Promoting FDI through a tax treaty
In addition to its main function to eliminate double taxation, a tax treaty is also intended to promote foreign direct investment (FDI).
Investors normally consider the treaty networks of a targeted investment country in deciding their investments. The more extensive the treaty networks, the more attractive for the investors. Extensive treaty networks would be used by the investors to structure the investment returns to achieve the most efficient structure, with the ultimate aim to reduce total tax costs. A treaty can facilitate this and is legally accepted by any tax authority.
Indonesia has signed tax treaties with more than 60 countries and is one of the most extensive treaty networked countries in the region. The government should use this in wooing FDI into the country.
The recent development of the Indonesia-Netherlands Treaty can be used as a very good example. The amendment of the treaty was signed at the end of July. The treaty is expected to woo investment from European Union countries and other countries using the Netherlands as their investment hub.
The Netherlands has been playing an important role to bridge the investment from EU countries because the Netherlands has adopted participation exemption, so no additional tax would be imposed in the Netherlands, and no further tax would also be imposed if profits are repatriated to the ultimate parent company within the EU.
The Netherlands is probably the most extensive treaty network country with around 100 treaties. The Netherlands is also commonly used for international headquarters and hub office operations by many multinational companies.
So a treaty with the Netherlands plays a very strategic role in promoting FDI in Indonesia.
However, the use of the Netherlands as an investment hub had been disrupted in the past because of a different interpretation of treaty provisions between Indonesian and Dutch tax authorities.
It was noted that the Indonesian tax authority did not agree with the application of a zero percent withholding tax on interest payments introduced by the 2002 treaty by reason of treaty abuse.
The new treaty with the Netherlands provides more certainty with respect to the most important provision for the investor.
The withholding tax on dividends is now being reduced from 10 to 5 percent if the beneficial owner is a company directly holding at least 25 percent of the capital of the distributing company. Furthermore, the most disputed provision, the withholding tax on interest payments, is now agreed at 5 percent.
This new treaty will enter into force on the first day of the second month following the date on which last government notified the other state of having completed the procedures for bringing the treaty into force.
In the current situation, it would be better if the Indonesian government hasten the ratification process by the House of Representatives so the treaty would apply immediately.
The treaty with the Netherlands may be one of the most attractive and competitive tax treaties entered into by Indonesia. This momentum can be used by the government to woo FDI into Indonesia by actively promoting the benefit from the treaty.
On the other hand, it is expected also that the tax authority will equally view the treaty as not merely losing tax revenues, but in a broader macro view. The more FDIs enter into Indonesia, the more potential tax revenues there would be. Consistent application of the treaty would be the key factor to woo FDI into Indonesia.
