Indonesia, the world's largest archipelago and a vibrant democratic nation, recently concluded a presidential electoral process that could alter the trajectory of its growth towards the so-called Golden Indonesia. Under the governance of the current president for the past 10 years, Indonesia has initiated and completed many strategic government projects. Such projects were financed from several sources, including tax revenues, foreign grants, and foreign loans.
Under the newly elected president and his government, the roadmap to achieve the intended Golden Indonesia may include the list of programmes that the president-elect promised during the election campaign. Among others, the priority programmes will include the continuation of the development of Indonesia’s new capital in Kalimantan, free lunches and milk for students, the continuous modernisation of military defence equipment, and building schools and hospitals.
With its vast potential and diverse needs, the new administration is expected to continue to engage with its foreign partners to fuel the nation's development initiatives. Foreign loans and grants, a beacon of hope in financing Indonesia's development projects, have been instrumental in the growth of sectors such as infrastructure, social welfare, environmental conservation, and military defence equipment. To further amplify the positive impact of these financial resources, it is imperative to update the tax facilities for government projects funded by foreign loans and grants.
The prevailing tax facility on foreign loans and grants for government projects
The tax facility regarding foreign loans and grants for government projects dates back to 1995, when Government Regulation (GR) No. 42 (GR 42/1995) was issued, and its latest amendment, GR No. 25, was issued in 2001. The main idea of this tax facility is to provide:
An exemption from customs duties in relation to the implementation of government projects financed through foreign grants or loans;
Non-collection of import VAT and VAT on the delivery of goods or services in relation to the implementation of government projects financed through foreign grants or loans; and
Income tax borne by the government for income received by the main contractors, consultants, and suppliers for implementing government projects financed through foreign grants or loans.
In general, the tax facilities above would be able to help the government to obtain the financial resources needed for its projects. However, the government and its contracting parties are required to take note of the implementation instructions of GR 42/1995, which are regulated under Minister of Finance (MoF) Decree No. 239 of 1996 (KMK 239/1996) as most recently amended by MoF Decree No. 486 of 2000 to mitigate any potential taxation risk that may be incurred from the tax treatment of their transactions.
Understanding the subject and requirements of the tax facility
KMK 239/1996 and its amendments specify that foreign loans and grants for government projects that are eligible for the said tax facility should be listed in the project identification list or equivalent documents, including projects financed with a subsidiary loan agreement.
The parties eligible for the tax facility are also limited to the ‘main contractors’, which should be stipulated under the contract concerning foreign loans and grants for government projects.
The tax facility can be elaborated as follows.
1 Income tax borne by the government
The income tax payable that is borne by the government refers only to the main contractor’s income that is received or obtained in connection with the implementation of a government project that is financed entirely by foreign grants or loan funds. If the project is only partially financed by foreign grants or loan funds, the income tax payable to be borne by the government would only cover the partial amount of funds that comes from the foreign grants or loans.
The main contractor is still required to create an income tax payment slip and affix a stamp stating “income tax borne by the government” to be provided to the project owner.
The other objects of income taxes – i.e., the salary tax obligation that is payable for the main contractor’s employees and the income of the subcontractors – would still be payable in accordance with the Income Tax Law.
2 Input VAT and VAT on luxury goods not collected
The input VAT and VAT on luxury goods that arise from the importation of goods or services, the utilisation of offshore services or intangible goods, and the delivery of goods or services by the main contractor shall be fully exempted if the transaction is in connection with the implementation of a government project that is financed entirely by grants or foreign loan funds. If the project is only partially financed by grants or foreign loan funds, the VAT exemption would only cover the partial amount of funds that comes from the grants or foreign loans.
The main contractor is not required to create any VAT payment slip in relation to the import VAT from the above subject. However, the main contractor is still required to issue a VAT invoice and affix a stamp on the VAT invoice stating that the “VAT is not collected” in relation to the delivery of goods or services by the main contractor.
The input VAT incurred from the main contractor’s transactions with other parties would still be payable and creditable in accordance with the VAT Law.
