Debt to Equity Ratio (DER) Implementing Regulation

Transcription

1 March 2018 Tax Alert Debt to Equity Ratio (DER) Implementing Regulation The Director General of Tax (DGT) has issued DGT Regulation No. PER- 25/PJ/2017 (PER-25) as an implementing regulation on Indonesia s thin capitalization rules, which apply a 4:1 debt-to-equity ratio approach. The primary rules are contained in Minister of Finance (MoF) Regulation No. 169/ PMK.010/ 2015 (PMK-169). This DER rule is applicable from Fiscal Year 2016 onward. However, the requirement to attach the DER calculation and any private overseas loan report starts from Fiscal Year 2017 onward. The annual reporting of the DER calculation and any private overseas loan must use the prescribed forms attached to PER-25. PER-25 provides clarification on: The relationship between the DER rule and the application of Articles 6 and 9 of the Income Tax Law. The relationship between the DER rule and the application of arm s length principle for related party debt. Borrowing costs that are not deductible when calculating taxable income. Details on the calculation of the DER. The requirement to submit a DER report on an annual basis. The requirement to submit a report on any private overseas loan on an annual basis.

2 General approach Consistent with PMK-169, PER-25 applies to broadly defined borrowing costs, which include interest, as well as premiums, discounts, guarantee fees, other costs, financing costs on borrowing, and foreign exchange gains and losses related to the borrowing. Banks, insurers and other specific industries remain outside these thin-capitalization rules. Debt and equity balances are to be calculated using the average of the month-end balances. Debt is defined in PMK-169 as including short and long term debts, as well as interest bearing trade payables. Equity is defined as balance sheet equity under Indonesian financial reporting standards, plus interest free loans from related parties. PER-25 provides a number of worked examples, showing the application of the DER and adjustments for other matters dealt with in the regulation e.g. borrowing for non-deductible purposes. The worked example also provides an approach to reduce the deductions claimed on each loan on a proportionate basis. Where borrowing costs are capitalized into the basis of a depreciating asset, the regulations can also apply to remove a proportion of those costs from the basis, reducing future depreciation deductions. Thin-capitalization limits are in addition to general deduction rules PER-25 clarifies that the deductible interest expenses permitted under the DER rules also need to satisfy Article 6 and Article 9 of the Income Tax Law, which cover the general rules for deductible and non-deductible expenses. DER rule and the application of arm s length principle for related party debt In the event a company has borrowing from its related party, in addition to the thin-capitalization regime, the interest expense is also required to meet the arm s length principle contained in Article 18(3) of the Income Tax Law. A worked example is provided showing the application of the 4:1 DER to reduce interest deductions, in a situation where the arm s length rule also applies to reduce the rate of interest on one of the loans. Interest expenses that are found not to meet this requirement will be considered as a dividend to the lender. The interest would become non-deductible and would become dividend income of the lender when the interest is paid or due to be paid. Borrowing costs that are not deductible PER-25 clarifies the borrowing costs that are not deductible in calculating taxable income include: a) The difference between borrowing costs borne by the company and borrowing costs determined by the maximum 4:1 DER; b) The difference between borrowing costs determined under the DER and borrowing costs that meet the arm s length principle for related parties; c) Borrowing costs on borrowed funds used to earn income that is not a tax object; and d) Borrowing costs on borrowed funds used to earn income subject to final tax. Requirements to submit an annual DER calculation and private overseas loan reports PER-25 sets out implementing rules on the PMK-169 requirement to attach a DER calculation attachment to the company s corporate income tax return, and attaches a standard form and instructions for this purpose. There is also a form attached to be used to report all private crossborder borrowing. This includes information on lender, jurisdiction, movements in principal, as well as the interest rate and interest expense. 2 Debt to Equity Ratio (DER) Implementing Regulation

