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s young and entrepreneurial nations, Indonesia and Australia must strive to position themselves to prosper in the twenty-first century, where free trade and intangible and intellectual capital are increasingly becoming the dominant drivers of economic prosperity.

The resumption of talks earlier this year aimed at concluding the Indonesia-Australia Comprehensive Economic Partnership Agreement (I-ACEPA) is a welcome development, as these two nations seek to deepen strong trade and other economic ties for their mutual advantage.

The I-ACEPA is a free trade agreement that proposes to reduce or eliminate barriers to trade between Indonesia and Australia such as import and export tariffs as well as other, less obvious barriers including reforming and reducing business regulation and competition policy where appropriate.

However, significantly less focus to date has been on a corollary issue for all potential exporters: taxation.

Where businesses operate in or have connections to both Indonesia and Australia, perhaps resulting from the successful implementation of the I-ACEPA and reduction in trade barriers, their business activities will likely be subject to the taxation regime of both countries.

In order to avoid enterprise killing “double taxation”, or paying two taxation levies on the one profit, most nations have entered into bilateral double tax treaties.

These treaties regulate which nation (or both) has the right to tax income derived from cross-border investment and business activity and contain methods to avoid double taxation where both countries have the right to tax the one income. Indonesia and Australia entered into such a treaty called the Current Tax Treaty on Dec. 14, 1992.

The Current Tax Treaty is based generally on the 1992 OECD model tax treaty, modified to address particular requirements by both Indonesia and Australia at the time.

For example, the definition of “Permanent Establishment” in the Current Tax Treaty is considerably broader than the 1992 and current OECD model tax treaties, including (amongst other things) farms and rigs or ships used for the exploration and exploitation of natural resources.

Whether a foreign business’s activities in the host treaty country are taxable at the normal rate usually depends on whether that foreign business is deemed to have a permanent establishment there.

With agriculture and natural resources making up large components of the Indonesian and Australian economies, it was in both countries’ interests to broaden the definition of “permanent establishment” in their respective double tax treaties to ensure an equitable amount of taxation was paid by foreign investors and businesses.

Since entering into the Current Tax Treaty, however, the Indonesian and Australian economies have evolved considerably alongside increased administrative burdens on business and advances in competition policy.

More broadly, the nature of global investment and business is increasingly digital and reliant on intangible and intellectual property.

A key issue facing the taxation authorities of most nations today is aggressive or artificial taxation avoidance by global corporations selling digital and electronic based goods and services.

These corporations are readily able to shift where their or their subsidiary companies’ taxable profits are generated to taxation havens and away from the countries in which they operate.

In response, global bodies such as the OECD and national governments have been developing new laws and co-operating amongst themselves to reduce the erosion of taxation revenue derived from economic activity taking place in countries such as Indonesia and Australia.

Such responses include the introduction of “diverted profits taxes”, which impose a high rate of tax on the profits of businesses where profits from their operations in the host country are artificially diverted to a foreign country, and the resulting tax liability is significantly less than would have arisen in the host country.

As part of the I-ACEPA negotiations, Indonesia and Australia should also update the Current Tax Treaty in light of the evolution of their economies and global developments since 1992.

The “non-discrimination” clause included in the 2014 OECD model tax treaty should be incorporated. This clause would seek to ensure that Indonesian and Australian businesses operating each other’s economies are not subject to any taxation or requirement that local businesses do not similarly face.

A non-discrimination clause would very much be within the spirit of the I-ACEPA and in line with recent developments in both nations’ economies and competition policy, providing more certainty to relevant businesses that they will not be at an unfair competitive disadvantage.

Another update should be a change from the “credit method” to the “exemption method” in addressing double taxation under Article 24. The credit method allows a credit against a business’s domestic tax liability for taxation paid to foreign countries, whilst the exemption method exempts (foreign) taxed profits from foreign operations when assessing a business’s domestic tax liability.

The evolution and modernization of the Indonesian and Australian economies and taxation systems has resulted in a staggering administrative complexity and often inequity from the credit tax method.

Issues include differences in the “tax base” between countries resulting in excessive or insufficient tax credit and which foreign taxes are recognized as creditable domestically and against which domestic taxes they should be credited.

Finally, with Australia committed to introducing a diverted profits tax and Indonesia exploring this possibility, how such a tax could be levied on each other’s businesses needs to be addressed.

Indonesian or Australian companies subject to a diverted profits tax by the other nation could arguably claim a credit for the amount of this tax against their domestic taxation liability, a credit the domestic taxation authority may be unhappy to allow.

Agreement on how diverted profits are to be treated under the Current Tax Treaty and whether the credit allowed under Article 24 is allowable needs to be reached and any required amendments made.

Reducing or eliminating barriers to trade is a necessary step to deepening the already strong trade and other economic ties between Indonesia and Australia, to their mutual advantage.

However, ensuring the cross-border taxation regime faced by Indonesian and Australia companies is modern, responsive and fair will be crucial in unlocking the full benefits potentially available by the implementation of the I-ACEPA.
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The writer, an Australian banking and finance lawyer, has practiced law at major international law firms in the UK and Australia for almost six years.