Indonesia

Yusuf Wangko Ngantung and R. Herjuno Wahyu Aji

1 Characteristics of the Indonesian CFC Legislation

1.1 Indonesia’s worldwide tax system

Residents of Indonesia are subject to tax on their worldwide income, regardless of whether the income
is derived from sources within or outside Indonesia. Double taxation for foreign sourced income is
mitigated through tax credits, which is granted unilaterally by Indonesia irrespective whether there is
tax treaty or not. All tax treaties concluded by Indonesia also applies the tax credit method as method
for elimination of double taxation. Whether the foreign income is passive in nature or active in nature
(permanent establishment income), the tax credit method applies for all foreign sourced income of tax
residents of Indonesia.

There are further no exemptions for foreign sourced income, i.e. even intercompany dividends from
substantial ownership is taxable, except for intercompany dividends from substantial ownership that are
distributed by a resident taxpayer to a resident taxpayer. Given the above, it is not surprising that
Indonesia tax system is classified as a predominantly worldwide tax system and that is regarded as one
of the few countries in the world that are strict followers of the residence principle1.

On the other hand, non-residents are taxable only for their income that is sourced from Indonesia. Non-
residents that do not have a permanent establishment in Indonesia are taxed by way of withholding. In
this case, income is considered sourced from Indonesia if the income is paid or accrued by a resident
taxpayer or a permanent establishment in Indonesia. While non-resident with a permanent establishment
are taxable not only for income that is attributable to that permanent establishment but also profits of
the enterprise as a whole whether or not the profits are derived from performance or activities through
that permanent establishment, i.e. the so-called force of attraction rule. Nevertheless, the effect of the
force of attraction rule is somehow limited as Indonesia does not consistently insist a force of attraction
clause in its tax treaties. The essence is however that Indonesia also applies some degree of territoriality
principle for its non-resident taxpayers, but for resident taxpayer, Indonesia is a predominantly
worldwide tax system. Of course, then a controlled foreign corporation (“CFC”) rule is necessary, as
the concept of worldwide taxation and capital export neutrality cannot be achieved if tax deferral is
possible.

1.2 History of Indonesia CFC regulation

Indonesia CFC rule was enacted as one of the six specific anti-avoidance rules in Article 18 Income
Tax Act (“ITA”) which came into force in the year 1984. The CFC rule is provided in Article 18 (2)
ITA and states that:

“The Minister of Finance is authorized to determine as when dividends are accrued

by a resident Taxpayer on capital participation in an offshore company other than
public companies, provided that one of the following condition is met;

1
Wei Hwa See, “The Territoriality Principle in the World of the OECD/G20 Base Erosion and Profit Shifting
Initiative: The Caes of Hong Kong and Singapore – Part I, Bulletin for International Taxation, IBFD, January
2017, p. 46.
 (1)the Taxpayer owns at least 50% of the paid in share capital of the company; or

(2) the Taxpayer together with other resident Taxpayer own at least 50% of the paid
in share capital of the company.”

(unofficial translation)
The elucidation of Article 18 (2) ITA states:

“In line with the globalization and the enhancement of economic and international
trade, resident Taxpayers may invest in an offshore company. To minimize tax
avoidance, the Minister of finance is authorized to determine as when dividends
accrued by a resident Taxpayer on participation in an offshore company other than
public company.

Example:
PT. A and PT. B respectively own share of 40% and 20% in X Ltd. which is
domiciled in country Q. X Ltd. is not a public company. In 2009, X Ltd’s net income
after tax is Rp 1,000,000,000.00 (one billion rupiah). In such case, the Minister of
Finance is authorized to determine the timing when dividends are deemed to be
received on accrual basis and the basis of calculations.”

(unofficial translation)
As with many other tax laws of Indonesia, it is often the case that subsequent detailed regulations on a
specific topic are delegated to other government institution, such as in the case of the CFC to the
Minister of Finance (“MoF”). This is to ensure that regulations are more flexible to change rather than
laws which must go through the complex political process and approval from the People’s
Representative Body. As a consequence of this delegation of powers to the MoF, CFC rules in Indonesia
were subject to several substantive changes throughout the years, without the wording of the law itself
being amended.

