The revisions to the current income tax and value added tax laws are still under discussion. The main changes currently proposed are:

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1 Highlights The amendment to the law on tax administration was passed in July 2007 and will come into effect 1 January Among the most significant changes are: The statute of limitations has been reduced from 10 years to 5 years The payment obligations for disputed tax assessments have been relaxed Greater flexibility for correction of tax returns The revisions to the current income tax and value added tax laws are still under discussion. The main changes currently proposed are: Continued commitment to reduce the income tax rates Beneficial owner is now specifically addressed with respect to withholding tax on payments to non residents Treatment of VAT on services is clarified The government has issued several implementing regulations to the new investment law, Law No.25/2007. However, many issues remain to be resolved or clarified and we expect it will take some time before the new procedures are in place. At this time, the role of BKPM (the Investment Coordinating Board) and revisions to the investment negative list are among the key issues being discussed. Of particular significance are the following: Presidential Regulation No.90/2007 regarding the reorganization of BKPM has been issued The grandfather clause in the investment negative list (Presidential Regulation No.77/2007) will be clarified BKPM s role as the one stop shop is under discussion These and other issues are discussed below. Tax Update Tax Administration Law Indonesia adopted a new tax administration law in July 2007 (Law No.28/2007) which will bring about some significant changes. Below are the highlights. Tax Audits A critical change in this law is the shortening of the statute of limitations for tax assessments and collection of taxes from 10 years to 5 years. However, this period may be extended where a taxpayer has been convicted of a criminal breach of the tax laws or other laws which result in a loss to the state. Although taxation rights and obligations for 2007 and prior years will remain subject to the former tax administration law, the statute of limitations for those years will not extend beyond 2013 (i.e. the statute of limitations for fiscal years will be 2013). Records must still be kept for tax purposes for 10 years. Harsono Hermanto & Partners is the advisor of choice for providing business, investment and related tax and customs advisory services to multinational and domestic companies in a wide range of business sectors.

2 Listed companies which are subject to an audit as the result of a tax overpayment request or were selected under the normal risk analysis process, may have the audit performed as an office audit, which is a faster and simpler procedure than the usual field audit. To qualify, the company must have attached its audited financial statements to its tax return and had an unqualified audit opinion from their external auditors. Tax Assessments and Disputes Under the former law, a taxpayer is required to pay the full amount of a disputed tax assessment prior to filing an objection. Under the revised law, only that portion of the assessment which is agreed during the closing conference must be paid before initiating the objection process. If the objection is subsequently rejected, in whole or in part, and this is not appealed, a 50% penalty will apply on the underpaid tax. If the decision is appealed to the Tax Court and the appeal is rejected, in whole or in part, a 100% penalty will apply on the underpaid tax. Alternatively, as before, the taxpayer can pay the full disputed amount and if that amount is eventually reduced on objection or appeal, the taxpayer is entitled to interest at 2% per month, up to 24 months. Given the uncertainty of the objection and appeal process, and the severity of the penalty if the taxpayer loses, as a practical matter we expect companies will simply opt to pay the full disputed amount. A taxpayer who is considering filing an appeal may request, and the tax office must provide, a written explanation concerning the basis for the decision to reject an objection. Any documents or other information which were not provided during the audit will not be taken into consideration during the objection process, unless such information had not yet been obtained from third parties. The rules pertaining to the correction, reduction or cancellation of tax assessments, tax collection letters and decision letters have been revised: If the tax authority fails to respond to a taxpayer s request for a correction of typographical errors, calculation errors or the inappropriate application of the tax law within 6 months (12 months at present), the request for restitution will be considered accepted. Taxpayers can request that a tax assessment be cancelled if they were not provided with written findings during the tax audit or if they were not given the opportunity to attend the closing conference. Sanctions on Tax Officials Tax officials have been known to summarily reject objection applications, issue arbitrary audit findings and abuse their power in other ways. The new law has strengthened the administrative and criminal sanctions for misconduct by tax officials. Although this is a positive development, it remains to be seen what effect it will have in practice as taxpayers may be reluctant to bring action against a tax official and, even if done, providing evidence of misconduct may be difficult. Tax registration If the tax office officially registers someone who should have been registered, taxes will be payable retroactively from the date income was generated or operations began, up to 5 years before the date of registration. Thus, tax obligations may arise prior to obtaining a tax registration number. However, individuals who register voluntarily in 2008 will be granted amnesty from administrative sanctions on the underpaid taxes and will not be subject to tax audit, unless their returns are subsequently found to be incorrect. The revised law now imposes a time limit for the tax office to confirm an application to deregister a tax number of 6 months for individuals and 12 months for companies. Tax Returns Under the former law, annual income tax returns were to be lodged 3 months after the year end and 2