3 If the company fails to submit the DER calculation attachment along with its annual corporate income tax return, the annual corporate income tax return submitted by the company is considered as incomplete (which can trigger potential penalties). If a company has any private cross border borrowing, it must also submit the private overseas loan report as an attachment to its annual corporate income tax return. Failure to submit the private overseas loan report along with its annual corporate income tax return, would also mean that the return is considered as incomplete. Further, the interest expense from those private overseas loans would become non-deductible. Examples for the determination of the DER, the calculation of deductible borrowing cost, and the calculation of non-deductible borrowing cost The regulation contains some useful worked examples, which form part of the regulation. Example 1: PT XXX is a manufacturing company. The Balance Sheets and Profit and Loss Statements reported by PT XXX stated the following: 1. Liabilities (in Rupiah thousand) Liabilities Position as of 31 December FY 2016 FY 2015 a. Trade payable - interest bearing 810, ,000 - non-interest bearing 700, ,000 b. Non-interest bearing loan from XXX Ltd. (related party) 50,000 50,000 c. Short term loan: - payable to PT ABC (related party) 725, ,000 d. Long term loan: - payable to PT JKL 660, ,000 - payable to WWW Co., Ltd. 1,970,000 2,500,000 - payable to XXX Corp. (related party) 1,054,500 1,984, Equity (in Rupiah thousand) Equity Position as of 31 December FY 2016 FY 2015 a. Share capital 150, ,000 b. Share premium 110, ,000 c. Retained earnings 475, , Gross income of Rp20 billion (for FY 2016). 4. Borrowing costs borne by PT XXX in the amount of Rp million consist of: a. Borrowing cost to PT ABC of Rp96 million; b. Borrowing cost to PT JKL of Rp20.66 million; c. Borrowing cost to WWW Co., Ltd. of Rp million; d. Borrowing cost to XXX Corp. of Rp million; and e. Borrowing cost on interest bearing trade payable of Rp million. Debt to Equity Ratio (DER) Implementing Regulation 3

4 Based on the available information, the calculation of DER for FY 2016 is as follows: The calculation of average payable balance: The average payable balance is calculated based on the average of each month payable balance for FY 2016 as follows: End Month Balance (in Rupiah thousand) Month Trade payable Payable to Payable to Payable to Payable to Total (interest bearing) PT ABC PT JKL WWW Co, Ltd. XXX Corp. Jan 800, , ,000 2,500,000 1,984,000 6,984,000 Feb 790, , ,000 2,500,000 1,899,500 6,839,500 Mar 750, , ,000 2,500,000 1,815,000 6,715,000 Apr 820, , ,000 2,500,000 1,730,500 6,700,500 May 850, , ,000 2,500,000 1,646,000 6,636,000 Jun 720, , ,000 2,500,000 1,561,500 6,421,500 Jul 800, , ,000 1,970,000 1,477,000 5,647,000 Aug 810, , ,000 1,970,000 1,392,500 5,572,500 Sep 845, , ,000 1,970,000 1,308,000 5,508,000 Oct 860, , ,000 1,970,000 1,223,500 5,438,500 Nov 805, , ,000 1,970,000 1,139,000 5,299,000 Dec 810, , ,000 1,970,000 1,054,500 5,219,500 Avg 805, , ,000 2,235,000 1,519,250 6,081,750 The average payable balance of PT XXX for FY 2016 is Rp6,081,750,000. The calculation of average equity balance: The average equity balance is calculated based on the average of each month equity balance for FY 2016 as follows: End Month Balance (in Rupiah thousand) Month Share Share Retained Non interest Total capital premium earnings bearing loan from XXX Ltd. Jan 150, , ,000 50, ,000 Feb 150, , ,000 50, ,000 Mar 150, , ,000 50, ,000 Apr 150, , ,000 50, ,000 May 150, , ,000 70, ,000 Jun 150, , ,000 70, ,000 Jul 150, , ,000 70, ,000 Aug 150, , ,000 30, ,000 Sep 150, , ,000 30, ,000 Oct 150, , ,000 30, ,000 Nov 150, , ,000 50, ,000 Dec 150, , ,000 50, ,000 The Avg average equity 150,000 balance of 110,000 PT XXX for FY ,000 is Rp760,000, , ,000 Based on the average of payable and average equity balances of PT XXX for FY 2016, PT XXX s DER for FY 2016 is: DER = average payable balance: average equity balance = Rp6,081,750,000/ Rp760,000,000 = 8:1 4 Debt to Equity Ratio (DER) Implementing Regulation

