OMNIBUS LAW ON TAXATION: WINNING OR Key Points: LOSING?

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English Version24Policy BriefAugust 2020OMNIBUS LAW ON TAXATION:Key Points: The reduction in theCorporate Income Taxrates (PPh Badan) can bemisused by large domesticcorporations to avoid taxesthrough round tripping or“local capital” being rolledback. The elimination of Income Tax(PPh) on overseas dividendsdoes not always guaranteerepatriation or return offunds parked abroad tothe country. The risk oftax avoidance will remainhigh despite the removalof foreign dividend incometax. Providing discretivesanctions relief underminesthe integrity of tax lawand distracts the authorityfrom the goal of increasingtaxpayer compliance. Positioning tax incentivepolicies as an attractionfor foreign investment,especially without adequatetransparency and evaluation,can potentially lead to a lossof tax revenue that shouldhave been received (revenueforgone). Tax incentivesare not investors’ mainconsideration in placing theirinvestment in a country.WINNING ORLOSING?Source: FreepikIntroductionThe government has submitted the Omnibus Law onTaxation to the House of Representatives (DPR) fordiscussion and ratification. The public’s attentionhas not been as alert, as compared to the laborprovisions within the Law, although the Law onTaxation will have a direct impact on communitywelfare. At the time of writing this Policy Brief, thediscussions on the Omnibus Law on Taxation in theDPR were still unclear, whether it would continueor not.The government argues that tax relaxation throughthe Omnibus Law on Taxation is needed to attractforeign investment in Indonesia. However, based onvarious examples of literature, the biggest obstacleto investment in the country is not tax relaxation,but legal uncertainty, inefficient bureaucracy, andcorruption.1 According to data from the WorldBank, which routinely measures the level of easeof doing business in world countries, Indonesia’sindex in 2020 is a rank of 73 out of 190 countriesand it has not changed since the previous year. Thecountry’s rank is still far below other SoutheastAsian countries such as Singapore (2), Malaysia (12),Thailand (21), Brunei Darussalam (66), and Vietnam(70).2This Policy Brief tries to analyze critically three mainissues in the Omnibus Law on Taxation, namely: (1)a reduction in the Corporate Income Tax rates (PPhBadan), (2) elimination of the tax on dividends, and(3) placement of tax incentives in one statute.Reduction in Corporate Tax Income Rate(PPh Badan)The Academic Paper of the Omnibus Law onTaxation outlines the main reason for the reductionin PPh Badan, namely to increase competitivenessto attract investment from abroad. This assessmentfrom the government seems to refer to “the globalrace to the bottom” trend and the report fromthe Organization for Economic Cooperation andDevelopment (OECD), in which the average rate ofPPh Badan globally is 21.4% and in the SoutheastAsia region 22.3%. The government has assessedthe current tariff as too high and not supportive ofdomestic businesses.Although the government acknowledges that taxrate competition can have negative consequencesincluding the risk of the potential loss of taxrevenues, it hopes that the reduction in PPhBadan can contribute to the growth of economicactivity and have a positive impact on increasinginvestment. To achieve this, the government willreportedly complement the policy with a variety ofapproaches, namely:1.The reduction in PPh Badan will be accompaniedby improvements in other factors that supportthe investment climate;2.To anticipate a decline in tax revenue in thenear future and overall, the government willtake measures to improve taxpayer complianceand increase the tax base; and3.The rate reduction may reduce the taxpayer’sintentions to avoid taxes.On the other hand, in the context of a developingcountry like Indonesia, there is a fact that investmentthat is claimed to be “foreign investment” is actuallydomestic capital that is “round-tripped”. After firstbeing sent to tax havens, it is then taken back toIndonesia packaged as “foreign investment” toobtain tax breaks.3 Looking at the list of the top 20countries that channel funds as foreign investmentto Indonesia, some of them are tax havens, suchas Singapore, the Netherlands, the British VirginIslands and Mauritius. This provides a strongindication of the round tripping phenomenon.Therefore, it becomes important to investigate: forwhom is the plan of PPh Badan relaxation intended?Is it to encourage national economic growth or is itto provide incentives to national oligarchs who havebeen avoiding taxes, diverting their profits to tax