3 paid by the 25 th of that month. Now, annual corporate income tax returns are to be lodged 4 months after the year end and the tax must be paid prior to the due date for lodgment of the return. There is no change to the deadline for lodging individual income tax returns. A 2 month extension to lodge the annual return (reduced from 6 months) may be obtained through a notification letter rather than the current request for approval. There are several changes regarding the correction of tax returns, including: Returns may be corrected within the 5 year statute of limitations, provided no tax audit has begun. However, corrections to a tax loss or tax overpayment must be lodged within 3 years of the year end. If a tax loss is changed as a result of a tax assessment or a decision on objection, appeal or judicial review, the company may correct its tax returns for subsequent years within 3 months. If tax returns for years prior to 2007 are corrected within 12 months of the new law coming into effect, administrative penalties may be cancelled or reduced. Administrative penalties for late lodgement of tax returns will be increased, with fines ranging from Rp. 100,000 1,000,000 (previously Rp 50, ,000). Other Interest has been awarded on applications for objection or appeal; under the revised law, interest will also be awarded upon reconsideration to the Supreme Court or a correction request. Interest will continue to apply to underpayment assessment letters and will also apply to nil assessment letters. Tax authorities can request information relating to taxation from third parties including government agencies, agencies and associations and failure to provide such information will be a criminal offense. Similarly, it will be a criminal offense for directors, employees, public accountants and tax consultants, among others, to advise or assist in the commission of a criminal offense. A deliberate failure to maintain accounting records in Indonesia will be a criminal offense. For a first time offense, anyone who, due to negligence, fails to submit a tax return or submits a false return, is subject to an administrative penalty of up to 200% of the unpaid tax or, for subsequent offenses, a jail sentence of 3 12 months. A taxpayer who deliberately fails to file or files an incorrect or incomplete tax return is subject to a penalty of % of the underpaid tax and a possible jail sentence of 6 months to 6 years. Income Tax Law and Value Added Tax Law: Proposed Changes Income Tax Beneficial Owner A non resident is subject to a 20% withholding tax on income received from Indonesia. For dividends, interest or royalties, this rate can be reduced by tax treaty where the recipient is the beneficial owner of the income. For years, no proof of beneficial ownership was required in order to take advantage of the reduced treaty rates. However, the tax office has begun to scrutinize certain transactions more closely to ascertain whether the party receiving the interest is, in fact, the beneficial owner. Reference to the beneficial owner of income is now specifically mentioned in Article 26 of the proposed draft income tax law. The draft law states that the country of domicile of a nonresident taxpayer which has no permanent establishment in Indonesia and receives income 3

