Thin Capitalisation refers to a condition where a company is financed with a high level of debt compared to the equity (highly leveraged). Taxand Indonesia explores Indonesia’s new Thin Capitalisation rules.
Multinational companies are often structured through this arrangement whereby they get advantage by having the lender in a very low tax rate country (as they receive interest income) and the borrower in a country where interest cost can be deducted for income tax purposes. This structure can be made in a way to shift profit to the lower income tax rate countries. The financing of MNCs in Indonesia through debt more than equity has become a big concern in Indonesia.
To overcome this issue, on September 9, 2015, the Minister of Finance issued a regulation through MoF regulation number 169/PMK.010/2015 (PMK-169) regarding the determination of ratio of debt to equity for income tax calculation purposes. This thin Capitalisation rule has set a 4 to 1 debt to equity ratio in limiting the deductibility of interest expense when calculating the income tax liability. This regulation is effective starting in fiscal year 2016.
Historically, in October 1984, the Minister of Finance issued a decision number 1002/KMK.04/1984, which stipulated a debt-to-equity ratio (DER) of 3:1 as a determination of interest expenses deduction for income tax calculation purposes. However, within six month period, the Minister of Finance issued another decision Number 254/KMK.04/1985 dated 8 March 1985 which postponed the implementation of the regulation with consideration that the regulation could diminish the investment growth in Indonesia. After 31 years of postponement, the Minister of Finance issued PMK-169 to revoke the old decision and reissued a new DER of 4:1.
Multinational Companies should prepare a robust transfer pricing documentation related to their intercompany loan arrangement to be able to equip themselves when challenged regarding the deductibility of the loan interest expense.