The first implementing CFC regulation is MoF Regulation 650/1994, which added a designated
jurisdiction approach , i.e. a defined or listed low-tax countries. The list of countries included:
Argentina, Bahama, Bahrain, Belize, Bermuda, British Isle, British Virgin Isle, Cayman Island, Channel
Island Greensey, Channel Island Jersey, Cook Island, El Salvador, Estonia, Hongkong, Liechtenstein,
Lithuania, Macau, Mauritius, Mexico, Netherland Antilles, Nicaragua, Panama, Paraguay, Peru, Qatar,
St. Lucia, Saudi Arabia, Uruguay, Venezuela, Vanuatu, Greece, and Zambia. The policy consideration
why Indonesia chose this approach is unclear and not published. Nevertheless, it could be reasonably
assumed that the list of countries in majority represents countries that have indeed low tax rates in
comparison with Indonesia standard and/or countries that are typically associated with designation of
tax havens. CFC’s in low taxed countries are typically targeted because the effect of tax deferral
benefits, i.e. time value of money, is greater when foreign income that benefits from deferral is taxed
at lower effective rate than domestic income.2 It may the case the low-taxed country list is how
Indonesia reflects its purpose of CFC regulation as stated in the elucidation of the law, namely to prevent
tax avoidance.

The second change on CFC regulation is MoF Regulation 256/2008. Now, the list of low-tax countries
is entirely abolished. Again as with other regulations in Indonesia, the policy considerations are rarely
published. Presumably the reason for abolishing the designated jurisdiction approach is due to the lack
of an objective criteria, pressure from other countries and trend of decreasing tax rates around the Asia
Pacific region. Instead MoF Regulation 256/2008 only regulates on administrative aspects such as
timing of reporting and CFC income calculations, which is not new and was earlier already adapted in
MoF Regulation 650/1994. As a consequence of the deletion of the low-tax country list also means that

2
Brian J. Arnold, “A Comparative Perspective on the U.S. Controlled Foreign Corporation Rules”, Tax Law
Review, Volume 65, 2012, p. 477.
Indonesia CFC regulations under MoF Regulation 256/2008 operates as an global jurisdiction approach,
i.e. CFC regulations apply irrespective whether the CFC is located in country with low tax rate or not.
In fact, the CFC regulations are now not targeted at all, because it also lacks a targeted criteria to
determine income of CFC that is attributable to its resident shareholders. Indonesia resident taxpayers
that owns at least 50% or more of the shares of a CFC are subject to Indonesia tax on their share of all
of the CFC’s income as booked under retained earnings. There are no exemptions from the CFC
regulations for active income or active entities with substance, in other words as long as the share
ownership threshold is met then all income of the subsidiary company is captured under the CFC rules.
The only exemption in this regard are public companies, which are not captured under the CFC rules.

The third change and present CFC regulation is MoF Regulation 107/2017. The background of this
change is to close certain loopholes in the old regulation MoF Regulation 256/2008. Specifically MoF
Regulation 107/2017 targeted the following loopholes: (i) indirect ownership of CFC’s, (ii) ownership
through other rights than shares for example trusts, and (iii) partial dividend distributions. Indeed
although MoF Regulation 256/2008 has already quite wide applicability due to the global jurisdiction
approach and lack of targeted criteria to determine CFC income, nevertheless the regulation has serious
loopholes that has been exploited throughout the years3.

The first loophole is with regard to the definition of CFC, namely on the criteria of legal control which
in the CFC regulation is deemed to be present when a taxpayer owns 50% of the shares. Indonesia CFC
regulation also includes a constructive ownership rule to prevent taxpayers from fragmenting share
ownership among related person in order to avoid the ownership threshold. Note however that the issue
is the fact that the proxy to determine legal control is only share ownership. In fact the law nor MoF
Regulation uses the term “legal control” at all, and instead refers to CFC’s with the criteria of share
ownership only. This has raised the question whether indirect controlled entities fall within the scope
of CFC regulation, in particular because the Indonesia resident shareholder does not own (directly) any
shares of the indirect controlled entity. The argument is strengthen by the fact that under Article 18 (4)
ITA, the legislator actually used the wording direct or indirect ownership in defining related parties. As
such, should the intend of the law is to include indirect ownership also for CFC purposes, then the
legislator should have used a consistent wording also in Article 18 (2) ITA concerning CFC. However
the legislator has chosen not to do so which could be interpreted that CFC does not apply for indirect
controlled entities. MoF Regulation 107/2017 now state that income of subsidiaries that are owned
indirectly for at least for 50% of the shares are attributed to the directly held CFC and such as subject
to the CFC rule4.

The second loophole is still within the area of the definition of CFC, namely on the criteria of legal
control through ownership of shares. The fact that law and the old MoF Regulations only state “shares”,
has been interpreted that control though other rights than shares is not captured by CFC regulations, i.e.
trust, partnerships or other entities whose capital is not divided by shares. MoF Regulation 107/2017
fixed this loophole by stating that trust or other similar entities are treated as transparent entities, i.e.
the Indonesia resident shareholder is deemed to hold the share ownership directly as if the intermediary
entity/body does not exist5.