4 from Indonesia is determined based on the residence or domicile of the offshore taxpayer who is the actual recipient of the income ( beneficial owner ). According to the elucidation, the domicile is the country where an individual resides, or in the case of a legal entity, the country where 50% of the shareholders are domiciled or the place from where the business operations are effectively run. Although this does not provide a clear definition of beneficial owner it is evidence that the tax office will review transactions with overseas parties more closely than in the past. In particular, we expect the use of conduit companies will be subject to full scrutiny and, consequently, their use may need to be avoided in the future. Of concern is that the tax office may view all special purpose companies (SPC) as conduits, and scrutinize them accordingly. If this provision is included in the final law, cross border transactions which use SPCs should be reviewed to ensure they have sufficient justification and substance. Anti avoidance Provisions As in previous drafts, steps are being taken to combat what the government views as abuses of the tax law. An Indonesian company which uses an offshore SPC to buy shares or assets of another Indonesian company at a price that is not arms length may be deemed to be the actual purchaser of the shares or assets. Where an offshore resident has a permanent establishment or holds shares in an Indonesian company through a conduit or SPC which is located in a tax haven country and this conduit or SPC has a special relationship with the Indonesian entity, if the offshore resident sells the shares in the conduit or SPC to a third party, the sale of shares could be treated as a sale of shares in the Indonesian company or sale of the permanent establishment. Permanent Establishment The definition of what constitutes a permanent establishment is extended. Unless tax treaty protection is available, tax will be payable on the profits of: Mining and quarrying of natural resources A dedicated server which carries on business electronically, which is owned by a foreign resident (this is intended to cover on line business transactions conducted through the internet) A warehouse (although certain activities may be protected by tax treaty) Tax Rates For corporate tax, a single flat of 30% will apply, as opposed to the progressive tax rates currently imposed. This will be gradually reduced to 28% and 25% by The reduced rate may be accelerated for publicly listed companies. For individuals, the rates will be as follows: Up to Rp. 50 million 5% Rp. 50 million Rp. 100 million 15% Rp. 100 million Rp. 200 million 25% Over Rp. 200 million 35% The highest rate will be gradually reduced to 33% and 30% by To encourage tax registration, the following surcharges will be applied on payments to recipients who have not registered for tax purposes: Employees and individuals (Article 21) 20% more than the normal rate Transactions subject to Article % of the normal rate Transactions subject to Article % of the normal rate 4

5 The impact of the 20% surcharge for unregistered employees should be reviewed as this could have an impact on tax planning and remuneration policies. Other Income subject to final tax, at a rate yet to be determined, is extended to include: Dividends received by individual taxpayers and mutual funds Income received from transactions involving bonds, government securities and derivatives traded on a stock exchange Deductible expenses are extended to cover, among others: Scholarships Donations connected to disaster relief, research and development, and educational facilities Development of social infrastructure Value Added Tax VAT on Services and Intangible Goods The treatment of VAT on the export of services is not specifically covered in the current law. Consequently, some tax officials have stated that VAT does not apply, while others claim VAT applies at 10%. For consistency, services should be treated the same as goods; tangible goods are subject to 10% VAT on import and 0% on export. Under the current and proposed law, services which are performed offshore but the beneficiary is in Indonesia (imported services) are subject to 10% VAT, which is self assessed by the Indonesian taxpayer. The applicable test in this case is where the services are used. Regarding the treatment of VAT on exported services, under the proposed draft, if services are performed by an Indonesian company for a beneficiary outside Indonesia, VAT will apply at 10%, but if the services are performed wholly outside of Indonesia, 0% VAT applies. Thus, for exported services the test is where the services are performed. We believe it should be irrelevant where the services are performed and, therefore, it would be more appropriate if all services provided to overseas parties were subject to 0% VAT. Under the proposed law, the export of intangible goods (e.g. trademarks, copyrights, etc.) will be subject to VAT at 0%. VAT Refund Under the current law, all taxpayers may apply for a VAT refund on a monthly basis. The draft law limits this to certain taxpayers, including exporters of goods, suppliers to VAT collectors, taxpayers who are not obliged to collect VAT and taxpayers in the pre production/start up period. Other taxpayers will need to wait to claim a refund at the end of the tax year. This is intended to free up the tax office s resources, however most companies, other than those listed taxpayers, should be in a profitable/vat paying position in which case refunds should not arise. This revision could create difficulties for companies which are expanding their production facilities or purchasing additional inventory. Restructuring Transfer of title to assets resulting from a merger will not be subject to VAT, provided all entities are registered for VAT purposes. This should simplify the administration of input VAT claims and avoid refunds. However, we think this treatment should also apply to other types of restructurings, such as consolidation and expansion. Other VAT incurred on the purchase of capital goods and services during construction or pre production may be credited or refunded. However, if the taxpayer fails to enter production, then the input VAT which had been refunded should be repaid to the tax office on the grounds the taxpayer is the final consumer. 5

