The digitalization of the economy presents a new challenge for tax authorities around the world, particularly in collecting tax from transnational economic transactions. Technology has changed taxpayers' business models. A transaction can be conducted remotely by email or through a website. Accordingly, establishing a physical presence in consumers' countries is not a transaction requirement.
The digital economy has a potentially significant value in Indonesia. Statista projects that digital media and digital advertising could reach US$4.12 billion in value in 2021. The e-Conomy SEA 2019 report values Indonesia's internet economy at $40 billion and projects it will more than triple by 2025 to $130 billion.
Under international tax regulations, a source country may tax the profits of an offshore business entity only if that entity conducts its business through a permanent establishment (PE) in that country. A PE is defined as a fixed place of business where the business activities are conducted, such as a branch, an office or a factory. It refers to the physical presence of an offshore entity in a source country where it conducts business activities that are not characterized as preparatory or auxiliary activities.
The primary characteristic of digital businesses is their reliance on intangible assets, which allows them to manage the value chain in some jurisdictions. It enables them to locate their operations in lower-tax countries, separate from where their consumers are located.
In this sense, a digital company can avoid establishing a PE in their consumers' country, which is required to tax business profits. In the EU, this strategy is one of the main causes of losses in tax revenue of 50-70 billion euro ($58.6-82.1 billion) per annum, or 17-23 percent of corporate tax revenues (Deutsche Bank Research, 2019).
Indonesia, which primarily fills the role of a source country, is also looking at potential revenue loss from digital taxes. Business profits made from electronic transactions in Indonesia cannot be taxed locally, as offshore suppliers shift their business profit to their jurisdiction of residence. This strategy is called base erosion and profit shifting (BEPS), and raises two key issues: potential loss of tax revenue and an uneven playing field between domestic taxpayers and offshore suppliers.
BEPS also occurs in value-added tax (VAT). As explained in the Action 1–2015 Final Report of the OECD, BEPS can occur through remote digital supplies to exempt businesses. Because input VAT is not creditable for exempt businesses, they can benefit from avoiding VAT on imported intangible goods and services.
The government has enacted Law No.2/2020 to initiate a tax policy on transnational e-commerce. Regarding income tax, the law authorizes the Directorate General of Taxation (DGT) to treat an offshore supplier that has a significant economic presence (SEP) in Indonesia as having a permanent establishment (PE). The presence of a PE enables Indonesia to tax offshore suppliers' cross-border business profits in Indonesia.
However, Indonesia's existing tax treaties rely on physical presence and do not recognize the SEP concept, which make this regulation ineffective. Accordingly, the law introduces the Electronic Transaction Tax (PTE) for taxing business profits of offshore suppliers located in jurisdictions in Indonesia's tax treaty partners. Because the PTE is outside the tax treaty, it is non-creditable in the supplier’s country of residence and could potentially raise the issue of double taxation.
Profit allocation between the source country and the residence country is another crucial issue in terms of corporate income tax. This is necessary to determine the proportion of the business profit attributed to a PE, and needs a consensus on how to share the right to tax business profits of offshore suppliers and eliminate double taxation.
Regarding VAT, the law requires offshore suppliers to collect VAT on transactions with Indonesian customers. If the aggregate value of transactions in Indonesia is more than Rp 600 million ($41,300) in a single year, suppliers can be designated as a VAT collector and be obliged to collect VAT from its customers and report and transfer the collected VAT to the Indonesian government.
The European Union (EU) and Australia have also taken a similar approach. The EU, for example, has designed the Mini One Stop Shop (MOSS) system that requires non-EU taxable persons to register in an EU member state. However, low compliance of non-EU taxable persons is a key issue in implementation, due to the high compliance cost and ineffective enforcement strategy. Another problem is determining a customer’s location, which can be at times complicated.
The Organization for Economic Cooperation and Development (OECD) is continuing to develop a unified approach that blends the new nexus (taxing right) and profit allocation rules as a framework for consensus. The unified approach proposes a new nexus rule that enables jurisdictions with no physical presence to be allocated profit. This rule focuses on large consumer-facing businesses that have a sustained and significant involvement in the economy of a market jurisdiction (OECD, 2019).
A new nexus will not be eligible for profit allocation under the current transfer pricing rules, because it does not possess function, assets or risks borne in a market jurisdiction. Accordingly, new rules are needed to allow the allocation of residual profits to a market jurisdiction as proposed in the Amount A (new taxing right) unified approach.
The sales-based profit split as proposed by Ulrich Schreiber (2019) could be an option to allocate the worldwide consolidated profit of multinational enterprises to a market jurisdiction. In this case, the profit allocated to the source country will become a corporate tax base in that country. To eliminate double taxation, the tax paid in the manufacturing country can be credited with tax payable in the source country.
As for VAT, clear criteria are needed on determining customer location to mitigate issues like that in the EU. Understanding regulation is also important, and can be supported by providing a simple system for registering, submitting tax reports and making payments. However, to ensure that the appropriate amount of VAT is collected, the DGT must enforce data exchange from financial institutions, such as on credit card transactions, and take serious actions against non-compliance.
A global consensus on taxing the business profits of a digital company is critical, because it reflects the commitment of stakeholders like jurisdictions and digital businesses to following the rules. Regulations on the digital economy should be aligned accordingly. While waiting for that consensus, optimizing VAT revenues from cross-border digital transactions is more achievable and supported by the law.
The writer is an auditor at the Directorate General of Taxation, the Finance Ministry. This is a personal view.
Disclaimer: The opinions expressed in this article are those of the author and do not reflect the official stance of The Jakarta Post.