JP/Dhoni Setiawan

Many countries are now facing a major issue concerning digital economies: they cannot impose taxes (either direct or indirect) on digital companies selling digital and non-digital goods or services through websites or online platforms. This issue arises because current international tax rules are no longer compatible with digital business models.

For direct taxes, especially income tax, a source country cannot tax digital companies because there is no nexus or relationship between an income and the country where the income is generated. Due to international tax rules, a source country has the right to tax business profits derived by foreign residents only if there is a fixed place of business called a permanent establishment (PE) in the country.

Unfortunately, in many tax treaties, including those of Indonesia, the word “fixed place” mainly refers to a physical presence in the source country. In this emerging digital world, the definition of PE should be redefined as a foreign resident company that can easily run a business and sell goods or services without having a physical presence in the source country. So, no PE, no tax. That is why many digital companies, including giant techs such as Google, Facebook and Amazon, remain nontaxable due to existing treaties.

Many tax authorities also face big challenges in imposing indirect taxes — which are not as complicated as direct taxes — from digital companies, especially value-added tax (VAT). Under a destination principle rule in VAT, a country can tax goods or services that are consumed in the country regardless of the origin of the sellers (either residents or nonresidents). However, the application of destination principle and VAT collection from nonresident sellers is not easy, considering the fact that they can run their business and sell goods or services without having a physical presence.

The issue now is how to create a level playing field for digital and traditional business. So, what’s the solution?

The Organization for Economic Cooperation and Development (OECD) — through the Inclusive Framework, of which Indonesia is a member — issued a policy note in January. The note highlights its view that a source country should have more taxing rights in cross-border transactions involving digital companies. There are three concepts for expanding the taxing rights of the source country, namely User Participant, Significant Economic Presence (SEP) and Marketing Intangibles. A global consensus on which concept will be agreed among the members of the Inclusive Framework is expected to be achieved by 2021.

While waiting for the consensus, the Indonesian government has taken a bold step in its endeavor to tax the digital economy by proposing a draft bill, namely Taxation Provisions and Facilities for Strengthening the Economy, to the House of Representatives a couple of weeks ago.

The government opted for the SEP concept, broadening the definition of a classic PE. By this concept, a foreign resident company will be constituted to have a PE if it generates significant income from the country, despite having no physical presence in Indonesia. However, there will be a two-to four-year waiting period until the draft is approved by the House.

So is there something we can do to create a level playing field for traditional and digital business until the draft bill is enacted? Well, we do not have any specific regulations to tackle digital companies with regard to direct taxes or indirect taxes. While we have moved one step forward to imposing income tax by proposing a SEP concept, we still, however, do not have rules to collect VAT from foreign resident sellers or companies.

Therefore, it is good to consider what other countries do in their attempts to tax the digital economy.

In 2018, the European Union Commission proposed the “interim tax” to tackle loopholes in taxing digital economies. This tax aims to create a level playing field and to generate more revenues across the EU amid the difficulties in taxing digital businesses. This measure can be considered as a bridging-measure or a temporary solution until the proposed SEP concept under the EU law is implemented to all member states.

This interim tax targets foreign digital companies’ income from advertising, data collection activities and online platform intermediaries such as online marketplace apps. This measure imposes a three percent tax rate that applies only to companies with worldwide revenues of more than 750 million euro (US$822.907 million) and 50 million euro in annual EU revenues.

So small businesses and start-ups remain untaxed, giving them an incentive to grow. Some countries like India and Israel have also taken this kind of unilateral measure in their domestic rules.

Our neighbor, Australia, can be a good example of how to enforce VAT on nonresident suppliers selling goods or services within the country. As of July 1, 2018, those suppliers are required to register, report and remit VAT through a “simplified registration” mechanism if their turnover exceeds A$75,000 ($50,497). This measure certainly promotes a level playing field.

To identify prospective nonresident suppliers, the Australian Taxation Office (ATO) profiled those suppliers by using its data resources, including from the Exchange of Information, commercial databases and collaboration with other institutions, such as customs and a financial intelligence unit called Austract.

The ATO took persuasive communication measures to engage eligible international suppliers about these new VAT rules in the first stage. If the suppliers neglect to comply, the ATO will take necessary enforcement actions.  

In the end, imposing VAT on nonresident sellers is about providing a mechanism for them to pay VAT and to effectively communicate the mechanism because the VAT rules are basically in place. Finally, it will remain a big question of whether we should leave the level playing field unfair and lose the opportunity to collect more taxes from digital businesses.

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The views expressed are their own

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