The third loophole is with regard to circumstances that triggers CFC income to be attributable to the
Indonesia resident shareholder. According to MoF 256/ 2008 such circumstance is when the relevant
CFC does not distribute dividends to its entitled shareholders within a prescribed month after the end
of the tax year. In other words, if dividends are factually distributed by the CFC before the prescribed
date, then the CFC regulations will not be triggered. After all, there is no tax deferral anymore if the
dividends are factually distributed to the shareholders. This exemption has been abused by partial
dividend distributions, for example if entitled dividends amounts to 100, then only 10 is distributed as
dividends while the remaining 90 is deferred. The issue with exemption in MoF 256/2008 is that it does

3
Presentation by Danny Septriadi during Ikatan Akuntan Indonesia – International Tax Conference 2017.
4
Article 4 (3) and (4) MoF Regulation 107/2017.
5
Article 4 (8) MoF Regulation 107/2017.
not prescribe the amount of dividends that must be factually distributed in order to avoid consequences
of CFC regulations. MoF Regulation 107/2017 closed this loophole by stating that the remaining part
of profits that the Indonesia resident shareholder is entitled to, but has not been factually distributed yet
by the CFC remains subject to CFC regulations6.

1.3 Features of Indonesia’s CFC regime

Further to the above, the main features of Indonesia CFC regime under MoF Regulation 107/2017 could
be summarized as follows.

1.3.1 Definition of a CFC

A CFC is a foreign company that is owned directly of at least 50% of the total paid-in share capital by
a resident taxpayer (whether individual or corporate) or a foreign company is owned by resident
taxpayer for a participation that represents at least 50 % of all the voting rights. If a foreign company is
held through a trust or similar bodies, then the trust is regarded as a transparent. The CFC rule includes
a constructive ownership rule to prevent fragmentation of share ownership through other resident
taxpayers that are not necessarily related to avoid the ownership threshold. In other words CFC may be
deemed to exist even if there are non-related resident taxpayers that collectively own more than 50% of
the shares of a foreign company.

Furthermore indirect ownership of shares are calculated separately for each level, for example:

PQR Ltd in this case is a direct CFC of PT GHI because the share ownership of PT GHI in PQR Ltd
exceeds 50%. STU Co. is an indirect CFC because STU Co is owned more than 50% by another CFC
of PT GHI. On the other hand, VWX Co. is not a CFC because VWX is not directly owned by PT GHI
nor indirectly owned by another CFC of PT GHI for more than 50%.

1.3.2 Level of foreign tax paid by a CFC

Indonesia CFC regulation operates as a global jurisdiction approach, i.e. Indonesia CFC regulations
apply irrespective whether the CFC is located in country with low tax rate or not and whether the actual
foreign tax paid is low or not. In other words, even in the case that a CFC is subject to foreign tax that
is equal to or greater than Indonesia taxation, the CFC rules still applies and there are no exemptions
on this aspect.

1.3.3 Nature of income earned by a CFC

The CFC rules does not distinguish between active or passive income neither relevant is whether the
CFC entity have sufficient business activity in its country of residence (such as office and number of

6
Article 6 MoF Regulation 107/2017.
employees) or not. The CFC rules simply applies to all CFC’s income, which in this context refers to
profit after tax including other income in accordance with applicable accounting principles in the
country of residence of the CFC and after deduction of income tax due in country of residence of the
CFC, i.e. retained earnings. All income booked under retained earnings falls under the scope of income
that is subject to the CFC rules, which will be attributed to the Indonesia tax resident shareholder
proportionately to their share ownership in the CFC.

The CFC income must be reported in the annual tax return by the Indonesia resident shareholder as
deemed dividend income, which is subject to normal tax rates for individuals (progressive rates up to
30%) or companies (25%). Note in this regard that Indonesia intercompany dividends participation
exemption regime for substantial share ownership only applies for domestic share participations, i.e.
share ownership in a Perseroan company. As such, Indonesia shareholders with CFC’s will never
qualify for a participation exemption.

There are no specific regulations pertaining to the situation when financial information of the CFC is
unavailable. Note however that CFC income is included in the items to be reported under the annual
tax return obligation. As part of annual tax return obligation, taxpayers that do not report CFC income
are subject to the risk of penalties and potential criminal persecution for not filing a correct tax return
under the General Provision and Tax Procedure Law. Due to this risk together with the possibility of
tax authorities to obtain information from exchange of information with countries, it could be assumed
that tax authorities will rely on the self-assessment system to enforce the CFC rule.

1.3.4 Computation of CFC income

The computation of CFC income attributed to the Indonesia resident shareholder could be explained by
the following example.

XYZ Ltd. retained earnings amounts to USD 1,500,000 which amount does not include dividends from
MNO Pte Ltd. PQR Ltd. retained earnings amounts to USD 3,000,000, which amount does not included
dividends from MNO Pte Ltd. MNO Pte Ltd. retained earnings amounts to USD 1,000,000.

