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New Indonesian Tax Incentives

In June 2019, the Indonesian government issued GR 45/2019, which sets out a series of tax incentives for businesses that invest in labor intensive industries, training programs, as well as research and development (R&D).

GR 45/2019 also amends GR 94/2010 to expand the criteria for taxpayers eligible to receive tax incentives irrespective of industry. Under GR 94/2010, those eligible for tax facilities were those that had invested in pioneer industries.

Taken together, the incentives are designed to encourage more foreign direct investment (FDI), expand the skilled labor base, and develop industry.

Investment in labor-intensive industries

Taxpayers that invest or expand into labor-intensive or pioneer industries can enjoy a net income reduction of 60 percent of their total investment in the form of tangible fixed assets, which
includes any land used for the main business activities over a certain period.

The Ministry of Industry defines a labor-intensive industry as one that employs a minimum of 200 workers with labor costs not exceeding 15 percent of production costs, while the Ministry of Finance defines a pioneer industry as one that provides value-added economic consequences to surrounding areas.

To attain this tax facility, the taxpayer must not obtain any other tax allowance facilities under Article 31A of the Income Tax Law.

Still, investors will need to wait for upcoming Ministry of Finance regulations that are expected to explain the duration of the facility period and more details on the specific industries that are eligible for the tax incentive.

Foreign investors can take advantage of this new incentive – along with the country’s manufacturing base, competitive labor costs, and large consumer market – to establish bases in Indonesia for key sectors, such as textiles and garments, commodities, as well as services.

Greater FDI into labor-intensive industries will generate employment and help improve the existing infrastructure and business ecosystem – companies that invest now will also benefit from a first mover advantage.

Apprenticeships and training activities

Investors looking to start apprenticeship programs or training activities to develop workers based on ‘certain competencies’ can receive a gross income reduction of up to 200 percent of the total costs incurred. The regulation defines ‘certain competencies’ as developing human resources that can meet the labor requirements needed by national industries and businesses.

This incentive will be particularly advantageous for foreign companies that need to develop a skilled labor pool or improve the efficiency of their operations. Meanwhile, companies already based in the country who undertake regular training of its workers, especially those in high-end manufacturing, such as automotive production and electronics, will benefit.

This incentive will likely increase demand for vocational training, which offers further downstream opportunities for investors. Language courses for instance, are in high demand as students and professionals are eager to equip themselves with the language skills needed to compete in today’s global economy.

Furthermore, the fields of hospitality and IT are also becoming increasingly popular as many secondary schools do not have the capabilities to prepare students for the job market. The country is also in dire need of quality teachers, another opportunity for foreign investment in vocational education.

R&D activities

Taxpayers that engage in R&D initiatives can receive a tax facility of 300 percent in gross income reduction of total costs incurred. To avail of this facility, the taxpayer must be conducting R&D that is assessed by the government to be advancing the national economy, new industries and technologies, or transfer of foreign technology to local businesses.

It is still unclear whether the 300 percent tax reduction is applicable for the first year only or for every year and investors will have to wait for the upcoming Ministry of Finance regulation for further details.

This incentive is designed to encouraging more companies to generate innovation and shift to more high technology industries and products, whether it be developing specialized fabric finishes or new farming cultivation methods. This type of innovation is a necessity for expanding industries.

Indonesia is currently behind its neighbors in the field of R&D. According to UNESCO, Indonesian companies only conducted some half a million dollars’ worth of R&D compared to that of Malaysian and Singaporean companies, which conducted US$4 billion and US$6 billion, respectively.

However, Indonesia has plenty to contribute to the world of science, technology, and academia. Its position on the Asia Pacific ring of fire presents unique opportunities for foreign education partners in niche subjects, such as herbal medicine, in addition to marine science, renewable energy, and horticulture technology — Indonesia is the world’s largest exporter of crude palm oil— among many others.

Indonesia as an investment destination

This regulation could hamper short-term tax revenue growth. Meanwhile, other measures, such as good governance, infrastructure development, and the streamlining of business licence procedures need to also be implemented to fully harness the impact of these tax incentives.

These challenges are evident in the country’s ranking of 134 out of 190 countries in the Starting a Business indicator in 2019, despite its rise in Ease of Doing Business ranking from 91 to 73 in 2018.

But GR45/2019 shows some ambition.

Despite China’s position as the leading manufacturer of goods in the world, its evolving economy, increasing labor costs, as well as the ongoing trade war with the US, has caused manufacturers to move their operations, or partly, to markets in Southeast Asia, such as Indonesia.

[tips title="Did You Know"]This ‘China plus one’ approach allows foreign businesses in China to diversify their manufacturing strategies and protect themselves against a wide-range of risks and Indonesia has emerged as a strong investment destination for businesses using this strategy as a result of its established manufacturing base and comparatively low operating costs.[/tips]

However, challenges remain if Indonesia would like to take full advantage of the changing trade and investment environment in Asia.