3 Exemption from customs duty and other levies
The customs duty and other levies arising from the importation of goods by the main contractor shall be fully exempted if the transaction is in connection with the implementation of a government project that is financed entirely by grants or foreign loan funds. If the project is only partially financed by grants or foreign loan funds, the customs duty exemption would only cover the partial amount of funds that comes from the grants or foreign loans.
The project owner is required to prepare a list of goods that would be imported (Master List) in accordance with the contract and have it authorised by the echelon I officials or other officials assigned to handle the project. One hard copy of the authorised Master List and the contract should be submitted to the Ministry of Finance through the Directorate General of Taxes (DGT), and another copy should be submitted to the main contractor’s registered tax office. If the main contractor has not obtained a tax ID, the copy should be submitted to the Tax Office for Foreign Bodies and Expatriates.
Issues regarding the tax facility
Firstly, it is common practice for a foreign country that provides grants or loans for government projects to appoint an entity serving as the main contractor to enter into a contract with the Indonesian government. The presence of a foreign entity as a main contractor may constitute a permanent establishment (PE) under the prevailing tax law, under the pretext that the conditions of a PE are satisfied.
By creating a PE, the main contractor is obliged to register for a tax ID and report its tax returns in Indonesia. Although KMK 239/1996 and its latest amendment implied that the tax rate for transactions with foreign entities could refer to the prevailing tax treaty with the respective counterparty’s jurisdiction, KMK 239/1996 and its latest amendment does not stipulate any specific treatment on the PE issue for the foreign country that acts as the main contractor. However, a circular letter from the DGT, No. SE-4/PJ.03/2008, clarifies that the income tax on net after-tax income of a PE shall also be borne by the government.
Secondly, KMK 239/1996 and its latest amendment allows the full tax facility for government projects that are fully funded through foreign loans or grants. However, if the foreign loan or grant covers only a part of the total amount of the project, the tax facility is only allowed on the portion of the loan or grants invested. Theoretically, the main contractor should be able to separate the transaction and the portion related to the foreign loan or grant, since KMK 239/1996 does not provide further information on this.
Thirdly, KMK 239/1996 and its latest amendment stipulates that the withholding tax that is borne by the government for the main contractor can serve as a tax credit in its corporate income tax return, which in some cases would result in an overpayment of tax in the event that the total tax credit amount exceeds the total tax payable. In the event of a tax overpayment arising from the income tax borne by the government, the tax overpayment cannot be refunded to the main contractor. It is still unclear whether such overpayment from the tax facility would trigger an immediate tax audit process for the main contractor, as stipulated in the prevailing tax law. This uncertainty may hurt the main contractor, which bears the potential risk of a tax audit.
Finally, even though the VAT on deliveries by the main contractor to the project owner is not collected, the transactions between the main contractor and its suppliers are still subject to VAT and this serves as the input VAT of the main contractor. The absence of output VAT from the main contractor's delivery of goods or services may result in an overpayment of VAT in the main contractor’s VAT return. When the main contractor opts to claim a refund on the VAT overpayment amount, the refund request will attract a tax audit by the Indonesian tax authority.
Moving forward with the tax facility
Indonesian tax law has undergone several amendments in the past 15 years, most recently through the issuance of the Law on Harmonisation of Tax Regulations in 2021. Despite the dynamic revision of tax law, the tax facility concerning foreign loans and grants for government projects has remained unchanged.
Tax facilities could play a crucial role in maximising the impact of foreign loans and grants in Indonesia. They could create a comprehensive environment between the contracting parties, incentivise investment, promote economic growth, and facilitate the efficient utilisation of financial resources for development. To have a clearer understanding of the tax facility procedures, communicating with a tax consultant starting from ‘day one’ would be a good option to mitigate any misconceptions regarding the process.
As Indonesia continues to pursue its Golden Indonesia dream, effectively leveraging tax facilities to keep up with the prevailing tax law will remain crucial in promoting sustainable development and building a prosperous future for its citizens.