Policy Briefhavens only to reinvest in the country using the clothesof foreign investors and again to enjoy various tax relieffacilities?Before the plan for the formation of the Omnibus Lawon Taxation, even without a reduction in the tax rates,Indonesia’s investment performance had been good.Indonesia is too important to be ignored by foreigninvestors because of the scale of the country’s economicactivity,4 which is similar to China and India whose PPhBadan remain at around 25% but still attracts globalinvestors. Also, tax instruments are not really neededto increase competitiveness to attract investmentfrom abroad. In the 2017-2018 Global CompetitivenessReport by the World Economic Forum (WEF), five mainproblems were listed as affecting investment in a country:corruption, complicated bureaucracy, access to finance,infrastructure, policy consistency and political stability. Taxrates and taxation policies occupied the sixth and eighthpositions. This means that relaxation and tax incentivesare not the highest priority of investors and are not partof the main reasons for choosing an investment area. In adifferent report on the ease of doing business, Indonesia’srank in 2020 is stagnant at 73, with the worst scores onthe indicator being starting a business with an index of140 and enforcing contracts with 139.5 However, thesefacts have been ignored by the government and academicdrafters by forcing rate reductions as an instrument toattract investment.6Furthermore, the government has not put muchconsideration into studies that reveal that only nonessential types of investment, such as portfolio shufflingand ‘accounting nonsense’, are aggressive and interestedin the reduction in PPh Badan.7 Meanwhile, the typesof real investment that create jobs, which build a longterm supply chain network accompanied by transfer ofexpertise, do not particularly pursue tax relaxation. Thesereal investors will continue investing in Indonesia forthe reason that the country is rich in natural resources,has a large population, abundant labor, a large scale ofeconomic activity (member of the G20) and high sociopolitical stability.An external factor that shapes the plan to reduce PPhBadan is an objective to strengthen Indonesia’s positionin the “tax competition” (race to the bottom) at theregional and global levels. Tax competition is a tax ratewar that is very destructive for the countries involved,especially developing countries with large scales ofeconomies, as opposed to rich countries, which do notrely on state revenues from corporate tax rates.8 Thegovernment is aware of these facts and threats; however,it insists that it can anticipate them by providing somenotes and calculations.9According to the government’s calculation, the impact ofthe decrease in the Gross Domestic Income (GDI) due tothe lowered PPh Badan in the short term will be paid offand will be exceeded in the long term due to increasedinvestment, employment, and household consumptionwhich will increase economic growth.10 However, somethings are ignored and overlooked in this calculation,one of which is the small proportion of the PPh Badanreduction on the growth of the Gross Domestic Product(GDP) at the macro level. Until now, many studies haveshown that there is no significant effect of reducing taxrates on economic growth. The general explanation forthis is because the proportion of PPh Badan contributionsto the economy as a whole is small compared to theproportion of other sectors.11 Even as can be seen in thecalculation of the Fiscal Policy Agency (BKF) in 2019, theincrease in the impact of the lowered PPh Badan on theprojected GDP growth in 2030 is only 1.20%.12Table 1. BKF Simulation regarding the Direct Impact of the Reduction in PPh Badan (2019)ImpactGDP GrowthRevenue ForgoneNet Tax (% thd -0,54-0,44-0,23-0,24-0,24-0,22Source: Omnibus Law on Taxation Academi Paper.Based on this calculation, the reduction in PPh Badanwill in fact contribute to the worsening of the problemof inequality and further concentrate or the moreconcentrated political and economic power among theselect few. Profits from corporations generally or mostlyend up in the pockets of shareholders and corporatecapital owners, which only worsens inequality. Thiscould only be avoided if the PPh Badan reduction policywere covered by a larger tax imposed on the super-richindividuals. However, this would be difficult to imposeas the reduction in PPh Badan itself is a reflection of thegovernment’s strong support for the super-rich.Another objective of this income tax reduction is toencourage compliance and reduce taxpayers’ intentions02to avoid taxes. However, so far, there is no empiricalevidence to support the claim that a reduction in thetax rate will have a positive effect on the behavior oftaxpayers to be more compliant and stop engaging intax avoidance practices. The narrowing of the gap inthe Indonesian corporate income tax rate with those ofother countries especially in Southeast Asia may reducethe practice of profit shifting from Indonesia to othercountries or tax havens.13 However, many believe thatthe previous government’s measure of using anti-taxavoidance instruments is far more effective in controllingand preventing tax avoidance practices than the Taxationpolicy in the Omnibus Law.14Furthermore, the government claims that a reduction in

