How to deal with the expected increase in tax audits in Indonesia
Benjamin Simatupang of GNV Consulting explains that preparation is vital for Indonesian taxpayers in aiming to weather the storm of tax audits, and why tax office challenges can be seen as an opportunity for improvement.
“On this good earth there are three peoples I don’t mess with. The I, the R, and the S.”
– The movie Set It Off (1996)
Don’t mess with taxes
Even though Benjamin Franklin famously said, “in this world nothing can be said to be certain except death and taxes”, normally most people do not want to mess with the tax authority. The IRS mentioned in the movie line is the US’s tax authority. In Indonesia, the equivalent body is also represented by three letters: DJP (Direktorat Jenderal Pajak, the Directorate General of Taxation, or the Indonesian Tax Authority).
In 2023, the world seems to have recovered from the COVID pandemic and is moving towards the endemic stage. The Indonesian government seemed optimistic entering 2023 by projecting 5.3% economic growth. From the Indonesian Tax Authority, the optimism may be fuelled by the 2022 revenue realisation, which exceeded the state budget target (at almost 116%).
The government has also put effort into attracting investors to come to Indonesia and has issued regulations that are considered business/investor friendly. Naturally, the Indonesian government expects investors to comply with the prevailing regulations, including the tax regulations. Under a self-assessment tax regime, tax audits are conducted by the tax authority to test taxpayers’ compliance. In Indonesia, most tax audits are conducted to verify a claim for a refund of tax overpayment, or to close the statute of limitations (five years) of tax years that are open for audit.
In this regard, while the incentives provided by the Indonesian government may seem appealing, businesses/investors also need to be aware of lurking tax audits that may be conducted by the Indonesian Tax Authority. The achievement of exceeding the state budget target in 2022 will not lessen the Indonesian Tax Authority’s effort to collect tax revenue from tax audit processes in 2023. It is even anticipated that there may be more tax audits in Indonesia in 2023, because the Indonesian government has targeted an increase in tax revenue of almost 16% from 2022.
It is not uncommon in Indonesia that a tax audit triggered by a request for a refund of tax overpayment concludes with the opposite result; i.e., an enormous tax underpayment. To make matters worse, the underpayment may be coupled with penalties for late payment and other relevant penalties. For certain customs cases, the penalty can even reach 1,000%.
Therefore, because of the magnitude of consequences that may arise in a tax audit process, taxpayers need to anticipate tax audits conducted by the Indonesian Tax Authority, and manage the process if they are subject to an audit, to avoid unnecessary risk. Maybe no taxpayer wishes to be audited by the tax authority; nevertheless, as one military adage puts it, taxpayers need to “expect the unexpected”.
Before the ‘storm’
It may seem an exaggeration to consider a tax audit as analogous to a storm. A big storm may have fierce winds, obliterating barns and houses, and even causing deaths. However, if a tax audit is not well managed, the consequences may also be severe. The key phrase to emphasise to deal with a future tax audit is: plan ahead.
The taxpayer must be prepared long before a tax audit starts. In fact, preparation should even begin before a transaction, and continue throughout the transaction process, until the settlement of the transaction and its tax compliance. In the preparation of tax returns, everything should be supported with sufficient documents and a clear basis. This is to anticipate any questions from the Indonesian Tax Authority.
Taxpayers also need to prepare reconciliations that are normally requested in the event of a tax audit.
Normally, the tax auditors request the taxpayer to prepare a reconciliation between the revenue declared in the annual corporate income tax return or audit report and the delivery of VAT-able goods or services reported in the monthly VAT returns. Any discrepancy would raise questions from the tax auditors and need to be explained in detail.
Another reconciliation that is normally requested is between salary expenses in the general ledger and the gross income reported in the employee income tax returns. Other reconciliations that taxpayers may consider preparing are between:
The purchase amount (if any) declared in the annual corporate income tax return and the input VAT credited in the monthly VAT returns;
The withholding tax returns (Article 23/26 and Article 4(2)) and the taxpayer’s general ledger; and
The self-assessed VAT declared in the monthly VAT returns and transactions with offshore entities.
