Tax planning is the process of structuring transactions and business activities to manage a company’s tax burden efficiently while remaining compliant with applicable tax laws and regulations.
For companies, tax planning is not merely about paying less tax. Proper tax planning can also help manage cash flow, improve business efficiency, and reduce the risk of tax disputes. Our tax law services routinely assist companies in structuring tax-efficient and compliant business arrangements. Looking to understand legal and sound tax planning strategies for your company? Read this article to learn more about the strategies, benefits, and risks that should be considered.
Understanding Tax Planning, Tax Avoidance, and Tax Evasion Under Indonesian Law
These three terms are often used when discussing how companies manage their tax obligations. However, each has distinct characteristics and legal consequences.
Tax planning refers to structuring transactions and business activities to achieve tax efficiency within the bounds of the law. A company may choose a transaction structure that results in the most tax-efficient outcome, provided that the structure has a legitimate economic basis and is supported by adequate documentation.
Tax avoidance refers to efforts to reduce tax liabilities by taking advantage of provisions or loopholes in tax regulations. Such practices may fall into a gray area when the transactions lack sufficient business substance.
Tax evasion involves illegal acts intended to reduce or eliminate tax liabilities. Examples include concealing income, using fictitious documents, or providing false information.
For companies, the distinction between legitimate tax planning and aggressive tax practices must be taken seriously. Article 28 paragraph (1) of Law No. 28 of 2007 on the Third Amendment to Law No. 6 of 1983 on General Provisions and Tax Procedures (“KUP Law”) provides that:
“Individual taxpayers conducting business activities or independent professional services and corporate taxpayers in Indonesia are required to maintain accounting records.”
Such accounting records serve as one of the bases for calculating and reporting a company’s tax obligations. Therefore, every tax strategy should be traceable through proper records and adequate supporting documentation.
For a broader perspective on how Indonesia compares with other jurisdictions, read our article on the comparative analysis of tax systems in Indonesia and Malaysia.
Legal Tax Planning Strategies for Companies
Effective tax planning begins with a comprehensive understanding of a company’s tax obligations. Companies should map out the applicable taxes, transactions, expenses, and relevant tax facilities.
Maximizing Deductible Expenses
One legal strategy is to ensure that all business expenses meeting the applicable requirements are properly accounted for. Article 6 of Law No. 36 of 2008 on the Fourth Amendment to Law No. 7 of 1983 on Income Tax (“Income Tax Law”) provides for the deduction of gross income by expenses incurred to obtain, collect, and maintain income.
These expenses may include the purchase of materials, salaries, interest, rent, royalties, travel expenses, administrative costs, and certain other expenses. Companies may also account for depreciation and amortization in accordance with applicable tax regulations.
However, not every expenditure automatically qualifies as a deduction from gross income. Companies must ensure that the expenses are sufficiently connected to their business activities and that all applicable administrative requirements are satisfied.
Utilizing Tax Incentives
Tax planning can also involve identifying available tax facilities. One example is tax facilities available for investments in certain business sectors or regions.
Article 31A of the Income Tax Law provides the legal basis for tax facilities for certain investments. These facilities may include deductions from net income, accelerated depreciation and amortization, and certain loss carryforward benefits.
These provisions are further regulated through implementing regulations. One of them is Government Regulation No. 78 of 2019 on Income Tax Facilities for Investments in Certain Business Sectors and/or Certain Regions (“GR 78/2019”).
In addition to investment-related facilities, companies may evaluate other tax facilities based on the characteristics of their business activities. These may include facilities relating to research and development or human resource development. For example, we have previously discussed income tax incentives for workers in Indonesia’s tourism industry and the latest VAT regulation on taxable services.
The key is to ensure that the company satisfies all applicable requirements before claiming any such facility. Utilizing tax incentives in accordance with applicable regulations does not constitute tax avoidance.
When Can Tax Planning Create Legal Risks?
Tax planning can become risky when its sole objective is to reduce tax liabilities. The risks increase when transactions lack genuine business substance or are supported by inadequate documentation.
Aggressive tax practices may exploit gray areas in tax regulations. This may increase the risk of tax adjustments and audits by the tax authorities.