The CFC income attributed to PT ABC and PT DEF is computed as follows.

 PT ABC : 60% x (USD 1,500,000 +[70% x USD 1,000,000]) = USD 1,320,000

 PT DEF : 50% x (USD 3,000,000 +[20% x USD 1,000,000]) = USD 1,600,000

Note that the lower tier CFC (MNO Pte Ltd) is considered a CFC from the perspective of PT DEF
because of the constructive ownership rule, i.e. a foreign company that is collectively owned more than
50% by resident taxpayers of Indonesia.

Furthermore, the CFC rule also provides relief from double taxation in situations where the CFC
actually distributes dividends out of the income that has already been attributed to the resident
shareholder under the CFC rule. This relief operates like a loss carry forward for a maximum of 5 tax
years, such as the following example.
PT ABC, a resident taxpayer, received dividends amounting to USD 2,000,000 in the year 2022 from
a XYZ Ltd, an foreign entity that qualifies as CFC. In the previous 5 years, PT ABC has been subject
to CFC rules and reported the following amounts as deemed dividend income from XYZ Ltd.

Deemed dividends in reported in tax year 2018, 2019, 2020, 2021 and 2022 amounts to respectively
USD 200,000, USD 700,000, USD 500,000, USD 400,000 and USD 100,000. As such the dividends
received by PT ABC from XYZ Ltd in the year 2022 is subject to tax as follows: USD 100,000 (actual
dividends received – deemed dividends reported in the last 5 tax years) x corporate income tax rate.

1.3.5 Exemption for public companies

A notable feature of the Indonesian CFC rule is the exemption for public companies, i.e. if a Indonesia
resident shareholder owns shares of a foreign public company then the CFC rule does not apply. The
exemption goes as far as indirectly owned subsidiaries that are held through a foreign public company.
In other words, the chain of CFC could be broken if subsidiary entities are held through a public
company. Arguably the public company exemption is based on a the presumption that shares of a
publicly traded companies are generally widely-held and are subject to stringent securities legislation,
these companies are unlikely to be established for tax avoidance purposes. This rationale does not have
a generally applicability in countries, as there are also countries that have sufficient flexible corporate
and securities legislation that might very well invalidate this presumption7.

1.3.6 Foreign tax credits

The Indonesian CFC rules allows a credit for foreign taxes actually paid, but only for CFC tax on the
directly held companies and as such not including the CFC tax assessed on lower tier companies. The
actual tax paid refers foreign income tax on dividend payments by the CFC to the Indonesia resident
shareholder (i.e. dividend withholding tax) and does not include foreign tax on the CFC income itself
(i.e. corporate income tax on the CFC itself). The credit for foreign taxes actual paid is further restricted
to the lower amount between foreign tax that should have been due if a tax treaty is applied, the foreign
tax actually paid, or the proportion of the deemed dividend on the total taxable income multiplied by
the total tax due in the Indonesia taxpayer tax return. There are further administrative requirements in
order to claim foreign tax credit such as the CFC’s financial statements, corporate tax return, calculation
or lists of profits after tax for the past five years and tax payment or withholding tax slip on the actual
dividends paid.

1.3.7 The timing of deemed dividends

If the CFC is required to file a tax return in its country of residence, then the deemed dividend will be
assumed to have been accrued by the Indonesia taxpayer on the fourth month after the tax return
deadline of the CFC. In the case the CFC has no tax return filing obligation in its country of residence
then the deemed dividends will be assumed to have been accrued by the Indonesia taxpayer on the
seventh month following the end of such CFC’s fiscal year.

2 Implementation of Articles 7 and 8 of the Anti-Tax-Avoidance Directive

Not applicable.

7
See a similar discussion on the public company test in the context of LOB in Luc de Broe and Joris Luts,
“BEPS Action 6: Tax Treaty Abuse, Intertax, Volume 43, Issue 2, Kluwer Law International, 2015, p. 129.
3 Special CFC Rules
Indonesia does not have special CFC rules. Article 18 (2) ITA and MoF Regulation 107/2017 have a
general applicability to all resident taxpayers and there are no other anti-deferral rules.

