Permanent Establishment

Permanent Establishment (PE), in Indonesia Tax Law, is one kind of tax person and so one kind of taxpayer. The definition of PE, base on Article 2 Paragraph 5 Indonesian Tax Law, shall be an establishment used by an individual who does not reside or is present in Indonesia for not more than 183 (one hundred and eighty-three) days within any 12 (twelve) month period, or by an entity which is not established or domiciled in Indonesia in the form of, among others:

a place of management;
a representative office;
an office;
an office;
a factory;
a workshop;
a mining and extraction of natural resources, drilling used for mining exploration;
a fishery, animal husbandry, farm, plantation or forestry;
a construction, installation or assembly project;
the furnishing of services through employees or other personnel, if conducted for more than 60 (sixty) days within 12 (twelve) month period;
an individual or an entity acting as a dependent agent;
an agent or employee of an insurance company that is not established or domiciled in Indonesia if it collects premiums or insures risk in Indonesia.

A permanent establishment contains the concept of the existence of place of business, namely facilities that may be in the form of lands and buildings, including machinery and equipment .The place of business is permanent in nature and used to carry out the business or to conduct the activities of an individual not residing or an entity not established and domiciled In Indonesia.The concept of permanent establishment also includes individuals or entities as agents the positions of which are not independent, acting for and on behalf of an individual or entity not residing or domiciled in Indonesia. An individual not residing or an entity not established and not domiciled in Indonesia can not be assumed to have a permanent establishment in Indonesia if the individual or the entity, in conducting his/its business or activities in Indonesia uses an agent, broker or intermediary who have independent status, provided that the agent, broker or intermediary in reality fully acts in the framework of carrying out his own business/activities. An insurance company established or domiciled outside Indonesia is deemed to have a permanent establishment in Indonesia, if it collects insurance premium in Indonesia or bears risk in Indonesia through employees, representatives or agents in Indonesia. Bearing risk in Indonesia shall not mean that the event causing the risk occurs in Indonesia. Due regard being had to the fact that the insured party shall reside, stay or domicile in Indonesia. Although PE is part of foreign (non resident) tax person but the engagement of PE’s right and obligation is same as resident tax payer’s. This means that PE must have taxpayer identity card (or NPWP) and PE has to fill tax return every month and every year as long as the PE is stull exist.

Taxable Object

Based on Article 5 Indonesian Income Tax Law, Taxable object of a PE consists of:

income from its businesses or activities and from its owned or controlled properties. A permanent establishment will be taxed on income from its business or activities and from its owned or controlled property. Accordingly, all income concerned is subject to tax in Indonesia income of the head office from businesses or activities, sales of goods, or furnishing services in Indonesia which are similar to those undertaken by the permanent establishment in Indonesia. In accordance with this provision, income derived by a head office from business or activities, sale of goods or furnishing services which are similar to those undertaken by the permanent establishment is considered income of the permanent establishment because such business or activities fall within the scope of, and could be undertaken by, the permanent establishment.Example: Business or activities similar to those of a permanent establishment occurs where a foreign bank with a permanent establishment in Indonesia directly provides a loan to a company in Indonesia and not through its permanent establishment.Sale of goods similar to those sold by a permanent establishment occurs where an overseas head office having a permanent establishment in Indonesia directly sells products similar to those sold by its permanent establishment to Indonesian buyers. Furnishing services similar to those furnished by a permanent establishment occurs where a head office of an offshore consultant company directly provides consultancy services similar to those provided by the permanent establishment to clients in Indonesia income referred to in Article 26 received or accrued by the head office provided that the properties or activities giving rise to the aforesaid income is effectively connected with a permanent establishment. income referred to in Article 26 received or accrued by the head office is treated as income of a permanent establishment if the properties or activities giving rise to the aforesaid income is effectively connected with a permanent establishment. For example, "X" Inc. concludes a license agreement with PT "Y" for the use the trademark of -X- Inc. Upon the use of that right, "X" Inc. receives compensation in the form of royalties from PT "Y". In connection with this agreement, "X" Inc. also provides management services to PT "Y" through a permanent establishment in Indonesia in the course of marketing products of PT Y" bearing the trademark. In this case, the use of the "X" Inc. trademark by PT "Y" has an effective connection with the permanent establishment in Indonesia, consequently, X Inc.'s income in the form of royalties is treated as income to the permanent establishment. ExpensesExpenses related to gross income referred to in paragraphs above may be deducted from the permanent establishment’s income. Administration expenses incurred by a head office to support the business or activities of a permanent establishment in Indonesia may be deducted from the income of the permanent establishment. The type and amount of expenses that may be deducted are stipulated by the Director General of Taxes. Basically a permanent establishment and its head office are considered as a single unit, therefore, payments made by the permanent establishment to its head office, such as royalties on the use of head office property, are considered as a flow of funds within one company. Therefore, under this provision, payments made by a permanent establishment to its head office, such as royalties, compensation for services and interest is not deductible from the income of the permanent establishment. Where, however, the head office and the permanent establishment are engaged in a banking business, payments in the form of interest loan may be charged as an expense.As a consequence of the foregoing, payments of a similar type received by a permanent establishment from its head office are not considered as taxable income, except for interest received by a permanent establishment from its head office related to a banking business.