One area requiring particular attention involves transactions with related parties. Such transactions must take into account the arm’s length principle and the principle of fairness and business reasonableness. The treatment of cross-border or intercompany payments, such as tax obligations on affiliate commissions in Indonesia, illustrates how the authorities scrutinize related-party arrangements.
Companies should also exercise caution when structuring transactions that do not reflect their actual business activities. Economic substance becomes particularly important when the tax authorities assess a transaction.
The Directorate General of Taxes (DGT) may conduct tax audits based on indications of non-compliance identified through concrete data or risk analysis. Such audits are intended to assess the company’s compliance with its tax obligations.
Accordingly, tax planning should be structured from a legal, well-documented, and defensible perspective.
Tax Planning Checklist for Companies
Before implementing a tax planning strategy, companies can take the following steps:
- Identify all of the company’s tax obligations.
- Map transactions and activities that have tax implications.
- Evaluate expenses that may qualify as deductions from income.
- Identify relevant tax facilities and incentives.
- Ensure that transactions have clear business substance.
- Document the economic rationale for each transaction.
- Ensure that related-party transactions comply with the arm’s length principle.
- Conduct periodic tax reviews.
- Retain supporting documents in accordance with applicable tax regulations.
Effective tax planning is not about finding ways to avoid taxes. Its primary focus is to manage tax obligations efficiently while maintaining compliance.
Conclusion
Legal tax strategies can help companies maintain efficiency while reducing tax-related risks. However, each strategy should be tailored to the characteristics of the business and the applicable regulatory framework.
Companies should also anticipate regulatory changes and developments in tax policies, such as the recent changes in the income tax rate scheme for construction services. An overly aggressive approach may instead increase the risk of tax adjustments, audits, and tax disputes.
Looking to understand the right tax planning strategy for your company? Consider consulting with legal and tax professionals before implementing any tax strategy.
Frequently Asked Questions
What is tax planning?
Tax planning is the process of structuring transactions and business activities to achieve tax efficiency within the bounds of the law. It aims to manage a company’s tax burden efficiently while remaining compliant with applicable tax regulations.
What is the difference between tax planning, tax avoidance, and tax evasion?
Tax planning is legal and uses legitimate structures supported by business substance and documentation. Tax avoidance reduces tax liability by exploiting loopholes in the regulations and may fall into a gray area. Tax evasion is illegal and includes acts such as concealing income or using fictitious documents.
Is tax planning legal in Indonesia?
Yes. Tax planning is legal as long as it complies with tax laws and regulations, is supported by legitimate economic substance, and is backed by adequate accounting records and documentation as required under the KUP Law.
What are examples of legal tax planning strategies for companies?
Examples include maximizing deductible business expenses under Article 6 of the Income Tax Law, utilizing tax incentives under Article 31A of the Income Tax Law and GR 78/2019, applying the arm’s length principle to related-party transactions, and maintaining proper documentation for every transaction.
What tax incentives are available for investments in Indonesia?
Under Article 31A of the Income Tax Law and GR 78/2019, facilities may include deductions from net income, accelerated depreciation and amortization, and certain loss carryforward benefits for investments in certain business sectors and/or regions.
What happens if tax planning is too aggressive?
Aggressive tax practices increase the risk of tax adjustments and tax audits by the DGT, and may lead to disputes and sanctions. The risk is higher when transactions lack genuine business substance or adequate documentation.
Why is documentation important in tax planning?
Indonesian law requires taxpayers to maintain accounting records. Proper documentation provides traceability for every tax strategy, supports the economic substance of transactions, and serves as a defense in the event of a tax audit.
Regulations
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- Law No. 28 of 2007 on the Third Amendment to Law No. 6 of 1983 on General Provisions and Tax Procedures (“KUP Law”) — read the regulation
- Law No. 36 of 2008 on the Fourth Amendment to Law No. 7 of 1983 on Income Tax (“Income Tax Law”) — read the regulation
- Government Regulation No. 78 of 2019 on Income Tax Facilities for Investments in Certain Business Sectors and/or Certain Regions (“GR 78/2019”) — read the regulation