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The Indonesian government recently launched tax hunt on Google Indonesia. If Google were indeed guilty of tax avoidance, it would have to pay a huge price for its actions. But Google is not alone in avoiding paying tax to Indonesian government. Indonesians and Indonesian companies are squirrelling their wealths in nearby tax-haven, Singapore. Can Indonesia be firm and stand up to such erroneous behaviour?

By Tan Zhi Xin

Tax planning or tax avoiding?

Google once again comes under international scrutiny for tax avoidance as Indonesia announced its intention to bill the search giant for five years of back taxes and fines. If Google were found to be guilty of tax evasion, it would have to pay up to $400 million for 2015 alone. Total estimated amount for the five-year period is not revealed.

“If Google generates income from Indonesia, it has to pay taxes. It is immoral if Google refuses to do so,” said Muhammad Haniv, head of the tax office’s special cases unit.

According to digital-focused market research company eMarketer, digital advertising spending increased from $230 million in 2013 to $830 million in 2015, of which Google benefited 70.0 percent of the total revenue. But Google is accused of paying less than 0.1 percent of its income and value-added taxes it owed in 2015.

In response, head of corporate communications for Google Indonesia, Jason Tedjasukmana maintains that Google Indonesia has been “(complying with the government) by paying all taxes which apply in Indonesia.”

The real issue is Google Indonesia’s business structure. Google only has a representative office in Indonesia; it is not a legal fixed business institution with office presence. Instead, it is highly dependent on its headquarter in Singapore, Google Asia Pacific.

“Google Indonesia operates only as what it describes as an event (organiser) for the Singapore operation, Google Asia Pacific. The Singapore unit handles all the contracts from Indonesian advertisers and pays all of Google Indonesia’s expenses, adding an additional (8.0 percent) that is booked as Indonesian business’s profit”, said Mr Hahiv.

As such, most of the revenue it generated in Indonesia is booked at its headquarter. Google justified this behaviour as part of its tax planning to ensure tax-efficiency.

While it is legal to do tax planning, Mr Haniv said, “aggressive tax planning – to the extent that the country where the revenue is made does not get anything – is not legal.” This is exactly what Google is doing in Indonesia. In that sense, is Google tax planning or tax avoiding?

Double Irish with a Dutch sandwich

This is not the first time Google is accused of tax avoiding. Google has just emerged from a case with the United Kingdom after it agreed to pay the tax authorities $185 million of back taxes.

But what exactly is the reason why Google had been able to pay much lesser tax than it was supposed to?

The answer lies in its tax structure. Google operates a complicated tax structure that allows it to avoid paying huge amount of taxes, legally and illegally. More specifically, this tax structure is known as “Double Irish with a Dutch Sandwich”.

“Double Irish with a Dutch Sandwich” is a tax avoidance technique. It is mostly employed by tech firms because they could easily shift huge amount of pre-tax profit to other countries by assigning intellectual property rights to subsidiaries abroad. This technique involves arranging transactions in a way that it takes advantages of the differences in tax code, hence reducing overall tax rates dramatically. Profits are shifted to jurisdiction with low or no tax. For Google, the final destination is corporate tax-free haven Bermuda.

With this tax structure, Google managed to lower worldwide tax by $2.4 billion by moving $12.0 billion through the Netherlands to Bermuda in 2014.

Google is using also similar tax avoidance technique in Indonesia. Most of its business functions like finance and operation and holding of intellectual property rights take place in Singapore. And Singapore happens to be a low tax regime with generous tax incentives programs for multinational corporations.

Can Indonesia stand up to tax avoidance?

Indonesia has tried to force over-the-top companies such as Google to establish themselves as a Permanent Establishment (BUT). As a BUT, firm would have to declare earnings and pay taxes. However, Google failed to comply.

Currently, there is an urgent need in Indonesia to narrow its budget deficit due to the global economic slowdown and plunging energy prices. Hence, the Indonesia authority is evidently very determined to stand up to tax avoidance.

Former Finance Minister Bambang Brodjonegoro told reporters that failure of Internet-based firms to set up BUT will have their bandwidth reduced or blocked entirely.

Aside from forcing companies to establish physical presence, Indonesia could adopt either the “Google tax” law or regulation akin to that. However, because the Internet is borderless, it is very easy for Google or any other Internet-based firms to find loophole in the regulation.

But fortunately, given that the Indonesian government is eagerly finding ways to increase its state revenue to fund President Joko Widodo’s ambitious infrastructure plans, we can rest assured that it will take great caution if it decides to follow this path.

Tax amnesty program

The tax amnesty bill was passed into law on 18th July. Under this new law, people who declare their previously undeclared wealth before 31st September will only receive a 4.0 percent tax rate. If the taxpayer declares and repatriates his wealth back to Indonesia, then only a 2.0 percent tax rate is applied. The tax rate increases according to the time taken to declare their assets. Tax evaders who insist on refusing to join the program will face 400.0 percent tax rate after the deadline.

Source: Indonesian Finance Ministry

The government aims to see $76.0 billion worth of fund return to Indonesia under this program. It also expects to generate at least $12.5 billion additional tax revenue.

Many Indonesians are however hesitant to join the program for two reasons. Firstly, trust in government is low. Many of them do not believe in promises of legal certainty and immunity from persecution. This low level of trust is understandable, given that Indonesia experiences frequent policy flip-flops.

Secondly, repatriated wealth has to remain in the country for at least three years and can only be invested in either governmental debt instruments, government projects, or appointed investment products.

But if this program succeeds in attracting more wealth to return to Indonesia, there will be an overall net benefit. The government will be able to collect more revenue from taxes and channel them to improve on public goods and infrastructures. Industries like banks and property developers will benefit greatly from tax amnesty in the sense that banks will see an increase in deposits, while there will be increased sales for property developers.