5 Maximum allowable DER for tax is 4:1. Therefore, the deductible borrowing cost is 4/8 1 x borrowing cost for each payable, with the calculation as follows: (In Rupiah thousand) Type of payable Average Borrowing Deductible borrowing cost payable balance costs for taxable income calculation (2) Payable to PT ABC 742,500 96,000 48,000 Payable to PT JKL 780,000 20,660 10,330 Payable to WWW Co., Ltd. 2,235, ,575 50,288 Payable to XXX Corp. 1,519, ,720 79,360 Interest bearing trade payabl 805,000 10,765 5,383 Total 6,081, , ,360 2 Deductible borrowing cost for taxable income calculation Since the payable to PT ABC is a related party payable, the borrowing cost to PT ABC of Rp48 million and to XXX Corp of Rp79.36 million that are potentially deductible for tax must also meet the arm s length principle contained in Article 18(3) of the Income Tax Law. The example of the applicable arm s length principle on the related party payable is as follows: If the borrowing cost to PT ABC of Rp96 million is interest expense with interest rate of 12% p.a. and the interest rate for non-related party is 9% p.a. so that the arm s length interest expense is Rp72 million, the deductible borrowing cost for taxable income calculation for related party borrowing cost is: (In Rupiah thousand) Type of payable Average payable balance Borrowing cost Non-deductible borrowing cost (exceeds DER of 4:1) Non-deductible borrowing cost (exceeds arm's length interest expense) Deductible borrowing cost for taxalble income calculation (1) (2) (3) (4) (5) (6) = (3) - (4) - (5) Payable to PT ABC 742,500 96,000 48,000 (a) 12,000 (b) 36,000 (a) 96,000,000 x (1-4/8) (b) (96,000,000-48,000,000a) x (96,000,000 72,000,000/96,000,000) Example 2: Continuing from example 1, we assume that PT XXX s gross income for FY 2016 includes income from land and building rental of Rp5 billion that is subject to final tax, and the borrowing cost is a common cost that cannot be separated in calculating taxable income. In such a case, the deductible borrowing cost in calculating taxable income is proportionally calculated. The deductible borrowing cost is: Rp15,000,000,000/ Rp20,000,000,000 x Rp193,360,000 = Rp145,020, /8 is a coefficient number based on maximum allowable DER for tax divided by company s DER which is 4:1 : 8:1 = 4/8 2 Deductible borrowing cost for taxable income calculation is the multiplication of the coefficient number (4/8) with each of the borrowing cost. Debt to Equity Ratio (DER) Implementing Regulation 5

6 Example 3: Continuing from example 1, we assume that: (a) the loan from PT ABC was used to buy 60% of shares in PT ZZZ, where dividend income received from PT ZZZ will not be subject to tax. The borrowing cost paid to PT ABC is Rp96 million. (b) In addition, the payable to XXX Corp. cannot be verified. PT XXX has been unable to prove that cash was received as a loan from XXX Corp. The borrowing cost paid to XXX Corp. is Rp million. Under the Income Tax Law, borrowing costs on loans used to buy shares which produce tax exempt dividend are non-deductible. Also, borrowing costs on loans which cannot be verified are not tax deductible. Therefore, the payables to PT ABC and XXX Corp. must be taken out from the DER calculation. The calculation of average payable other than the payables to PT ABC and XXX Corp is as follows: The calculation of average payable balance The average payable balance is calculated based on the average of each month payable balance for FY 2016 as follows: End Month Balance (in Rupiah thousand) Month Trade payable (interest bearing) Payable to PT JKL Payable to WWW Co., Ltd. Total Jan 800, ,000 2,500,000 4,200,000 Feb 790, ,000 2,500,000 4,190,000 Mar 750, ,000 2,500,000 4,150,000 Apr 820, ,000 2,500,000 4,220,000 May 850, ,000 2,500,000 4,250,000 Jun 720, ,000 2,500,000 4,120,000 Jul 800, ,000 1,970,000 3,430,000 Aug 810, ,000 1,970,000 3,440,000 Sep 845, ,000 1,970,000 3,475,000 Oct 860, ,000 1,970,000 3,490,000 Nov 805, ,000 1,970,000 3,435,000 Dec 810, ,000 1,970,000 3,440,000 Avg 805, ,000 2,235,000 3,820,000 The average payable balance of PT XXX for FY 2016 is Rp3,820,000,000. The calculation of average equity balance: The average equity balance of PT XXX for FY 2016 as calculated in example 1 is Rp760,000,000. Based on the average of payable and average equity balances of PT XXX for FY 2016, PT XXX s DER for FY 2016 is: DER = Rp3,820,000,000: Rp760,000,000 = 5:1 6 Debt to Equity Ratio (DER) Implementing Regulation

7 Maximum allowable DER for tax is 4:1. Therefore, the deductible borrowing cost is 4/5 3 x borrowing cost for each payable, with the calculation as follows: (In Rupiah thousand) Type of payable Average payable balance Borrowing costs Deductible borrowing cost for taxable income calculation Payable to PT JKL 780,000 20,660 16,528 Payable to WWW Co., Ltd. 2,235, ,575 80,460 Interest bearing trade payable 805,000 10,765 8,612 Total 3,820, , , /5 is a coefficient number based on maximum allowable DER for tax divided by company s DER which is 4:1 : 5:1 = 4/5 Debt to Equity Ratio (DER) Implementing Regulation 7

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