6 Only input VAT which is paid to a supplier of goods or services is creditable, which reflects a change from an accrual basis to a cash basis when calculating input VAT. This approach is inconsistent with the recognition of output VAT, which should be reported and paid to the tax office in the month the VAT invoice is issued, even though the buyer has not paid yet (i.e. accrual basis). The maximum rate of sales tax on luxury goods is increased from 75% to 200%. We believe this rate is excessive and could increase illegal smuggling activities and it is hoped that this will be reconsidered before the final law is passed. Investment Update Implementing regulations for the new investment law, Law No.25/2007, are being discussed and it is hoped that these will be issued in the near future to provide guidance on the new investment procedures and facilities. On a positive note, the government is consulting with the business community to obtain its input on several issues of importance to investors. BKPM restructured Presidential Regulation No.90/2007 reorganized the BKPM so that it will now have a Head, a Deputy Head, a Prime Secretariat, an Inspectorate and 6 Divisions. This regulation reiterates that BKPM is to coordinate capital investment and itemizes a wide range of functions to be undertaken by the BKPM, including studying and recommending a national investment plan, establishing the appropriate procedures and issuing licenses. In addition, a new Capital Investment Committee may be formed to gather input from experts and the community and provide it to the Head of BKPM. Grandfather Clause The new investment negative list was issued in July 2007 and will soon be revised. Due to the lack of consensus within the government, the plan is to revise the list in stages, thus allowing the uncontroversial changes to take effect as soon as possible. One critical provision which we understand will be one of the first to be addressed is the grandfather clause. Presidential Regulation 77/2007 states that the regulation (a) does not apply to investments which have already been approved, but (b) will be applied to any change other than a change in the composition of shareholders. Thus, it is unclear precisely which changes could render an investment subject to the new rules. We understand that the government is currently considering how to clarify this provision and we await further developments. BKPM: The One Stop Shop The new investment law states that a company engaged in business activities must obtain a license issued by an authorized agency. This agency may be at the central or regional administration level. In order to simplify the process, the license will be obtained through the one stop integrated service to be coordinated and implemented by BKPM. The plan is to abolish the BKPM approval system; however, it is not clear what system will replace this. Discussions are underway concerning the appropriate procedure for how business and operating licenses should be issued in the future. However, this is a monumental undertaking as an entirely new procedure is contemplated. In addition, the question of how much control or input regional governments should have over investments in their jurisdictions must be resolved. Therefore, it is unknown when, if ever, the BKPM will become a true one stop shop. Local Shareholder Requirements Among the major stumbling blocks to investment have been the numerous foreign ownership restrictions imposed on many business sectors. In 6

7 the past, before an investment application could be approved, BKPM took into consideration the investment negative list, BKPM s internal technical guidelines as well as unwritten policies; other ministries could also impose additional requirements if the activity fell under their jurisdiction. The new investment negative list is intended to provide greater transparency and certainty to investors by providing a complete list of sectors which are (a) closed to any investment, (b) open only to domestic investment, and (c) open to foreign investment but with restrictions. All restrictions, including local shareholder requirements, location restrictions, the need to obtain special permits and/or the need to partner with micro, small or medium scale businesses, are now itemized in detail. The restriction of greatest concern to foreign investors is the increased local shareholding required for many business sectors. Before the new negative list was issued, the business community was optimistic that local shareholding requirements would be relaxed. Unfortunately, these have become more onerous in several critical sectors. We do not expect any significant changes to local shareholding requirements at this time, although we remain hopeful that they will be addressed in the future. For additional information, please contact: Sudirman Plaza, Plaza Marein 9th Floor Jl. Jend. Sudirman Kav Jakarta 12910, Indonesia Telephone: +62 (21) Facsimile: +62 (21) Dwi Ary Retnani, Senior Director dwiary.retnani@harsonopartners.com Terri Shreve, Technical Advisor terri.shreve@harsonopartners.com The information contained herein is of a general nature and should not be assumed to apply to the circumstances of any particular person or entity. Although we try to provide accurate and timely information, we rely on a variety of sources for information about tax and other developments and we cannot guarantee that such information is accurate when received or that it will continue to be accurate in the future. Appropriate professional advice should be sought to determine the effect of the matters raised herein on any particular situation. Corporate Briefing is a copyrighted publication and may not be reproduced without the express written consent of HH&P. 7