Introduction to the Debt-to-Equity Ratio

Financial ratios and indicators have long been used to assess company performance, ranging from the current ratio, turnover ratio, return on assets, return on investment, and so on. There are several benefits obtained from calculating these ratios and indicators, including assessing company performance, assessing the company's ability to pay debts, comparing company performance with competitors as an evaluation material in decision-making, and predicting the company's financial performance in the future.

Among the many financial indicators, one of the most necessary ratios and indicators is the solvency ratio. These ratios calculate the company's ability to meet long-term obligations. This ratio is essential for creditors to assess the company's creditworthiness. In addition, this ratio is also beneficial for the company's long-term risk assessment.

There are two main ratios in the solvency ratio: the debt-to-asset ratio and the debt-to-equity ratio. The debt-to-asset ratio is a ratio that compares total debt to the assets owned by the company. This ratio calculates the value of assets financed by creditors. The higher the debt-to-asset ratio value, the more it indicates that the company is increasingly dependent on debt to carry out its business activities.

The second solvency ratio is the debt-to-equity ratio. The debt-to-equity ratio is a ratio that compares the debt to the total capital of the company. This ratio is essential for investors and creditors in assessing and predicting future company performance. The higher the debt-to-equity ratio value, the more it indicates that the proportion of debt is more dominant than capital in running the company's operations.

According to the Corporate Finance Institute, there are advantages and disadvantages to a high debt-to-equity ratio. A high DER value indicates that the company can easily pay off its debt obligations (through cash flow) and use leverage to increase returns on equity. In addition, a high DER can lower the cost of debt compared to the cost of equity. Thus, in some cases, an increase in DER can lower the weighted average capital cost.

However, behind the advantages of a high DER value, there are also disadvantages. The Corporate Finance Institute (2024) states that an increase in DER will also increase the corporate default risk. In addition, the high cost of DER will lead to excessively high interest and capital costs.

In the realm of taxation, high-interest costs have the potential to reduce net profit, which in turn reduces the amount of tax paid. Therefore, the government specifically regulates DER in the Minister of Finance Regulation Number 169/PMK.010/2015 concerning the Determination of the Ratio between Debt and Capital to Calculate Income Tax.

In this provision, among others, it is stipulated that to calculate income tax, the government determines the ratio between debt and capital for corporate taxpayers established and residing in Indonesia whose capital is divided into shares.

Following these provisions, DER is calculated by dividing the average balance of debt by the average balance of capital in a tax year. The average balance of debt includes the balance of long-term debt and the balance of short-term debt, including the balance of interest-bearing trade payables. While the balance of capital includes equity as referred to in the applicable financial accounting standards and interest-free loans from related parties.

PMK 169 of 2015 stipulates that the amount of DER is set at a maximum of four to one (4:1). This means that if the ratio of debt to capital is more than five to one, the excess interest expense cannot be charged in the calculation of Corporate Income Tax.

For example, in one tax year, PT ABC has the following data: average debt of Rp 6,000,000,000, average capital of Rp 1,000,000,000, and interest expense of Rp 60,000,000. Based on this information, the ratio between debt and capital of PT ABC is 6:1.

Because the ratio of debt to capital of PT ABC is greater than allowed in PMK 169 of 2015, PT ABC must recalculate the interest expense charged in the Annual Tax Return as follows:
Interest expense charged = 4/6 * Rp60,000,000 = Rp40,000,000
Thus, in the Annual Tax Return, PT ABC charges an interest expense of Rp40,000,000.

 

Keep in mind that there are taxpayers who are exempt from the application of the debt-to-equity ratio provisions. Some taxpayers who are exempted from the imposition of the DER provisions include:

• Bank taxpayers;
• Taxpayers of financing institutions;
• Insurance and reinsurance taxpayers;
• Taxpayers conducting business in the fields of oil and gas mining, general mining, and other mining that are bound by production sharing contracts, work contracts, or mining cooperation agreements, and the contracts or agreements regulate or include provisions regarding the limitation of the ratio between debt and capital; and
• Taxpayers whose entire income is subject to final income tax based on separate laws and regulations; and
• Taxpayers who run businesses in the infrastructure sector.

Thus, in the discussion about the debt-to-equity ratio, in case you need further assistance, Ideatax is always ready to help.