Sept 2005 - Association of Dutch Businessmen

KNOW YOUR TAX
Indonesian financing transactions:
from 0% tax to 20% tax?
Pieter de Ridder and Michiel Boeren
Loyens & Loeff, tax advisers, Singapore
Some time ago we published an article
entitled: Indonesian financing transactions:
going Dutch or not? Now, approximately
six months later, one can observe that the
Indonesian tax authorities seem to have
decided on an entirely different path
with respect to the tax treatment of
international payments in general, and
with respect to Indonesian financing
transactions involving a Dutch BV company
(‘BV’) in particular.
Let’s backtrack: on 1 January 2004 the
tax treaty between Indonesia and The
Netherlands took effect. Pursuant to article
11 of the treaty, the Indonesian withholding
tax on interest payments to Dutch lenders
is reduced from the domestic statutory rate
of 20% to nil, provided certain conditions
are met (one of them being that the interest
is paid on a loan made for a period of at
least two years). Since that date, a number
of large international bond/notes issuances
have been conducted, using Dutch BV
companies as the issuer of these bonds and
notes. Also, a number of foreign lenders
have restructured their offshore loans to
Indonesian companies by assigning their
loan receivables to Dutch BV companies.
This was inspired by the benefit of getting
the zero interest withholding tax rate in
Indonesia, instead of the statutory 20%
Indonesian withholding tax rate (or the 10%
interest withholding tax rate in the second
best tax treaty situation). Moreover, these
transactions were helped by the fact that
Indonesia had unilaterally terminated its
tax treaty with Mauritius during 2004,
which induced many international lenders
as well as Indonesian borrowers to take
steps to restructure their existing Mauritius
financing arrangements, by moving the
loans to the Netherlands.
For some time during 2004, a rumour
had been circulating that the Indonesian
tax authorities would take the view that
the interest article in the revised tax treaty
with The Netherlands could not be applied
because Indonesia and The Netherlands had
not yet settled the mode of application of
the interest article of the tax treaty (article
11(5) of the tax treaty). Paragraph 5
stipulates that “The competent authorities
of the two States shall by mutual
agreement settle the mode of application
of paragraphs 2, 3 and 4.”
Despite the fact that this view goes
against the general interpretation
consistently applied by other countries -
as well as the official commentary on the
OECD Model Convention - and contradicts
Indonesia’s practice to date not to
challenge the mode of application
mentioned in 23 other existing Indonesian
tax treaties (as well as the previous Dutch/
Indonesia tax treaty), the Indonesian
Director General of Taxation (‘DGT’) issued
a circular on 1 June 2005 stating that
Indonesian borrowers have to withhold 10%
withholding tax on interest payments to
Dutch lenders, regardless of whether the
interest is paid on a loan made for a period
of more than two years. Technically, we
believe this decision is flawed. Practically,
it creates a lot of confusion in the
international market place.
Furthermore, on 7 July 2005, the
Indonesian DGT issued another circular
which has great impact on the application
of tax treaties generally. This circular does
not only apply to overseas interest
payments but also to overseas dividend
and royalty payments (as well as anything
assimilated to interest, dividends or
royalties) made by Indonesian payers. The
circular deals with the term ‘beneficial
ownership’, which is a term used in
Indonesia’s tax treaties dealing with
reduced withholding tax rates on dividends,
interest and/or royalty payments. It
requires the overseas recipient of the
aforementioned payments, to qualify
as the ‘beneficial owner’ of these
payments, in order to be able to
claim the reduced withholding tax
rate specified in the tax treaty.
If the recipient would fail this
requirement, the payment is
subject to 20% withholding
tax in Indonesia.
The term ‘beneficial
owner’ is not defined
in any tax treaty and
therefore in general,
but subject to
conditions, this term
must be interpreted
in accordance with
the domestic tax
legislation of the country
applying the tax treaty.
Presently, the Indonesian tax law does
not contain a definition of the term
‘beneficial owner’. In the 7 July circular,
the Indonesian DGT has attempted to define
this term in a negative form. He stipulates
that ‘special purpose companies’, ‘paper
box companies’ and ‘pass-through
companies’ are not considered to be the
‘beneficial owner’ of the payment, and
consequently the payments will be subject
to 20% Indonesian withholding tax. The
position of the DGT is expected to have
significant consequences for, inter alia,
international finance transactions involving
overseas (including Dutch) companies
acting as the lender, as these companies
in the views of the Indonesian tax
authorities may not be eligible for tax
treaty benefits. It would also have potential
negative impact on foreign holding
companies as well as overseas service or
royalty companies.
Given the fact that the circular was only
released recently, we are, together with
Indonesian tax practitioners, discussing
the circulars mentioned above with
the respective local tax authorities in
Indonesia as well as the Netherlands.
We are examining possible alternatives.
One of the suggestions being raised by
Indonesian tax practitioners, is that it may
be helpful if the BV company involved would
obtain a statement from the Dutch tax
authorities that it is considered to be the
‘beneficial owner’ for Dutch income tax
purposes. Such a statement may then
strengthen the position in Indonesia
that the BV is more than just a
‘special purpose company,
a ‘paper box company’ or
a ‘pass-through company’.
It is very important
that clarity on both the
Indonesian side as well as
the Dutch side is obtained
as soon as possible. Not only
will the recent developments
cause hesitation on how to deal
with currently existing finance
transactions, but it will also
cause contemplated new financing
activities to be put on hold and this
may affect the economic growth and
stability in Indonesia.
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Vol.15 • No. 7 • September 2005