PE in Tax Treaty

It is important to know that the meaning of PE is depend on the tax treaty between Indonesia and other country. The definition of PE may vary from one tax treaty to others. So, to learn about PE practice in Indonesia, we also must know about PE in tax treaty. If Indonesia has no tax treaty with some country, the income tax law PE definition should be used.

Tax Treaty

Tax treaties exist between many countries on a bilateral basis to prevent double taxation (taxes levied twice on the same income, profit, capital gain, inheritance or other item). In some countries they are also known as double taxation agreements or double tax treaties. Most developed countries have a large number of tax treaties. The United Kingdom has treaties with more than 110 countries and territories. The United States has treaties with 56 countries (as of February 2007). Tax treaties tend not to exist, or to be of limited application, when either party regards the other as a tax haven. There are a number of model tax treaties published by various national and international bodies, such as the United Nations and the OECD.

Concept

International double taxation, narrowly defined, occurs when two different states impose a comparable tax on the same potential taxpayer on the same taxable item. The concept has been defined more broadly, but with less precision, as the result of overlapping tax claims of two or more states. For example, someone who is resident for tax purposes in France and who makes an interest-bearing deposit with a bank in the UK is potentially exposed to income tax on the interest in the UK and in France. The concept of international double taxation that bilateral tax treaties seek to remove is broader than the narrow definition. It includes some types of economic double taxation—that is, taxation of something already taxed under another country's laws whether or not it is formally subject to multiple levels of taxation. For example, many tax treaties operate to provide tax relief to a corporate group when a state has imposed a corporate income tax on profits earned by a subsidiary corporation and another state otherwise would impose a corporate income tax on its parent corporation when those profits are distributed as a dividend. In general, tax treaties attempt to eliminate most forms of international double taxation, narrowly defined, and various other forms of international double taxation when a failure to do so would have a demonstrably harmful impact on international trade and investment. A major goal of bilateral tax treaties is to remove impediments to international trade and investment by abating the risk of double taxation that can occur when both contracting states impose tax on the same income. This goal is advanced in five distinct ways.

First, a bilateral tax treaty generally increases the extent to which exporters residing in one contracting state can engage in trading activity in the other contracting state without attracting tax liability in that latter. The second state can usually only impose tax on the business profits of a person who is resident in the other state if they operate in the second state through a permanent establishment there.

Second, when a resident of a contracting state does engage in a sufficient activity in the other contracting state for that state to have the right to tax, the treaty establishes certain guidelines on how that income is to be taxed; that is, in general, which profits are attributable to the permanent establishment in the second state. For example, those guidelines may assign to one contracting state or the other the primary right of taxation with respect to particular categories of income. They may, in certain cases, provide for the allowance of deductions in measuring the amount of income subject to tax. They may require a reduction in the withholding taxes otherwise imposed by a contracting state on payments made to a resident of the other contracting state.

Third, a bilateral tax treaty provides a dispute resolution mechanism that the contracting states may invoke to relieve double taxation in particular circumstances not dealt with explicitly under the treaty.

Fourth, where income or gains remain in principle taxable in both contracting states, the state of residence of the taxpayer will relieve the double taxation that results either by allowing a credit for the tax paid in the other state or by exempting the income or gain from its own tax in practice.

Fifth, treaties provide mechanisms for taxing authorities to exchange information with each other.