Common Tax Mistakes Foreign Companies Make in Indonesia: Costly Errors, Legal Risks, and How to Avoid Them

Table of Contents

The Main Legal Question

What are the most common tax mistakes foreign companies make when doing business in Indonesia, and how can those mistakes be legally avoided?

In practical terms, most tax problems faced by foreign companies in Indonesia arise not from aggressive tax planning, but from misunderstandings of Indonesian tax rules, incorrect assumptions based on home country practices, and failure to comply with formal administrative requirements. These mistakes often lead to audits, back taxes, penalties, and long term business disruption.

Legal Explanation

Indonesia is one of Southeast Asia’s most attractive markets for foreign investment, but it is also one of the most aggressively administered tax jurisdictions in the region. The Indonesian tax system is highly formalistic, document driven, and enforcement oriented. This creates a significant gap between how foreign companies expect the system to work and how it operates in practice.

Many foreign companies—particularly those from the United States—approach Indonesia with assumptions shaped by U.S. tax concepts, such as substance over form, self assessment flexibility, and reliance on professional judgment. In Indonesia, however, formal compliance, documentation, and strict statutory interpretation often outweigh commercial intent.

The most common tax mistakes generally fall into several categories:

• Underestimating withholding tax exposure
• Misusing tax treaties
• Ignoring Permanent Establishment risks
• Misclassifying services, royalties, and reimbursements
• Poor transfer pricing documentation
• Late or incorrect tax filings

Understanding these issues early is critical, because Indonesian tax audits are retrospective and penalties accumulate quickly.

Legal Basis

Foreign companies’ tax obligations in Indonesia are governed by several core statutes. Each of these laws is frequently involved when tax mistakes are identified during audits.

Income Tax Law

Law No. 7 of 1983 on Income Tax, as last amended by Law No. 7 of 2021 on the Harmonization of Tax Regulations.

Key provisions include:

• Article 2 – Defines tax subjects, including foreign companies with a Permanent Establishment. Practical meaning: A foreign company may be taxed in Indonesia even without a local subsidiary.
• Article 5 – Determines income attributable to a Permanent Establishment. Practical meaning: Profits connected to Indonesian activities can be taxed locally.
• Article 26 – Imposes withholding tax on payments to foreign taxpayers. Practical meaning: Indonesian source income paid offshore is often taxed at source at 20% unless reduced by treaty.
• Article 32A – Authorizes application of tax treaties. Practical meaning: Treaty benefits are available only if formal requirements are met.

General Tax Provisions and Procedures Law

Law No. 6 of 1983 on General Provisions and Tax Procedures, as amended by Law No. 7 of 2021.
Practical meaning: This law governs audits, penalties, interest, objections, appeals, and criminal exposure.

Value Added Tax Law

Law No. 8 of 1983 on Value Added Tax, as last amended by Law No. 7 of 2021.
Practical meaning: Incorrect VAT registration or invoicing is a common compliance failure for foreign owned companies.

Double Taxation Treaties

Indonesia’s tax treaties—including the Convention Between the Government of the Republic of Indonesia and the Government of the United States of America for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (1988)—modify, but do not eliminate, domestic tax obligations.

Common Tax Mistake #1: Assuming No Tax Without a Local Company

Many foreign companies believe that Indonesian tax only applies after establishing a local subsidiary. This assumption is incorrect.

Under Article 2 of Law No. 7 of 1983, a foreign company may be taxed if it has a Permanent Establishment (Bentuk Usaha Tetap – BUT).

Practical meaning: Having employees, representatives, or long term projects in Indonesia can trigger corporate income tax—even without incorporation.

Common Tax Mistake #2: Ignoring Withholding Tax on Cross Border Payments

Foreign companies often treat Indonesian withholding tax as an issue for the Indonesian payer. This is one of the most expensive mistakes.
Under Article 26 of Law No. 7 of 1983, Indonesia generally imposes a 20% withholding tax on payments to foreign taxpayers.

Practical meaning: Service fees, royalties, interest, and dividends may be taxed before funds are received.

Common Tax Mistake #3: Misusing Tax Treaties

Tax treaties are often applied informally or incorrectly.

While Article 32A of Law No. 7 of 1983 allows treaty application, Indonesian authorities require:

• Valid certificates of residence
• Proof of beneficial ownership
• Correct income classification

Practical meaning: Treaty benefits can be denied even when a treaty exists.

Common Tax Mistake #4: Misclassifying Services as Non Taxable

Foreign companies frequently assume that offshore services are not taxable in Indonesia.
In practice, Indonesian tax authorities often reclassify service fees as taxable Indonesian source income under Article 26.

Practical meaning: Remote services may still trigger withholding tax or PE exposure.

Common Tax Mistake #5: Weak Transfer Pricing Documentation

Intra group transactions are heavily scrutinized.
Under Article 18 of Law No. 7 of 1983, the tax authority may adjust prices that do not reflect arm’s length principles.

Practical meaning: Poor documentation leads to profit adjustments and penalties.

Risks and Legal Consequences

Back Taxes and Interest

• Tax reassessments may go back several years, with interest imposed under Law No. 6 of 1983.

Administrative Penalties

Penalties may include:

• Late filing fines
• Underpayment penalties
• Surcharges

Tax Audits and Disputes

• Foreign companies are frequent audit targets due to cross border complexity.

Criminal Exposure

• Severe non compliance may escalate into criminal tax investigations.

Case Examples

Case 1: U.S. Tech Company Sales Team in Jakarta
A U.S. company sends sales staff to Indonesia. Authorities classify the activity as a Permanent Establishment under Article 2, triggering corporate tax.

Case 2: Misapplied Treaty Rate
An Indonesian subsidiary applies a reduced treaty rate without proper documentation. The tax authority denies relief and reassesses tax at 20%.

Case 3: Intra Group Management Fees
Management fees are reclassified as royalties, increasing withholding tax exposure.

What Can Be Done

Step 1: Conduct a Tax Risk Assessment Before Entry
Identify withholding tax, PE, and VAT risks early.

Step 2: Choose the Correct Business Structure
Evaluate PT PMA vs. non presence models carefully.

Step 3: Align Contracts With Tax Treatment
Contracts should reflect actual activities and tax classification.

Step 4: Strengthen Documentation
Maintain treaty documents, transfer pricing files, and invoices.

Step 5: Seek Ongoing Legal Advice
Continuous compliance reduces audit exposure.

Conclusion

Most tax problems foreign companies face in Indonesia are preventable. They stem from incorrect assumptions, informal treaty use, and lack of early legal planning rather than deliberate non compliance.

Indonesia’s tax system—governed primarily by Law No. 7 of 1983, Law No. 6 of 1983, and Law No. 8 of 1983, as amended by Law No. 7 of 2021—is strict, procedural, and enforcement driven. Foreign companies that adapt to this reality, invest in proper documentation, and seek professional guidance significantly reduce their legal and financial risk.

If your company is facing Indonesian tax uncertainty, audits, or planning cross border operations, consult an experienced Indonesian business law advocate through the contact details provided in this website’s navigation for practical, tailored advice.

FAQ

What is the biggest tax mistake foreign companies make in Indonesia?
Underestimating withholding tax and PE exposure.

Can tax treaties fully protect foreign companies?
No. They reduce tax but do not eliminate obligations.

Are audits common for foreign companies?
Yes. Cross border transactions are a primary audit focus.

Can mistakes be corrected voluntarily?
Yes, but timing is critical to reduce penalties.

Should foreign companies use Indonesian legal counsel?
Yes. Local legal insight is essential.