Farewell Double Taxation

The topic of the Draft Law (RUU) concerning Tax Provisions and Facilities for the Strengthening of the Economy commonly referred to as the Omnibus Law on Taxation, has recently been widely discussed. This is because the process of ratifying this law has entered a new phase with the submission of the draft law to the House of Representatives.

The government expects that the Omnibus Law on Taxation soon be promulgated to realise the various policies contained therein. Among such policies is one aimed at encouraging domestic investments, namely the policy of dividend income exemption received or accrued by resident individuals.

Inevitably, the policy of dividend income exemption will result in major changes to Indonesia’s tax system, wherein the corporate taxation system is linked to the corporate-shareholder taxation system.

Notably, the tax on a company pertains to the tax on an individual’s income as a shareholder of a company. This is because the company’s income constitutes income (in the form of dividends) for its shareholders. In other words, the company’s income is one of the sources of income for its shareholders.

Each country has a different system of regulating the taxation on companies related to individual shareholders. The system adopted by Indonesia based on the currently prevailing Income Tax provisions is the classical system, wherein a company is deemed a separate entity from its owner (separate entity system), thus, the company's income is subject to a different tax and taxed separately from its shareholders.

In the classical system, income sourced from a company is taxed twice, namely at the company level and the shareholder level when distributed as dividends (Cnossen, 1996). In other words, if an income has been taxed at the company level and when the income is distributed as dividends to individual shareholders, the same income will be taxed again at the individual shareholder level. The same system was also applied during the enactment of the Income Tax Law Number 17 of 2000.

In the foreseeable future, the official promulgation of the Draft Omnibus Law on Taxation will end the application of the classical system regime in Indonesia. Through the policy of dividend income exemption pursuant to Article 4 paragraph (4b) and Article 4 paragraph (5) of the Draft Omnibus Law on Taxation, Indonesia will switch from the classical system to the integration of distributed profits in the form of a single tier dividend system or more commonly known as the one-tier system.

Based on this system, a company’s income is only taxed once at the company level. Therefore, when the company's income is distributed as dividends to individual shareholders, the dividend income is no longer taxed in the hands of such individuals (Harris, 2013).

Simply put, in this system, every domestically sourced dividend received or accrued by resident individual shareholders will be excluded from income taxes in Indonesia provided that the dividends are invested in Indonesia within a certain period.

Thus, what positive impact will the change from the classical system regime to a one-tier system have on Indonesia?

Positive impact

To date, the application of the classical system in Indonesia has resulted in a double taxation burden for individual shareholders as the same income is taxed twice at different levels. However, with a one-tier system, the burden of double taxation may be eliminated because company income is only taxed at the company level and income received by individual shareholders in the form of dividends is no longer taxed.

This policy is expected to encourage dividend distribution which will be subsequently reinvested. Moreover, this policy will eliminate the phenomenon of disguised dividend distribution to avoid the imposition of taxes under the classical system regime.

The positive impact of this change will be even more evident, specifically, with the policy of gradual reduction of the corporate income tax rate formulated in the Draft Omnibus Law on Taxation namely the reduction of the corporate Income Tax rate to 22% for the 2021 and 2022 tax years and to 20% starting in 2023. The implication is, without any doubt, a lower effective tax rate on companies in respect of individual shareholders in Indonesia, i.e. from 32.5% as currently applicable to 22% for the 2021 and 2022 tax years and to 20% starting in the 2023 tax year.

Compared to several ASEAN countries, such as Malaysia, Singapore, the Philippines and Thailand, Indonesia’s effective tax rate will be the second lowest after Singapore, as indicated in the following comparison in Table 1.

Table 1 Effective Tax Rates on Companies in Respect of Individual Shareholders in Indonesia and Several ASEAN Countries

Table 1 above shows that due to the implementation of the one-tier system, the effective tax rates for Singapore and Malaysia amount to 17% and 24% respectively. In contrast, the Philippines that adopt the classical system applies an effective tax rate of 37%. Finally, Thailand, which implements an imputation system, applies an effective tax rate of 27%. Compared to the effective tax rates of the Philippines, Malaysia and Thailand, Indonesia’s effective tax rate is certainly more attractive.

Finally, the implementation of this one-tier system tax regime is expected to stimulate domestic investments to boost the Indonesian economy.