Policy BriefPPh Badan will have an impact on the broadening of thetax base, but there is no evidence to support this. Whatis often used as a strategy in expanding the tax base isincreasing the number of taxpayers and preventing taxavoidance practices or adding new tax objects so thatthe negative impact of the loss of state revenue (revenueforgone) can be controlled. In other words, instead ofcontributing positively to the widening of the tax base, thepolicy of lowering PPh Badan is burdening the governmentwith the need to find a replacement to cover it. Ideally, thegovernment should look for or add new sources of taxrevenue not as a substitute but instead to complementand expand the existing tax base.If we reanalyze the existing policies, the current legalfacilities are quite attractive to foreign investors. Theprovisions of the Income Tax Law (UU Pajak Penghasilan)(article 17 paragraph 2b) and the Government Regulation(PP) No.77 / 2017 stipulate that the PPh Badan in theform of a public company can enjoy a 5% reduction in theincome tax rate (PPh) by following several requirements.15These requirements include at least 40% of shares betraded on the stock exchange and other requirements thatencourage companies to “go public”, improving corporategovernance and transparency which are already very goodcompared to providing cuts in PPh Badan without theserequirements.Elimination of Domestic and Foreign IncomeTax on Dividends (PPh Dividen)The government argues that the elimination of PPh Dividenimposed within and outside the country is expected toresult in repatriation and encourage conglomerationpractices, mergers, and the establishment of subsidiaries.The returns from dividends that are reinvested areexpected to boost Indonesia’s investment climate in thelong term. The shift in the Indonesian tax system fromworldwide to territorial basis has so far not been effectivein addressing the problem of assets-parking abroad byIndonesians (lockout capital) nor encouraging repatriationor the flow of dividends back to Indonesia. In general,the system shift from worldwide to territorial is a taxreform step that has been taken by the majority of OECDcountries.16 Many studies support the greater benefits ofthis transformation, in particular, its ability to overcomethe weaknesses of the worldwide system which providesgreat opportunities for tax avoidance practices with thescheme of establishing controlled offshore entities andthe practice of parking assets abroad.17The abolition of PPh Dividen imposed abroad does notalways guarantee repatriation or the return of fundsparked abroad to the country. Britain’s failure to pursuea similar policy in 2009 can be instructive.18 Instead ofrepatriation, what happened was a 16.7% increase ininvestment by UK companies in countries with low taxrates. This again underscores the risk of tax avoidancethat remains high regardless of a system change. So far,to overcome the weaknesses of the worldwide system,tax authorities, including those in Indonesia, have usedanti-tax avoidance instruments such as the ControlledForeign Company (CFC) rule. By considering the possibilityof repatriation failure, the CFC rule instrument must stillbe put to use.19The elimination of PPh Dividen is very likely to have animpact on rerouting investment.20 However, the type ofinvestment needs to be monitored for 2 (two) reasons:(1) the risk of round tripping reappears with portfolioshuffling and accounting nonsense being very likely tobe carried out by foreign dividend holders;21(2) thepossibility of them placing an investment in the stockmarket presents a loophole for the funds to be divertedback to other tax havens.The requirement for a certain obligated period of domesticinvestment will not have a positive impact if there is norequirement for the investment to be placed in the realsector. The specified period, hence, is prone to failure andwill not achieve its true positive goal of contributing tothe national economy. One proof of this risk is the failureof the tax amnesty program to hold funds in the countryafter the three-year period ended because there was noobligation to place the funds in the real sector.22 If thathappens again, it will have an impact on the concentrationof wealth among the wealthy few shareholders andworsen the situation of inequality.23Besides, without certain preconditions, if immediatelyenforced, the domestic investment obligation will havean implication for the release of taxation of assets parkedabroad, or in other words, it can be considered as hiddentax amnesty. Therefore, the requirement to invest in the realsector is a form of reciprocity that is relevant to preventrisks, both revenue forgone and the aforementioned risk.The elimination of PPh Dividen imposed abroad also doesnot necessarily reduce tax avoidance practices conductedthrough disguising the identity of the beneficial owner.One of the main problems regarding dividend tax is thebehavior of shareholders to avoid taxes by deliberatelyholding profits at the company level and increasingretained earnings. Another problem is the concealment ofthe beneficial owner’s identity either through individualsor other companies (generally in the form of conduits andmailbox companies) in