The world consists of hundreds of different nations and legal jurisdictions, each with their own set of tax regulations. In cross-border transactions, the interaction of domestic tax systems can leave gaps that result in income not being taxed anywhere. 

Google is the poster boy of companies successfully practicing “tax optimization”. In the last couple of years, there have been intense discussions on how foreign-based online businesses have apparently failed to pay their “fair share” of tax.

Multinational internet corporations with the help of their financial advisers used the tax treaty network and international structuring regime to minimize their tax burden through various mechanisms. In the digital era, taxing multinational companies becomes a lot more complicated.

First, under international tax rules, local corporate tax will usually be levied on a business in its home country. The target country has the right to tax under traditional international tax concepts, if a non-resident business has a permanent establishment. 

Permanent establishment typically requires a relatively strong physical presence or a relatively high number of activities before a state has source-based jurisdiction over income. 

Most online businesses do not need these to do business; their online presence and payment systems are sufficient. It is very easy for businesses to claim that they have no taxable presence in a country. It becomes more difficult to apply traditional concepts to link an item of income with a certain location. 

Second, having a taxable presence is only the beginning of the story; countries then have to determine how much profit is attributable to that entity. 

There is a lack of definite legislation for guidance on this. Tax authorities have often left it to the companies to bargain with them. 

However, while negotiating, both parties will also be looking over their shoulders at their home country. 

Especially companies from the US, such as Google and Facebook, would prefer any tax they pay in other countries to be deductible as a credit against taxes to be paid in the US. 

Another question is how the government could tax a large business that has not yet been monetized, meaning it does not really earn any money, like WhatsApp? It is pretty much playing on the valuation, and taxes are applicable only when the business is sold.

Third, governments are often slow to adapt their tax laws to technology. Many countries are now struggling with how streaming video services like Netflix fit into their tax structure. 

Historically, the problem with the taxation of digital goods is that the sales tax was designed to be imposed on the sale of tangible personal property. 

The tax base has been expanded over time to include several specific services, but many digital products are a mix of an intangible product and a service. Most transactions do not systematically fit into existing tax laws. 

Indonesia’s government has tried to address some of these problems. The Communications and Information Ministry has issued Decree No. 3/2016, which stipulates that internet companies providing services in the country must establish a permanent establishment. 

Under Indonesian income tax regulations, a permanent establishment, or Bentuk Usaha Tetap ( BUT ), implies the existence of a place of business or a facility to operate a business from, be it in the form of land, buildings, warehouses, representative offices or machinery and office equipment. 

Besides such physical assets, other facilities, such as automated equipment that is owned, rented or utilized by the electronic transaction provider to conduct its business activities through the internet also fall under the definition of BUT.

Minister Rudiantara has told the media that companies failing to comply with the new regulations may be blocked from mobile networks. 

However, this scheme requires compliance by foreign internet companies, and sanctions are very difficult to impose in this situation. 

By comparison, physical products can be stopped at ports and airports. How does that process work when its digital? 

There is no choke point like customs. Everything is delivered directly to the consumer. 

Would blocking websites or applications be effective? People could always use a virtual private network service ( VPN ) that anonymizes internet activity. The government would need to block any online company that fails to comply with the regulation. 

Then how about big services like Google, YouTube and Twitter, which are widely used by the people and even by government officials?

If there are legal ways to get around paying taxes, corporations will use them. Blaming companies like Google, Facebook or Netflix is pointless. Certainly, they will not consider paying more tax anywhere than legally obligated. 

The problem is they are doing nothing illegal with their setup. It requires a concerted international effort to end tax avoidance schemes.

Multinational companies operating digital services across borders are placing an unfair burden on Indonesian taxpayers. 

Any company making money from business operations in Indonesia, regardless of where they are located, should pay their fair share of tax. 

Any tax that such companies avoid paying in Indonesia has to be made up for by local individuals or companies in the tax that they pay. Maybe our tax system is completely out of date with the modern world. Maybe it is time for a major overhaul of our tax system.

***

The author is a lawyer with a prominent law firm in South Jakarta. Currently he is interested in how the fast-growing but loosely regulated digital industry is becoming an attractive source of revenue for Indonesia.

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