4 CFC Legislation and Other Anti-Abuse Provisions

The ITA does not contain explicitly a General Anti Abuse Provision (”GAAR”).8 According to
Mansury9 however the ITA does contain general applicable substance-over-form doctrine that is
embedded in Article 4 (1) ITA as follows:

“Any increase in economic capabilities received or accrued by taxpayers, both

originating from Indonesia as well as from outside of Indonesia, which can be used
for consumption or for increasing the wealth of the taxpayers concerned, in
whatever name and form, including gains from the sale or the transfer of all or any
part of mining rights, participation in financing, or capitalization in a mining
company”; (unofficial translation and emphasis added)

Note that the above wording implies that in the determination on what constitute taxable income,
reliance should be placed on the economic substance rather than the legal form. In fact the wording
“whatever name and form” re-emphasis the wide concept of taxable income as “any increase of
economic capacity…” that is applicable in the ITA.10 As such the substance-over-form doctrine
embedded in Article 4 (1) ITA may be regarded as rule that merely determines the facts giving rise to
tax liability and could very well also used to counter tax-deferral such as the CFC rule, i.e. the sheltering
of the income by the CFC may be disregarded whereas the activity of the CFC or income derived from
it may be regarded in substance as an activity or as income of the taxpayer himself.11

Since the substance-over-form doctrine is rather implicitly hidden in the wording of Article 4 (1) ITA,
its application in the prevention of tax deferral such as a CFC rule is not that obvious and, to the best
knowledge of the author, has never occurred in practice nor there are relevant case laws in this matter.
Further, it has been reported that in practice the substance-over-form doctrine is mostly used in
combination with a specific anti-abuse rule (“SAAR”) 12, but it has never reported that the substance
over form doctrine is used as a stand-alone anti abuse provision.

The law itself is further silent on the hierarchy between SAAR’s and the substance-over-form doctrine,
but considering the general applicable principle of lex specialis derogate legi generali and the fact that
a specific abuse is already foreseen in a specific rule therefore it may be unnecessary and unreasonable
to apply in addition thereto a general substance-over-form principle as this would increase uncertainty
to the taxpayer to rely on the text of the law.

8
David Hamzah Damian and Ganda Christian Tobing, “Chapter 13 – Indonesia” in Simon Whitehead (ed.), The
Disputes and Litigation Review, 7th Edition, Law Business Research, 2009, p. 137.
9
R. Mansury, Pajak Penghasilan Lanjutan, Ind Hill Co, 1996, p. 70.
10
Darussalam and Freddy Karyadi, “Tax Treaty Disputes in Indonesia” in Eduardo Baistrocchi (ed.), Global
Analysis of Tax Treaty Disputes Volume 2, Cambridge University Press, 2017, p. 1273.
11
Similarly the 1987 OECD Base Companies Report states that substance over form doctrine may be used to
counter tax deferral. See OECD, International Tax Avoidance and Evasion, Double Taxation Coventions and
the Use of Base Companies, Issues in International Taxation, No.1, OECD, Paris, 1987, paragraph 21-22.
12
In Tax Court Decision No. 13602/PP/M.I/13/2008 and 23288/PP.MII/13/2010 the substance over form
doctrine is used in the context of interpreting the term “beneficial ownership” in tax treaties.
5 CFC Legislation and Tax Treaties
Article 32A ITA recognizes that tax treaties prevail over domestic tax law. As such, if it is found that a
domestic tax law, such as the CFC rule in this case, is in conflict with tax treaties then tax treaty
provisions will prevail over the application of the domestic tax law in question. As pointed out by some
scholars the issue whether CFC rules are in conflict with tax treaties is not internationally settled yet.13
Broadly CFC rules may conflict with tax treaties in two ways, i.e. (i) for countries following the look-
through/transparency approach model where profits of the CFC is attributed to the shareholder then a
potential conflict may arise when Article 7 (1) OECD MC is interpreted such that income of the CFC
could not be taxed unless the CFC has a permanent establishment in the state of the shareholder; and
(ii) for countries adopting the deemed dividend approach then depending whether the attributed income
is characterized as dividend or other income a potential conflict with the ban on extra-territorial taxation
in Article 10 (5) OECD MC may prevent application of the CFC rule.

Indonesia CFC rule attributes income booked under “retained earnings” (after tax profits) of the CFC
to the shareholder and deems when such CFC after tax profits are accrued to the shareholder. Therefore,
the effect of the Indonesia CFC rule is more in the nature of that of a CFC rule adopting the deemed
dividend approach and it is not likely that Article 7 (1) OECD MC will be the controlling provision to
test the CFC rule compability with tax treaties. On the other hand, if the attributed CFC income is
considered dividends within the meaning of Art 10 OECD MC then it could be argued that the ban on
extra-territorial taxation in Article 10 (5) OECD MC is not relevant since Article 10 (5) permits such
taxation in case of dividends distribution within the meaning of Article 10 OECD MC. Even in the case
that the attributed CFC income is considered as other income within the meaning of Article 21 OECD
MC, then it could be argued that nothing in Article 21 OECD MC prevents the applicability of the CFC
rule.

