a deemed dividend of IDR 612.625.000 in the 2019 Annual Tax Return.
This is a brief explanation of the CFC rules in Indonesia. In the next article, we will discuss other international taxation schemes along with their examples and applications.
Related Regulations
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Law No. 7 of 1983 concerning Income Tax as last amended by Law No. 7 of 2021 concerning Harmonization of Tax Regulations
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Regulation of the Minister of Finance Number 256/PMK.03/2008 concerning Determination of the Time of Dividend Acquisition by Domestic Taxpayers on Capital Participation in Foreign Business Entities Other than Business Entities Selling Shares on the Stock Exchange as amended lastly by PMK 107/PMK.03/2017 and PMK 93/PMK.03/2019
References
Chen, J. (2022, July 18). Controlled Foreign Corporation (CFC): Definition and Taxes. Retrieved from Investopedia: https://www.investopedia.com/terms/c/cfc.asp
OECD. (2023, August 29). About the Dataset Controlled Foreign Enterprise (CFC) Rules. Retrieved from OECD: https://qdd.oecd.org/subject.aspx?Subject=CFC
