Thin Capitalization Rules Dilemma

Taxes bias business decisions. Every company has the same goal of maximizing shareholder's wealth. While in enterprise theory, the company's goal is not merely enriching shareholders, the company must provide added value for the government such as taxes, levies, economic growth, and so forth. But pragmatically, the company tries as much as possible to make tax savings. We are familiar with the term tax planning. In choosing various decision alternatives, the company will always consider the aspects of taxation. There are no decisions that do not take into account the tax aspects. It is not uncommon, then, that all firms will avoid taxes to enlarge profit after taxes, and reduce their taxes.

Unacceptable tax avoidance practices. Large companies, especially multinational corporations, use their tax evasion practices to reduce their taxes. For example through the practice of thin capitalization, Controlled Foreign Corporation (CFC), transfer pricing, treaty shopping, and tax haven country. Of these practices, this paper will discuss more about thin capitalization. A company is called thinly capitalized when there is a high ratio between debt capital and equity capital. Treatment of deductible interest expense (deductible) against taxes will provide profit for after tax, even to return on investment and return on equity. A company is considered thinly capitalized based on the ratio of capital gear, leverage, or debt to equity ratio (DER).

Case illustration of thin capitalization. The company faces two decision scenarios with the following case details:

Decision I, debt ratio: capital = 1: 1

Decision II, debt ratio: capital = 4: 1

Interest of 10 percent of loan, dividend 15 percent capital, and 25 percent tax rate.

Profit before tax and interest of Rp 400 M. All profits after tax are distributed as dividends.

		Decision I	Decision II
Equity	A	1000	400
Liability	B	1000	1600
Earning before interest and taxes	C	400	400
Interest Expense (10%)	D = 10%*B	100	160
Earning before taxes	E = C-D	300	240
Tax (25%)	*F = 25%E**	75	60
Earning after tax	G = E-F	225	180
Dividend tax	H = 15%*G	33,75	27
Dividend distributed	I = G-H	191,25	153
Tax Payment	J = F+H	108,75	87
Effective Tax Rate	K = J/C	27,2%	21,8%
ROE	L = I/A	19,1%	38,3%

Government response: anti-avoidance rule over the practice of thin capitalization. The practice of tax avoidance through thin capitalization has been banned in Indonesia. This is in accordance with the Law of Income Tax Article 18 paragraph 1.

"The Minister of Finance is authorized to issue decisions concerning the magnitude of comparisons between debt and corporate capital for the purposes of calculating tax under this Act."

In Article 18 paragraph 3 also the DGT (Indonesia tax authority) can determine the amount of debt as capital for taxpayers who have a special relationship. Regulation of the Minister of Finance No. 169 of 2015 provides a more detailed explanation of the magnitude of the ratio between debt and capital for the purposes of calculating the income tax is set at the maximum of four to one (4: 1). However, in reality, it is quite difficult to determine the structure of debt to the right capital for the company. There is a trade off between the business realities on the one hand and the limitation of the amount of interest costs.

Conclusion. Tax is one aspect that companies consider in making their business decisions. It can not be separated from the main purpose of the company, maximizing shareholder wealth. The Company will seek to increase profits and reduce taxes. How can? This can be done through tax avoidance practices such as thin capitalization, Controlled Foreign Corporation (CFC), transfer pricing, treaty shopping, and tax haven country. Thin capitalization is an effort for companies to reduce taxes through capital schemes where the composition of debt is greater than capital. Supervision of taxpayers under the Act of Income Article 18 paragraph 1, 18 paragraph 3, and PMK No. 169 Year 2015 can detect the practice of thin capitalization through supervision of the ratio of DER (debt to equity ratio) of a company. So that based on Article 18 paragraph 3, the Director General of Taxation can determine the amount of debt as capital to calculate taxable income. Whatever your company intentions against the thinly capitalized conditions, be prepared, the Director General of Taxes will correct your company's taxable income :)

Referensi:

Pemerintah Republik Indonesia. Undang-Undang Nomor 36 Tahun 2008 Tentang Pajak Penghasilan.

Kementerian Keuangan. Peraturan Menteri Keuangan Nomor 165 Tahun 2015 Tentang Penentuan Besarnya Perbandingan Antara Utang Dan Modal Perusahaan Untuk Keperluan Penghitungan Pajak Penghasilan.

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