A potential argument to contest the CFC rule is therefore difficult to be found in the formalistic and
literal interpretation of tax treaty provisions and a more contextual interpretation may be necessary to
potentially contest the CFC rule against tax treaty provision, i.e. objective and effects of the CFC rule,
tax treaty global objectives and underlying principles etc. Note in this regard however that the Tax
Court tends to be formalistic and literal in interpretation of tax treaties.14 Nevertheless, the issue whether
the CFC rules are in conflict with tax treaties has not been considered yet by the Indonesian Tax Court.

6 CFC Legislation and Constitutional Law

Article 23A of the Constitution stipulates that every tax as required by the state must be prescribed by
Law. Consequently, no tax could be imposed, except by the Law. This means that the authority to create
tax liabilities rests with the legislature and that in principle taxes cannot be imposed by the will of the
Executive Power (Government). However, in practice, there are difficulties in tax collection if tax
regulation could only be issued by formal legislation. Therefore, Indonesia tax laws in general allow
delegation of powers to the Government and its agencies, such as in the case, Article 18 (2) ITA which
specifically delegates the powers to regulate concerning “when dividends are accrued by a resident
Taxpayer” to the MoF subject to certain conditions prescribed by the Law, i.e. (i) for the Taxpayer’s
participation in offshore companies other than public companies and (ii) if the Taxpayer owns at least
50% of the paid in share capital of the company or if the Taxpayer together with other resident Taxpayer
own at least 50% of the paid in share capital of the company.

13
Luc De Broe, International Tax Planning and Prevention of Abuse, Volume 14, Doctoral Series, IBFD,2008,
p. 575 and Mark Heidenreich, “CFC rules as an instrument to Counter Abuse” in Karin Simader and Elisabeth
Titz (eds.), Limits to Tax Planning, Linde Verlag, 2013, p. 241
14
Tax Court case no. 43131/PP/M.XIII/13/2013 as reported in Darussalam and Freddy Karyadi, “Tax Treaty
Disputes in Indonesia” in Eduardo Baistrocchi (ed.), Global Analysis of Tax Treaty Disputes Volume 2,
Cambridge University Press, 2017, p. 1270-1271.
In order to avoid overlapping regulations between the Law and regulations issued by the Government
and/or its agencies, Article 7 Law 12/2011 stipulates the hierarchy of regulations as follows:

1) Consititution (Undang-undang dasar 1945)

2) People consultative assembly decree (Ketetapan MPR)
3) Law (Undang-undang) or Government regulation in lieu of the Law (Peraturan Pemerintah
Pengganti Undang-undang)
4) Government Regulation (Peraturan pemerintah)
5) Presidential Regulation (Ketetapan presiden)
6) Regional Regulation

Note that in principal ministerial regulation/decrees are not binding as regulations but may have binding
effect within their respective agencies as administrative decisions, which regulate regarding the
procedural implementation of laws and regulations. In case however that a specific delegation is
provided under the relevant law or regulations then a MoF Regulation, such in this case with CFC rule
in MoF Regulation 107/2017, may have binding effect for the Taxpayer as well, but in principle only if
the relevant MoF Regulation does not contradict the Law or the hierarchy of regulations above.

In this regard, MoF 107/2017 may have the following conflicts with the Law. First, the elucidation of
Article 18 (2) states that the purpose of the CFC rule is to minimize tax avoidance, however it is not
evident from MoF 107/2017 whether the CFC rule is specifically targeted to tax avoidance or not since
the CFC rule operates regardless of the level of foreign tax paid by the CFC (see section 1.3.2 above)
and regardless of the nature of the income of the CFC (see section 1.3.3 above). If indeed the CFC rule
is meant to prevent tax avoidance, then MoF 107/2017 should apply only to specific countries with
considerable lower tax rate and/or specific types of tainted income.

Secondly, the definition of CFC in MoF 107/2017 now also includes indirectly owned subsidiaries. It
could be argued that the definition of CFC is significantly broaden by MoF 107/2017, since the Law
only prescribes that CFC’s are subsidiary companies, other than public companies that are (directly15)
owned by resident taxpayers for at least 50% of the paid-in share capital of the company. Nevertheless,
MoF 107/2017 may have circumvented this is conflict by cleverly drafting the rule such that indirect
owned subsidiaries are not CFC’s but income of subsidiaries that are indirectly held for at least 50% in
the shares are attributed to the directly held CFC and as such having the same effect as that of inclusion
of indirect owned entities in the definition of CFC16.

Third, also note that the Law only prescribed legal control by share ownership of at least 50% in the
paid-in share capital, however MoF 107/2017 has broaden this aspect so as to include legal control by
a participation that represents at least 50% of all the voting rights and legal control of subsidiaries
owned through trusts or similar entities.

