Thin
capitalization
Generally a company will be financed through a mixture of debt and
equity. In the situation where a company is financed through a relatively high
level of debt compared to equity, this condition is well known as thin capitalization
(“thin cap”). Thin cap is popular because a
company by having the higher level of debt will enable to deduct more interest and will have lower taxable profit. For this
reason, debt is often a more tax
efficient method of finance compared to equity. Multinational or nationals
groups are often to restructure their
financing arrangement to maximize this benefit.
For this reason, tax administrations of every country try to
introduce rules that place a limit of the amount interest to be deducted for
calculating taxable income, such as US that introduced thin cap rule in 1969. Thin
cap rule is intended to prevent or counter cross-border profit shifting through
excessive debt and to protect country’s tax base.
Thin cap rule
in Indonesia
Pursuant
to Article 18 (1) Income Tax Law, MoF is authorized to issue a regulation on
debt equity ratio for the purposes of computing tax payable in accordance with Income Tax Law. Elucidation of that article provided that:
This law authorizes the Minister of
Finance to prescribe the ratio of the company's liabilities to the company's
equity, which shall be valid for tax purposes. In a commercial business, there
is a certain level of arm's length debt equity ratio. If debt equity ratio of a
company is higher than the arm's length debt equity ratio, in general the
company is economically not in good condition. In such case, this law considers
it as disguise equity for the purpose of computation of taxable income.
The term "equity" shall be
referred to the term equity in accordance with the general accounting principles,
and the term arm's length or ordinary business means fairly engage in business
activities
Historically,
in October 1984, the MoF through Decision Number 1002/KMK.04/1984, had
issued a regulation that stipulated a debt-to-equity ratio (DER) of 3:1 as a
legal basis for the determination of deduction for interest expenses as part of
the corporate income tax calculation. Six months later, MoF through Decision
Number 254/KMK.04/1985 dated 8 March 1985, postponed (without limitation) the implementation of the
regulation based on the view that the regulation might hamper the investment
climate in Indonesia.
Thin cap rule is now reintroduce by the issuance of MoF-169 that revoked
the aforementioned regulations.
Brief summary of MoF-169 :
- This regulation essentially limits the amount of tax-deductible borrowing cost arising from the debt to a maximum DER of 4:1.
- This ratio will be effective from Fiscal Year 2016.
- PMK-169 has defined equity to include equity as defined by GAAP and shareholder’s free interest loan. It has also defined debt to include short term loan, long term loan, and interest bearing account payable.
- Cost of borrowing is defined to include:
- Interest;
- Discount and premiums in connection with the debt;
- Additional costs incurred in relation to the arrangement of borrowings;
- Finance charges on lease financing;
- Guarantee fee; and
- Foreign exchange differences arising from loans in foreign currencies as long as the differences are adjustments to the interest expense and other expenses (as referred to in b, c, d and e.)
-
Any borrowing cost on debt which exceeds this ratio will not be
tax deductible for corporate income tax purpose. For example, if the Taxpayer’s
DER is 5:1, one fifths of the borrowing cost will be non-deductible for income
tax calculation. It is applied to both related- and third-party debt, whether
foreign or domestic.
- The calculation of the debt or equity itself will be based on the average debt or equity balance at the end of each month in the relevant fiscal year
- Exemption for certain sectors which are guided by special rules, such as:
- Banks;
- Financing institutions;
- Insurance and re-insurance companies;
- Mining, oil and gas enterprises that are bound by Production Sharing Contract, Contract of Work or Coal Contract of Work which itself governs the DER. If the contract does not include a provision for the DER or the contract has expired, MoF-169 will prevail;
- Companies subject to Final income tax; and
- Infrastructure companies.
- Administrative requirement is added that taxpayers with foreign private debt also need to submit a report on the amount of the debt to the DGT. Failure to comply will result in a disallowance of the borrowing cost attributed to the foreign private debt. The DGT will issue an implementing regulation separately for the procedure to report foreign private debt
Comments
MoF-169 is well
designed compared to former 1984 regulation. The new ratio of 4:1 is under common practice
(see table below ). Indonesia employs ratio that is the range, from the lowest, New Zealand that employs
ratio of 0.75:1, and the highest, Switzerland that
employs ratio of 6:1 . Although MoF-169 adopts single ratio that does not take
into account specific market or situation, but the rule is simple to implement
and provides a great deal of certainty.
MoF-169 also
put anti avoidance provision by using average amount of loan
and equity in one year to calculate DER. This approach will counter what
is well know as “bread and breakfast” practice. This refers to a practice when
the debt level is reduced immediately before the end of financial statement reporting
period and then increased again after
the reporting period.
DER is also related to transfer pricing therefore MoF-169 requires that the application of DER to related
party has to follow arm’s length principle. For instance, if a company that has DER of 2:1
and want of maximize DER to 4:1 by lending unnecessary loan to related parties,
DGT will make an adjustment for the interest expense in accordance with arm’s
length principle guidance.
Source of table : IMF Working Paper 1412
No comments:
Post a Comment