While the country is developing its knowledge-based economy, and moving up the value-added chain, its growing industries find a shortage of skilled labor, in addition to technology and infrastructure challenges.

Policies like GR45/2019 will aim to attract significant foreign and domestic private investment to solve these issues and raise the country’s competitiveness on the global stage.

Income Tax Incentives: Opportunities in Specific Sectors and Regions in Indonesia

Indonesia’s government on December 13, 2019, issued Government Regulation 78 of 2019 (GR 78, 2019), which sets out a variety of income tax incentives for businesses investing in specific industries and provinces in the country. 

These incentives come in the form of tax deductions, the accelerated depreciation of fixed tangible assets, and the accelerated amortization of intangible assets. The regulation also increases the period for fiscal loss compensation, in addition to setting the income tax rate on dividends for foreign taxpayers at 10 percent. 

GR 78, 2019, along with GR 45, 2019 (which was issued earlier this year), are designed to encourage more foreign investment and develop major industries. As such, investors should seek the assistance of registered local tax advisors to better understand how these incentives can best benefit their business. 

What are the criteria for the incentives?

Investors will need to meet various requirements to be eligible for the incentives under GR 78, 2019

They are only allowed to: 

  • Invest in specific sectors as listed in Appendix I of the regulation (page 28); and
  • Invest in specific sectors in certain provinces in Indonesia as listed in Appendix II of the regulation (page 71). 

These sectors include pharmaceuticals, geothermal energy, and IT, among others Additionally, investors must:

  • Prove that their investments are of high-financial value;
  • Prove that the sector they are investing in is export-oriented;
  • Have their business absorb a large workforce (labor-intensive); and
  • Utilize high volumes of local content in any production process. 

Net income deduction

Taxpayers that fulfil the aforementioned requirements are eligible to receive a net income reduction of 30 percent of their total investment of any fixed tangible assets. This incentive is granted for up to six years with annual deductions set at five percent. 

The fixed tangible assets (which includes land) must be utilized in core business activities. The assets must also be documented on principal business and investment permits, as well as investment registration certificates. Moreover, the assets must be obtained in new condition, unless it is being imported or relocated from overseas. 

Accelerated depreciation of assets

Under GR 78, 2019, taxpayers are eligible to receive a tax incentive in the form of the accelerated depreciation of their fixed tangible assets. This type of depreciation reduces the taxable income much earlier in the life of the asset and thus businesses can reduce their tax liability. 

There are two methods to measure depreciation used in the regulation – straight-line method, and the declining balance method. 

Under the straight-line method, the depreciating value of the asset is spread evenly for every year the asset is still functional, useful, and profitable. The formula for calculating straight-line depreciation is as follows: 

Straight-line depreciation = (cost of the asset- estimated salvage value (value of an asset at the end of its residual life)) ÷ estimated useful life of the asset

Through the declining balance method, a constant percentage decrease is applied to the value of the asset each year. This results in greater depreciation in the early years of the asset and smaller depreciation in the later years.

GR78, 2019 sets out the two methods and their new depreciation percentages as well as the length of the benefit periods as stated in the following table. 

Methods of Calculating Depreciation of Assets

Class of fixed tangible assets

Benefit period

Depreciation tariff

 

Straight-line method

Declining balance method

Non-buildings

Class I (e.g. wooden furniture, printers, scanners, photocopiers, computers, motorbikes, telephones, buses, taxis, steel buoys etc.)

2 years

50%

100%

Class II (e.g. metal furniture, cars, trucks, tractors, agricultural machinery, semi-conductor equipment etc)

4 years

25%

50%

Class III (e.g. machinery for the production of textiles, garments, bleaching, drying, machinery for the production of chemicals, cargo ships, passenger ships, airplanes, helicopters etc)

8 years

12.5%

25%

Class IV (e.g. heavy equipment, trains, cars, passenger ships, cargo ships that weigh above 1,000 deadweight tonnage (DWT), floating docks etc)

10 years

10%

20%

Buildings

Permanent

10 years

10%

-

Non-Permanent

5 years

20%

-

Accelerated amortization of intangible assets

GR 78, 2019 provides for the acceleration of the amortization of intangible assets. The benefit period and depreciation tariffs are as shown in the following table.

Amortization of Intangible Assets

Class of intangible assets

Benefit period

Depreciation tariff

 

Straight-line method

Declining balance method

Class I

2 years

50%

100%

Class II

4 years

25%

50%

Class III

8 years

12.5%

25%

Class IV

10 years

10%

20%

Fiscal loss compensation

In Indonesia, businesses that are operating at a loss can be compensated in the following tax period for five years. Under GR 78, 2019, this period is extended, for up to 10 years.