Despite the above contradictions with the Law, the CFC rule in Indonesia has never been contested to
the Constitutional Court.17

15
See section 1.2 where it is argued that if the legislation should have intended to include indirect owned
subsidiaries in the CFC rule, then a consistent wording as in the definition of special relationship in Article 18 (4)
ITA should have been used.
16
See example of CFC income compution in section 1.3.4.
17
It could be observed that the Constitutional Court tends to be in favour with regulation that is connected the
implementation of BEPS Action Plan. Recent Constitutional Court Case No. 102/PUU-XV/2017 on the
compability of Law 9/2017 concerning Financial Information Access for example states that the Law in
question is necessary to prevent tax avoidance and evasion and also to respect Indonesia international
commitment to the Multilateral Convention on Mutual Administrative Assistance in Tax Matters.
7 Improving the Current Rules
Recently, it has been reported that the CFC rule will be amended again18. The Directorate General of
Tax has recognized the current CFC rule is not sufficiently targeted to counter tax avoidance. It is
expected that the subsequent amendment of the CFC rule will be more balanced, thereby taking into
consideration the BEPS Action Plan 3 recommendations to have CFC rules that are targeted to counter
profit shifting opportunities and long-term deferral of taxation. This means that the CFC rule will most
likely include certain exemptions or threshold requirements such as, the applicability of CFC rule on
only subsidiaries that are subject to low tax rates.

Given Indonesia general tax environment characterized by low tax revenue collection, tax compliance
challenges, shadow economy and low tax effort, the near term priority for Indonesia is to ensure that
businesses are aware of their obligation, to minimize the associated compliance burden and to ensure
that penalties for administrative mistakes are not disproportionate.19 As such it is further expected that
Indonesia would prefer a clear mechanical rule and rely on voluntary compliance. Complex rules, such
as rules on determination of which CFC income should be attributed to the shareholder, is not likely to
be adapted. As could be observed from current CFC rule in MoF 107/2017 for example, the attributed
CFC income simply refers to the retained earnings of the subsidiary company. This will not likely to be
changed in light of simplicity and ensure voluntary compliance.

From formal regulatory perspective, it would desirable to have the CFC rule legal basis as stipulated in
Article 18 (2) ITA changed so as to accommodate the definition of CFC in terms of legal control beyond
share ownership. At the current state, the CFC rule in “MoF Regulation” has still potential areas of
conflict in this aspect with the ITA that may create uncertainties. Not less important is also to eliminate
the exemption for public companies, which is explicitly mentioned in the ITA. This change could only
be done by way of amending the ITA, as changing this aspect by way of a “MoF Regulation” would
clearly contradict the Law and potentially challenged in the Constitutional Court.

Other areas that may require improvement is to regulate concerning interaction of the CFC rule with
transfer pricing regulations. The reason is to prevent instances where the CFC rules impose taxes on a
parent company’s profit from a foreign subsidiary that is generated based on prices that are in
accordance with actual value generated by the subsidiary.20

8 Outlook: The Future of CFC Legislation

Currently, Indonesia is undergoing a tax reform spanning from 2016 until 2020 with an agenda
composed of 5 pillars, namely (i) organization, (ii) human resources, (iii) information system and
database, (iv) business process and (v) law and regulations.21 The tax reform is expected to meet the
challenges of Indonesia low tax ratio in the midst of a changing tax environment characterized by BEPS,
and the growing revenue needs for development. Accordingly, the Government’s action plan for tax
reform is primarily focused on tax certainty and increasing tax compliance.22 In this context it would
interesting to see the developments on how the Government will implement BEPS anti-abuse measures,
such as the CFC rule in this case. Certain recommendations of BEPS Action Plan 3 concerning the

18
Kontan, “DJP sebut perubahan aturan terkait CFC akan selesai bulan depan”, 20 February 2019, website
accessed in May 5 May 2019: https://nasional.kontan.co.id/news/djp-sebut-perubahan-aturan-terkait-cfc-akan-
selesai-bulan-depan.
19
OECD, “OECD Economic Surveys: Indonesia”, October 2018, OECD Publishing, Paris, p. 81.
20
B. Bawono Kristiaji and Denny Vissaro, “Chapter 17: Indonesia” in Michael Lang et. al (eds.), Implementing
Key BEPS Actions: Where do we stand?, WU Institute for Austrian and International Tax Law – European and
International Tax Law and Policy Series, IBFD (forthcoming publication).
21
An overview of the Government’s tax reform agenda in English could be found in the official website of the
Directorate General of Tax at https://www.pajak.go.id/overview-tax-reform (accessed 17 July 2019).
22
Darussalam, “Reformasi Pajak: Menuju Kepatuhan Kooperatif”, Inside Tax, Edisi Khusus 39, p. 18-21.
strengthening of CFC rules envisages complex and comprehensive legal solutions, which may
contradict administrative simplification which is one of the main concerns for developing countries
when drafting tax rules.23 As with other developing countries, Indonesia may still lack the necessary
expertise to apply in practice complex and comprehensive anti-tax avoidance provisions, which could
result in uncertainty and increasing disputes with the Taxpayer. At present, there is already a large
backlog of tax cases accumulated in the Tax Court over the years, where case law is rarely published
and those that are published usually contain no reasoning beyond statement of facts and conclusions24.
As such the aim of the Government’s tax reform is already on the right track namely, to focus on
certainty and increasing tax compliance. In light of this, the developments in the CFC rule should prefer
simplicity over the effectiveness of more subjective rules.

