Loans are debts obtained from lenders (creditors) such as persons, financial institutions, or corporate entities that provide a sum of money to borrowers (debtors). In conventional loan transactions, loans usually come with interest as remuneration borne by debtor for the loan obtained. In consequence of loan interest, amount of money that must be returned to creditor is greater than amount borrowed. Loan transactions, on the other hand, can be carried out without interest. Loans made by parent company to its subsidiaries that meet Indonesian terms and conditions are one of the conditions that allow for interest-free loan transactions.

Based on the provisions in Article 4 paragraph (1) letter f of Income Tax Law, additional economic capability in the form of loan interest is an Income Tax object. Loan interest paid to creditors who are domestic taxpayers is subject to Income Tax Article 23 at a rate of 15%, while interest on loans paid to foreign taxpayers is subject to Income Tax Article 26 at a rate of 20%. Thereupon, what are the tax provisions for interest-free loan transactions?

In Indonesia, terms and conditions for interest-free loan transactions regulated on Article 12 paragraph (1) Government Regulation Number 94 of 2010 (PP 94/2010) juncto (jo.) Government Regulation Number 9 of 2021 (PP 9/2021) which stipulates that interest-free loan transactions from shareholders received by taxpayers in the form of a limited liability company are permitted if:

1. Loans come from funds owned by shareholders and not from other parties;
2. Shareholders who provide loans have deposited all capital that should have been paid up;
3. Shareholders who provide loans are not at a loss; And
4. Limited liability company receiving the loan is experiencing financial difficulties to continue its business.

The four terms and conditions above must be met cumulatively in making interest-free loan transactions. If the loan received by a taxpayer in the form of a limited liability company from its shareholders does not fulfill one of these terms and conditions, then it is payable with a reasonable interest rate. Directorate General of Taxes or the Tax Auditor has the authority to determine a fair interest rate for this loan transaction. Furthermore, fair interest rate is interest rate determined in accordance with arm's length principle (ALP).

How to Calculate Fair Interest Rates

Based on the attachment of Chapter IV letter C of Director General of Taxes Regulation Number 22/PJ/2013 (PER-22), intra-group loans are lending activities provided by a party in a business group to other members. In intra-group loan transactions, compensation provided commonly in the form of interest rates or guarantee fees, in the case of loans guaranteed by business group, which are charged to the borrower. However, loan transactions that do not bear an interest rate or guarantee fee as referred to in the regulation need to consider the arm’s length principle of intra-group loan transactions, including:

1. Conducting debt needs analysis;
2. Ensure that loans from affiliates actually occur;
3. Performing debt-to-equity ratio fairness tests; and
4. Conduct fairness tests of interest rates or other fees related to intra-group loans.

Appendix I Chapter II letter D of Director General of Taxes Circular Letter Number SE-50/PJ/2013 (SE50) further govern regarding intra-group loan transactions examination to test the fairness of debt and capital comparison of taxpayers and to test interest rates and/or other costs related to intragroup loan transactions charged to taxpayers.

Intragroup Loans and Hidden Dividend Issues

Loans made by one member of a business group to other members, including interest-free loans, frequently attract the attention of tax authorities. In fact, this has become one of the tax court's points of dispute. There are several reasons for this, such as tax authorities do not believe in the urgency of loan transactions and loan contracts made with affiliated parties are not considered the same as (usually) loan contracts made with independent parties. Furthermore, tax authorities also believe that loan's substance is paid up capital, so transactions involving debt costs are considered hidden dividend payments.

Hidden dividends issue often results in income tax corrections that has been reported by taxpayers through self-assessment system. It will become a problem because there are differences in income tax rates charged on loan interest and dividends. To overcome this, taxpayers must be able to explain loan transaction substance to tax authorities.

Furthermore, taxpayers need to apply ALP in conducting loan transactions with affiliated parties. Bearing in mind, provisions of Article 36 of Government Regulation Number 55 of 2022 stipulates that Directorate General of Taxes has the authority to determine amount  of income if taxpayers do not apply ALP, apply ALP not in accordance with applicable regulations, and/or determine transfer price that are not comply with ALP. If there is a difference between value of transaction that is not in accordance with ALP and that is in accordance with ALP, the amount difference is considered as an indirect distribution of profits to affiliated entities so that it is treated as dividends subject to income tax in accordance with the provisions of taxation laws and regulations.

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