Repositioning Indonesia’s Tax Policy In A World Of Multi-Layered Tax And Investment Interaction – Analysis

Since the international tax regime getting into the rise of multilateralism, tax authorities worldwide are dealing with the complex dynamics between tax and investment. They must also ensure the preservation of fiscal sovereignty in connection with the critical engine of investment, Foreign Direct Investment (FDI). Indonesia, as one of the fast-growing emerging markets in Southeast Asia, is no exception. Moreover, widespread geoeconomic fragmentation, stemming from discontent with globalization and rising economic nationalism, has compelled middle powers, like Indonesia, to recalibrate their own tax, trade, and FDI trajectories. 

Bilateral-based Tax Regime with Investment

Based on practical reasoning of Bilateral Investment Treaties (BITs), foreign capital exporters lack sufficient knowledge about host countries, they might question the reliability of local commitments and laws. From practical reasoning of Double Tax Conventions (DTCs), it aims primarily to minimize double taxation, forming the core principle of the bilateral tax regime. Both BITs and DTCs thus serve as bridging instruments to attract FDI inflows. One could argue that Bilateral Investment Treaties and Double Tax Conventions are two sides of the same coin.

International Investment Agreements (IIA), a general type of BIT, contains core mechanisms to reduce conflict dispute, which is Investor-State Dispute Settlement (ISDS) clauses. Unlike investment instrument, tax treaties generally lack well-designed dispute settlement mechanisms. In some cases, significant disputes arise when investors use BITs to challenge host country tax measures. From this reality, international tax disputes are often addressed not only within the framework of national or global tax laws but also through trade and investment instruments.

Multilateral-based Tax Regime with Investment

The evolving architecture of international tax regime, from bilateral to multilateral, challenges the compact of the international economic order, specifically its intimacy with trade and investment. In 2021, coinciding with the birth of the OECD’s two Pillars of Base Erosion and Profit Shifting (BEPS), the UNCTAD also proposed recommendations to redefine the responsibilities of national tax policy within the broader settings of international tax and investment policy.

Returning to the issue of dispute mechanism, a key benefit of multilateral framework, especially under OECD-led international tax regime, is Action 14 from BEPS 1.0.  Under this commitment, Action 14’s minimum standard seeks to improve the resolution of disputes related to tax treaties, enhancing taxpayer protections by mandating host countries to develop and facilitate better access to mutual agreement procedures (MAP). Accordingly, the multilateral-based tax regime is expected to positively impact legal and tax certainty, thus aiding FDI flows.

Yet, one crucial challenge drawn from multilateral tax regime cooperation is the threat to the protection of policy space to offer tax incentives. Conceptually as well as practically, tax competition mirrors FDI competition, with many jurisdictions deploying specific tax incentives to attract foreign capital. Constructively, The Global Minimum Tax introduces, however, a fair-play system by imposing a 15% minimum tax rate, placing a floor on tax competition.

Indonesia No Longer Plays Around with Tax Incentives 

Since the purpose of the evolving international tax regime is to turn down tax competition and BEPS, its real consequence confronts the existence of tax incentives. In the context for Indonesia, the government needs to rethink about its investment structural strategy.

Prior to the rise of Pillar 2 BEPS, Indonesia had arguably used tax incentives without well-established mapping and a primary strategy. Because every tax incentive inherently constitutes a tax expenditure, the government must carefully weigh the investment benefit against the fiscal cost. Expanding incentives without a better mapping and evaluation simply throws away the fiscal rationale for the expenditure.

One of the most common types of tax incentives Indonesia often regulates is the tax holiday. Under Minister of Finance Regulation 69 of 2024, the Government of Indonesia extends the tax holiday facility, specifically for pioneering industries. Categorized as a profit-based incentive, it reduces the amount of tax a company has to pay on its profits. From economic perspectives, this tax incentive is expected to serve as an instrument to gain broader economic objectives while offering economic benefits to foreign taxpayers. 

Since the rise of the Global Minimum Tax, such a profit-based incentive is no longer effective. This is due to the automatic imposition of a top-up tax by the MNE’s parent jurisdiction. The core mechanism is the OECD’s Pillar Two framework, which establishes the Income Inclusion Rule. This rule mandates that the parent company’s home country will apply a top-up tax to any income earned by its subsidiaries in a foreign jurisdiction, like Indonesia, if that income is taxed at an Effective Tax Rate (ETR) below the 15% minimum. Consequently, the tax holiday, a prominent Indonesian profit-based incentive, simply reduces the tax payable to the Indonesian government, but the resulting undertaxed profit is now immediately “clawed back” by the MNE’s home country.

This phenomenon drives the critical need to urgently pivot away from traditional profit-based incentives towards non-profit-based incentives, such as accelerated depreciation or grants, or Qualified Refundable Tax Credits (QRTCs) which are suggested to be compatible with the Global Minimum Tax framework. 

From a law and economic perspective, the Government of Indonesia, of course, must make sure its capability to attract FDI goes beyond taxation. Non-fiscal facilities, recommended by scholars and businesses, include simplifying administrative licensing and enhancing massive infrastructure. Compared with Vietnam, Indonesia’s biggest FDI rival in Southeast Asia, these efforts are what that country used to strengthen non-fiscal facilities for FDI.   

In the end, Indonesia should regard the emergence of the Global Minimum Tax and the multilateral-based tax regime as a gateway. It presents an opportunity for the nation to prioritize balancing its investment structural strategy with the incorporation of global tax standards and national tax reform.

About the authors:

• Andi Mohammad Ilham is a Graduate of the School of Government and International Relations, Griffith University. He is a Tax Researcher at MMStax Consulting, Indonesia. His research area focuses on the International Political Economy of Global Tax Governance.
• Andi Mohammad Johan holds a Master of Tax Policy from the University of Indonesia. He is a Partner at MMStax Consulting, Indonesia. He is also a member of the Indonesian Tax Consultants Association (ITCA).