Taxpayers are also required to support that their transactions with affiliates fulfil the arm’s length principle. In this case, the availability of transfer pricing documentation is very important.
Furthermore, the submission of monthly tax returns and annual tax returns, as well as the payments, must comply with the deadlines set in the prevailing tax regulations.
In general, for the annual corporate income tax return, the filing deadline is the end of the fourth month after the tax year ends, while for annual individual income tax returns, the filing deadline is the end of the third month after the tax year ends. If there is tax underpayment, it has to be settled before submission of the annual tax return. For reporting of the annual tax return, the taxpayer can extend the submission for a maximum of two months by submitting a notification to the Indonesian Tax Authority.
For withholding tax returns, the monthly filing deadline is the 20th of the following month, while the payment deadline is the 10th of the following month. The filing deadline for VAT returns is the end of the following month, and the payment deadline is before the VAT return filing deadline.
Taxpayers need to consider conducting regular tax diagnostic reviews to identify any potential areas that need to be improved. In the event that there is a gap observed from the diagnostic review, the taxpayer may still be able to amend the relevant tax returns or complete the required supporting documents. In general, after the Indonesian Tax Authority issues a tax audit instruction letter for the period/year concerned, tax returns can no longer be amended.
In the process of the tax diagnostic review, it would also be advisable to appoint a credible tax consultant to provide insights and comments to improve the taxpayer’s tax position.
In the eye of the storm
If a taxpayer is already in the middle of a ‘storm’ and being audited, it should be aware of certain mandatory steps/procedures that are critical. The initial meeting with the tax auditor team and submission of data/documents are among these critical areas. The tax regulation requires the director of a corporate taxpayer that is being audited to join the initial meeting. In the initial meeting, the tax auditors will ask a set of questions to understand the taxpayer’s profile.
With regard to the data/document submission, the taxpayer needs to be aware of the timeline. In general, data and document submission should be completed within one month. Data and documents submitted after the deadline may be deemed by the tax auditors as ineligible to be considered.
During a tax audit process, the taxpayer needs to anticipate disputes that continue to tax appeal or even to judicial review by the Supreme Court. Hence, any data/documents that are submitted to the tax auditors must be prepared carefully, bearing in mind that they must support the taxpayer’s argument and position up to the tax appeal level. In this regard, among other matters, receipts from the tax auditors when the data and documents are submitted can play an important part if a dispute is brought to the objection level or appeal level, as the receipts are usually requested during the dispute process.
Having proper data receipts during the tax audit process may save a lot of time and effort at the tax appeal level. In contrast, the absence of such receipts may make the case vulnerable.
Any reconciliation that is requested by the tax auditors must also be carefully prepared. The continuous submission of data/documents requested by the tax auditors, and maintaining communication with the tax auditors, also plays a key role during the tax audit process. By doing so, an impression of a responsive and cooperative taxpayer may be formed, creating a positive atmosphere for discussions with the tax auditors.
Once the tax findings have been issued formally, the taxpayer needs to prepare a formal rebuttal. The findings can be classified as juridical matter or evidence-proving matter. The rebuttal letter should be submitted within the specified timeline; i.e. seven days, which can be extended by three days.
It is relevant to refer to an article written for ITR by Ahdianto and Fabian Abi Cakra, of GNV Consulting, on “Intricacies of the tax audit process in Indonesia”. “In rebutting a finding related to the substance of transaction or business interpretation, the taxpayer should put considerable focus on the evidence, instead of the arguments,” the article reads. “This is important, as the Indonesian Civil Code requires the party that claims a right to prove the existence of it. Therefore, before claiming an argument, the taxpayer should ensure that the related evidence/proof is supportive. This is why careful language should be used in outlining the reconciliations and/or explaining any tax interpretations to the Indonesian Tax Authority.”
