Based on the official website of the Ministry of Finance of the Republic of Indonesia, tax treaty is tax imposition of more than once by two or more countries on the same income. Tax Treaty is intended to determine the allocation of taxation rights from a transaction that occurs between the source country (the country where the source of income originates) and the country of domicile (the country where the Taxpayer resides or resides) [1].
Tax treaty is part of International Law. Tax treaty comes from the need to create cross-border trade and investment and combat tax evasion that can harm the country by exchanging information. Tax treaty is carried out to avoid double taxation and ensure that the position between countries is equal, coordinate tax rights based on international tax principles, simplify the tax dispute mechanism, and avoid discriminatory tax treatment [1].
Double taxation occurs when the tax is imposed by two or more countries on the same tax object, the same tax subject and identical period which results in the tax charged to the Taxpayer is greater than the domicile tax rate that should be borne. In other words, tax treaty occurs when the tax borne by Taxpayer on the income received is equal to the tax rate of domicile country or in total the tax borne is equal to the rate of domicile country.
Example:
ABCD Ltd. is a company in Singapore that receives dividend payments from its share ownership in one of the go public companies in Indonesia. The tax rate on dividends applicable based on the Indonesian Income Tax Law is 20% while Singapore corporate tax rate is 17%. It is assumed that Indonesia and Singapore engage in a tax treaty that states that taxes on dividends are at most subject to a rate of 10% in the source country. Several schemes might occur:
If Indonesia and Singapore do not engage in a tax treaty, the transaction is subject to a tax rate of 20% in Indonesia. This rate is 3% higher than the domicile tax rate of ABCD Ltd. in Singapore which was supposed to be covered by ABCD Ltd. This is called double taxation.
If Indonesia and Singapore engage in a tax treaty and the agreement is effective, the transaction is subject to a tax rate of 10% in Indonesia. ABCD Ltd. You can then submit proof of withholding tax on dividends when you return to Singapore and will only be subject to tax in the amount of the remaining domicile tax rate difference that should be borne at the tax rate agreed in the Tax Treaty, which is 7% in Singapore (17% -10%) This is what is known as tax treaty.
Like many other international public laws, the Lotus Principle is used as the basis for tax treaty. The Lotus Principle or the Lotus Approach states "sovereign states may act in any way they wish as long as they do not contravene an explicit prohibition", that every sovereign state is authorized to do anything as long as it does not oppose an explicit prohibition. Concerning taxation regulations, tax treaty principle is that every country has the authority to apply any taxation in its country based on its authority as long as it does not oppose the existing prohibition. A tax treaty is agreed upon between two jurisdictional countries. To date, there are 67 tax treaties in effect between Indonesia and other jurisdictions listed on the DGT official website (more information in the following link).
Some basic aspects of Tax Treaty according to Brian J. Arnold are as follows
- Tax treaty is an agreement between sovereign nations;
- The obligations arising from tax treaty only appear for the two countries engaged in the agreement. Not for third parties like Taxpayer;
- Tax treaty is binding for two engaged countries and must be implemented in good faith;
- Tax treaty is commonly between two countries (bilateral), however, it also applies for more than two countries (multilateral agreements);
- Tax treaty is reciprocal;
- Tax treaty represents an important aspect of international taxation of many countries;
- The majority of countries are structured around a large part of the United Nations model and the OECD model.
The rules concerning tax treaty are contained in Article 32A of the Income Tax Law which states that "The government is authorized to enter into agreements with governments of other countries in the context of avoiding double taxation and preventing tax evasion". Thus, the application of a tax treaty is lex specialis and will override general legal rules, namely the Taxation Law in Indonesia. However, tax treaty regulation is not provided to replace Indonesian tax law. Tax treaty only restricts domestic taxation of a country, in this case the applicable tax laws in Indonesia.
The majority of tax treaties throughout the world are prepared based on the OECD Model and the UN Model, accompanied by commentaries as an interpretation and reference tool. However, there are several different views on the existence of commentaries in the application of tax treaty. Although compiled by a team of OECD experts, the OECD Commentary Model is not designed to be legally binding. This also applies to the UN Model Commentary which even explicitly states the prohibition of its use as a formal recommendation and can only be used as a reference. Like many other countries, the OECD Model Commentary and the UN Model are not legally binding instruments in Indonesia but are highly relevant to be used as a reference.
In general, the tax object stipulated in tax treaty is Income Tax, thus the taxation rights are regulated based on the resident who receives income or “resident recipient”. Income covered by tax treaty includes all income of the resident, regardless of the source country taxes it or not and what tax base is used. Tax treaty does not regulate resident taxation and does not affect the authority of resident countries to tax residents because resident countries are free to tax their residents. Furthermore, tax treaty addresses the determination of the resident and the distribution of taxation rights to the state in the agreement.
Tax treaty also provides general interpretations for the two countries. If the provisions between countries differ, then the two authorities will discuss to agree on the definition of something. To facilitate understanding of tax treaty, it is advisable to read tax treaty by paying attention to related agreements, such as protocols and Multilateral Interpretation (MLI).
In general, here are the steps for implementing tax treaty
- Domestic Law Application.
The country in the agreement first reflects an income transaction in the domestic tax law applicable in that country. If based on domestic taxation provisions there are taxation rights (there is income tax based on Indonesian tax rules). - Tax Treaty Utilization Rights
The country in the agreement will assess whether tax treaty can be applied and subsequently make a legal comparison of the income tax and tax treaty. If there are differences in Income Tax and Tax Treaty rules, then Tax Treaty is used (as long as they do not conflict with domestic tax law, the nature of tax treaty only restricts them). Tax treaty then identifies the information of the resident who receives the income. - Distributive Rule
States engaged in Tax Treaty should classify income into the application of the distributive rule by examining the scope of the distributive rule. - Relief
States engaged in Tax Treaty will check whether the relief is applicable (in this case if the other state in the engagement applied taxes). - Conclusion
Finally, states engaged in Tax Treaty concludes whether or not there are restrictions on domestic legal applications by tax treaty.
Reference:
[1] Ministry of Finance. 2020. Penjelasan Singkat Persetujuan Penghindaran Pajak Berganda (P3B) atau Tax Treaty.
[2] Brian J. Arnold. An Introduction to Tax Treaties.
[3] Law of The Republic of Indonesia Number 17 of 2000
[4] Law of The Republic of Indonesia Number 11 of 2020
corporate-tax-income , tax-treaty
