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6.5. Deductions

The general rule for any expenses to be deductible is that they must be in relation to obtain, collect, and maintain the income. In practice, the determination of whether or not a given expense is deductible is at the discretion of the taxpayer under the self-assessment system. The choice made by the taxpayer may be reversed in the framework of a tax audit. In preparing tax returns, taxpayers must consider the list of negative expenses that are treated as non-deductible items as set out above in section 6.2.

Though in general any costs incurred in order to obtain, collect and maintain the income is a deductible expense, there may be specific rules as explained below:

Financing Costs

In general, interest payments for both capital and operating expenses are deductible for tax purposes. Interest is not deductible for tax purposes if the loan is used to acquire shares in an Indonesian company. This is because dividends received from such an investment are exempt from tax and the Income Tax Law clearly stipulates that any expenses associated with non-taxable income should be treated as non-deductible expenses.  The same denial of the interest deduction applies to industries where the income or revenue is subject to a final tax. Under the Income Tax Law, where the income is subject to a final tax, all expenses are ignored. The industries covered by a final tax regime include construction activities, and rental of land and property. In addition, the Ministry of Finance is authorized to specify the limitation on deductible borrowing costs, based on internationally accepted methods such as Debt to Equity Ratio, borrowing costs compared to EBITDA (earnings before interest, taxes, depreciation, and amortization), or other methods (see Sec. 13.2.)

Royalties, Commissions and Licensing Fees

The Income Tax Law clearly stipulates that royalties, commissions and licensing fees are deductible items. However, if the payment is made to a related party, the Indonesian Tax Authority may challenge the amount if they consider that the remuneration exceeds the market price.

Buy-in Cost-Sharing Contributions

Buy-in cost sharing contributions are deductible but subject to transfer pricing rules if the payment is made to a related party. In addition, if the cost sharing is in relation to services, the Indonesian Tax Authority requires not only that the price reflects an arm’s length price but that the Indonesian company demonstrates in addition that (i) the services have been rendered; and (ii) there is economic benefit for the Indonesian company paying the service fees.

Debt Waivers

Debt waivers are deductible for an Indonesian company if all of the requirements are cumulatively satisfied: (i) the waiver has been appropriately recorded as an expense; (ii) a list of debt waivers is submitted to the Tax Authority; and (iii) the case has been registered at the Civil Court / other Institutions, or a debt waiver agreement has been signed, or the case has been registered in the specific publication, or the debtor has acknowledged that (some of) the outstanding loan has been waived.

Special Remunerations (including director’s fees)

Payments to directors are deductible for tax purposes as long as contractually stipulated. However, there is a restriction if the payments are made to a director who is also a shareholder. The Income Tax Law stipulates that payments to shareholders or other related parties exceeding the normal business practice are not tax deductible. This rule is basically introduced to avoid any situation where the payments are dividend in nature. If, however, the company can demonstrate that the payments are within the normal business practice, they should be tax deductible.

Taxes and Penalties

Direct and indirect taxes should be deductible for corporate tax purposes, except for input VAT where the company claims the VAT through the input and output mechanism. VAT in relation to expenses that are treated as being non-deductible expenses should also be treated as a non-deductible expense. The Income Tax Law clearly stipulates that tax and non-tax penalties are non-deductible for corporate income tax purposes.