low tax countries.An exemption from dividend taxes for shareholders andtaxation which is only done once at the corporate levelwill reduce the motivation of the capital owners to hidethrough a scheme of concealment of the beneficialowner’s identity. However, to eliminate this seemsimpossible. There is always a reason to keep the identityof the beneficial owner hidden for tax avoidance purposesunder other schemes.Placement of Tax Incentives in one Statuteand Customs FinesAs stated at the beginning, tax incentives and tax relaxationfacilities offered by a country, especially by a developingcountry, are not the main benefits that investors expect.24Therefore, making incentives as a promotion to attractinvestment without adequate evaluation only harmsthe state because of the loss of revenue that should bereceived (revenue forgone) and it encourages the practice03

Policy Briefof round tripping along with the widespread practice oftax evasion and avoidance.25 So far, the tax omnibus lawhas been used as a platform to collect and place varioustax incentives and relaxation facilities.One of the most important things that is not accommodatedin the Omnibus Law is that there are no rules that explainthe abuses of tax incentive packages for tax avoidancepractices. One common pattern of misuse of tax incentivesis by utilizing the loss compensation facility which is usedfor aggressive tax planning. Misuse of tax holiday is alsooften conducted to design complex corporate structureschemes such as holding company structure to carry outtransfer pricing.26Another problem related to providing tax incentives is thegovernment’s failure to ensure transparency in providingthe incentives. The absence of transparency and subjectiveassessments of taxpayers who are entitled to receiveincentives can become loopholes for abuse of authority.So far, this process has been very covered up, so thepublic does not know the list of corporate taxpayers orcompanies that have received the tax incentives. Disclosinginformation regarding this matter should not be againstthe rules of confidentiality of taxpayers’ information.Furthermore, besides the existence of several tax incentiveregulations, the government has also covertly providedincentives and subsidies in the form of tax expenditures.27In recent years, the activities of tax expenditures in theform of subsidies and incentives by the Ministry of Financehave been significant.28 Evaluation should have beencarried out to assess the impact of this policy and whetherthis policy is appropriate to be continued.It is expected that the reduction of customs fines willeffectively increase taxpayer compliance. However,in theory, apart from requiring the fulfillment of theprinciples of proportionality, accuracy and necessity,rearranging administrative sanctions to be lighterrequires assurances of transparency, justice and certaintyfor taxpayers. Ensuring that there are actions that areobjective, transparent, and wherever possible, eliminatediscretion provides more assurance of justice and certaintyrequired by taxpayers.30Reflecting on the massive practices of illicit financial flows,which is a problem for developing countries in optimizingstate revenues, it is necessary that export and importtransactions between countries are controlled. Therefore,in addition to rationalizing customs fines, improvingexport-import or customs governance is urgently neededto cover trade balance deficits.Policy RecommendationsBased on the analysis above, here are several suggestedpolicy recommendations: The government does not need to reduce PPhBadan. A reduction in the tax rates could burden thegovernment to find a replacement for the state revenuelost due to this policy. To increase economic growth,the government should focus more on improving theease of doing business, especially factors related tostarting a business, licensing, business contracts, taxreporting, and payment systems for business entities. The government needs to review the policy planfor the elimination of PPh Dividen imposed withinand outside the country. The abolition of PPhDividen imposed abroad does not always guaranteerepatriation. The requirement for investments to havecertain obligated time periods in the country will nothave a positive impact on national economic growthif there are no requirements for the mandatoryinvestment placement in the real sector. In addition, ifit is immediately enforced, it will have an implicationfor the release of taxation of assets parked abroad. The government must increase the transparency inthe provision of tax incentives that prioritizes theprinciple of transparency itself, including issuingregulations regarding the provi

The government has submitted the Omnibus Law on Taxation to the House of Representatives (DPR) for discussion and ratification. The public’s attention has not been as alert, as compared to the labor provisions within the Law, although the Law on Taxation will have a direct impact on community welfare. At the time of writing this Policy Brief, the

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