Arguments that are built to counter the tax auditors’ findings need to be supported with the relevant tax laws and regulations. In a case where the regulation is not clear, the taxpayer may consider searching for private rulings or similar cases in the tax court to have another angle to analyse the case.
After submission of the rebuttal, the tax auditors will invite the taxpayer to attend the tax audit closing conference. Data and documents that support the rebuttal should be shown during the closing conference. The tax auditors will prepare minutes to document the discussion. In the minutes, the taxpayer is required to state which findings are agreed upon and which are not. The taxpayer has to be very careful in making this statement, because it is binding on the taxpayer.
After the storm
There is a saying, “After every storm there is a rainbow”. If a ‘storm’ is a suitable metaphor for a tax audit, then what does the rainbow symbolise? We may consider the rainbow as hope for the taxpayer to minimise tax risks. This hope can be achieved by taking lessons learnt from the tax audit experience. Like the management concept of PDCA (plan – do – check – action), the taxpayer may need to sit down and perform a ‘check’ to find the lesson learnt.
After issuance of the tax assessment notice, the taxpayer needs to review the findings that were upheld by the tax auditors; i.e. whether the findings are valid. If the findings are valid, steps need to be taken to avoid similar findings occurring in the future. For this purpose, the taxpayer may consider submitting an amendment of past tax returns.
On the other hand, for cases where the tax regulations do not clearly govern the issue, the taxpayer may consider requesting a private ruling from the tax office. There is no clear deadline for when the tax authority must issue the private ruling. The process may take a long time. Furthermore, there is no guarantee that a private ruling issued by the Indonesian Tax Authority will be favourable to the taxpayer. Yet, whatever the result, the taxpayer is bound by the private ruling once it is issued.
For findings related to transfer pricing, the taxpayer may consider applying for a mutual agreement procedure (MAP) or advance pricing agreement (APA). This path is not a fast-lane process, but it may be worth considering, because findings in transfer pricing often result in massive tax underpayment. For that reason, even though it takes a long time, a MAP or an APA may provide more certainty on transfer pricing matters. As said by Charles Oetomo, Felic Setiawan and Wirawan Sasongko, of GNV Consulting, in their ITR article “The promising development of APAs and MAPs in Indonesia”, “Like the available domestic remedy, APAs and MAPs may not necessarily address double taxation and still provide uncertainty in terms of outcome. Strategic considerations and cost-benefit analysis are still required in deciding if APA and MAP provides taxpayers with greater chances of obtaining the required tax relief. For better or worse, with careful planning and due care, there is no denying that APA and MAP may just be an appropriate dispute mechanism for taxpayers.” For tax auditors’ findings that are not valid, the taxpayer may consider filing an objection. The deadline to submit an objection is three months from the date of the tax assessment notice. The tax objection will be reviewed by the regional tax office, a higher entity than the tax office that conducted the tax audit. Nevertheless, the tax office and the regional tax office are under the same institution; i.e., the Indonesian Tax Authority. If an objection is going to be pursued, a review process needs to be performed to ensure the completeness of the supporting documents, as well as research for regulations or laws that add weight to the argument. The objection process lasts a maximum of 12 months.
Once a taxpayer files an objection, its eyes must also be set to prepare submission of an appeal to the tax court, in the event that the objection is rejected.
To anticipate a tax audit, the taxpayer has to perform ‘tax audit management’, which begins long before any tax auditors’ findings are issued. This starts by planning ahead, carefully preparing the tax returns, and preparing sufficient supporting documents and a clear basis for each transaction. Such preparations prove to be very useful when facing a tax audit.
However, as in life, even though careful preparation has been done, the taxpayer must still expect challenges from the tax office. Any challenges should not be feared but rather seen as an opportunity to improve the taxpayer’s compliance. Any challenge from the tax auditors may be perceived as a strong wind that makes the sea rough, and rough seas make tough sailors.