An additional one-year of compensation is granted if investors implement one of the several options laid out in the regulation. These are: 

  • Invest in a sector and region as stated under GR 78, 2019;
  • Invest in industrial or bonded zones;
  • Engage in activities related to renewable energy;
  • Assign 10 billion rupiah (US$600,000 million) on social infrastructure programs;
  • Utilize domestic raw materials or components by at least 70 percent by the second year of operations; or
  • Employ at least 300 local workers and maintain this number for four consecutive years.  

To gain a two-year extension, investors can: 

  • Employ 600 Indonesians and maintain this number for four consecutive years;
  • Assign at least five percent of their total investment value to research and development aimed at improving their products or services; or
  • Export at least 30 percent of their total sales in a fiscal year (applies to specific sectors and are not located in bonded zones).

Imposition of dividends

The new regulation states that the rate of income tax on dividends paid to foreign taxpayers who do not have a permanent establishment in Indonesia is set at 10 percent; unless there is an applicable double tax agreement (DTA) in place, from which the lower rate between the two countries is used.

OSS submission

To apply for these incentives, taxpayers will need to submit their application to the government’s Online Submission System (OSS), and the approval will be issued within five working days.

On September 6, 2019, the Ministry of Finance issued Regulation No. 128 of 2019 (GR 128, 2019), which sets out tax incentives for businesses that invest in developing talent in Indonesia. 

GR 128, 2019 follows the tax incentives provided in GR 45, 2019, which set out a range of tax incentives for investment in labor intensive industries, training programs, as well as research and development (R&D). GR 128, 2019 is specific to the incentives offered for training programs, and clarifies that human resource development activities include apprenticeships, work experience programs, vocational programs, and learning activities. 

The government hopes this regulation will help attract foreign investors that would like to shift part of their supply chain or sell to the country’s massive market. Some analysts report that the size of Indonesia’s skilled labor base has limited the growth of the country’s industries and their competitiveness in comparison to its neighbors in Southeast Asia. 

[tips title="Important Tip"]Under GR 128, 2019, investors can receive a gross income deduction of up to 100 percent for the total costs incurred for internships, learning sessions, and training activities.[/tips]

To receive the additional 100 percent tax deductions, taxpayers must provide evidence for the following requirements: 

  • A ‘Cooperation Agreement’ with government registered vocational schools, schools, higher- education institutions, or government agencies that organize manpower affairs regarding human resources development activities;
  • The human resources development activities were conducted within ‘certain competencies’ that are taught in vocational schools, higher-education institutions, training centers, or at diploma-program institutions;
  • Not in any financial loss during the fiscal year; and
  • Submit a fiscal certificate that proves the taxpayer is complying with current tax obligations. 

GR 128, 2019 describes ‘certain competencies’ as developing specific skills for industries deemed by the government as being vital for the country. These include sectors such as manufacturing, healthcare, agribusiness, digital economy, and tourism, among many others. A full list can be found on page 14 of the regulation. 

What costs are covered by the incentive?

Under GR 128, 2019, the total ‘costs incurred’ include the following: 

  • For the provision of physical facilities in the form of supporting physical facilities for the purpose of carrying out the human resources development activities;
  • Utility bills such as for electricity, water, fuel, maintenance costs;
  • Costs incurred for hiring instructors or educators;
  • Costs for goods and materials for these activities;
  • Honorarium payments given to participants of the human resources development activities (these are not eligible to participants who have a relation of blood family, business, or ownership with the owners and/or administrators of the taxpayer); and
  • Competency certification costs.  

Developing local talent to improve competitiveness

Despite the country issuing various tax incentives and widening the number of positions open to expatriate workers, a major issue continuing to plague foreign investors is the skills mismatch of the Indonesian workforce. 

The regulation will be advantageous for investors who already have operations in the country and are looking to develop their skilled labor pool. This could improve efficiency and increase employee productivity, enabling businesses to move up the value-chain. The country was ranked 67 out of 119 in the Global Talent Competitiveness Index report in 2019, lagging behind Malaysia (27), the Philippines (58), and Thailand (66), and Singapore (17). 

Sectors that could benefit from this new law are those in hospitality and IT, particularly since the government has been pushing for an increase in international tourists and the establishment of more digital startups. The government wants to reap the economic potential of this sector after witnessing the success of local tech company Go-Jek, which contributed US$3 billion to the country’s economy in 2018. 

Furthermore, GR 128, 2019 could develop other downstream opportunities, such as increasing demand for language – especially for English – and technical training courses, which will become increasingly important as Indonesian companies become more integrated with the global supply chain.

 

 

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