Notwithstanding the above, there is also a debate whether Indonesia will introduce a GAAR in the tax
law25 . An introduction of GAAR is expected to counter abuses that are not covered within the often
mechanical and simple of nature of Indonesia SAARs. The consideration is that developments of
business models has always outpaced adaptations of domestic rules26, therefore Indonesia may need a
flexible rule to keep pace with the developments in business models. However, considering the
inconsistencies that may arise in tax administration practice and the current state of the Tax Court, this
subject is still debated. As alternative, Indonesia is also considering applying an minimum tax regime.
As recommended by the IMF in 201827, an alternative minimum tax may also reach the same tax policy
concerns such as GAAR namely, to be an effective safeguard against tax avoidance, but with less
uncertainties such as in GAAR. Since BEPS 2.028, there is now renewed highlight on this topic in
Indonesia and discussions whether such minimum tax should be included in the planned amendment of
the CFC rule.

Lastly, also interesting to note is that Indonesia has already since 2011 considered whether to change
its pre-dominantly worldwide tax system into a territorial tax system in light of competitiveness.29
However it is unlikely that Indonesia would change into a pure territorial tax system, but rather
potentially adopting a certain degree of territoriality such as foreign dividends participation regime or
lower tax rate for foreign dividends to eliminate excessive taxation due to economic double taxation on
intercompany foreign dividends30. It remains to be seen how the CFC rule will take into account this
development.

23
T. Dubut, Designing Anti-Base-Erosion Rules for Developing Countries in G. M. M. Michielse and V.
Thuronyi, Tax Design Issues Worldwide, Alphen aan den Rijn: Wolters Kluwer Law & Business, 2015, p. 154-
196.
24
Darussalam and Freddy Karyadi, “Tax Treaty Disputes in Indonesia” in Eduardo Baistrocchi (ed.), Global
Analysis of Tax Treaty Disputes Volume 2, Cambridge University Press, 2017, p. 1234.
25
B. Bawono Kristiaji and Denny Vissaro, “Chapter 17: Indonesia” in Michael Lang et. al (eds.), Implementing
Key BEPS Actions: Where do we stand?, WU Institute for Austrian and International Tax Law – European and
International Tax Law and Policy Series, IBFD (forthcoming publication).
26
As indicated in B. Bawono Kristiaji and Denny Vissaro, “Chapter 17: Indonesia” in Michael Lang et. al
(eds.), Implementing Key BEPS Actions: Where do we stand?, WU Institute for Austrian and International Tax
Law – European and International Tax Law and Policy Series, IBFD (forthcoming publication), it took 9 years
for the Government to revise the old CFC rules, i.e. from MoF Regulation 256/2008 to MoF Regulation
107/2017.
27
Luis E. Breuer et al (eds.), Realizing Indonesia Economic Potential, International Monetary Fund, 2018, 124.
28
Pillar two related to the global anti-base erosion proposal in OECD, Addressing the Tax Challenges of the
Digitalisation of the Economy, Public Consultation Document, 13 February – 6 March 2019, which some
authors have labelled as BEPS 2.0. See at Roth, Alexander, and Tan, “OECD digital economy tax reform: the
race to consensus”, Tax Journal, Issue 1430, 7 February 2019.
29
Presidential Regulation No. 32 Year 2011 concerning masterplan for acceleration and broadening of
economical development in Indonesia.
30
As illustrated in Darussalam, B. Bawono Kristiaji, and Khisi Armaya Dora, “Sistem Pemajakan: Dari
Worldwide ke Territorial, Bagaimana dengan Indonesia?, DDTC Working Paper 1818, p. 42-45 available at
http://ddtc.co.id/research/publications/working-paper, foreign dividends are potentially taxed three times, i.e.
corporate income tax in the country of residence of the subsidiary company, corporate taxation in Indonesia, and
final withholding tax if the dividends are further distributed to the individual Indonesia shareholder.