Page 3 - Working Paper (Multinational Firms Losses and Profit Shifting Behavior in Indonesia: Some Comments)
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DDTC Working Paper 1215

                   1. Background                                    motives of multinational firms’ losses. The author
                                                                    argues  that  financial  losses  could  not  be  directly
                      This year, Directorate General of Taxes (DGT),   associated with tax planning strategy to increase
                   Indonesia has been set an ambitious target by the   tax  saving  (profit  shifting).  On  the  other  hand,  a
                   Government of Indonesia to collect approximately   careful perspective that multinational firms –with
                   Rp 1,294 trillion. This is not an easy task considering   their ability to optimize their global profit by utilize
                   a  number  of  fundamental  difficulties,  such  as   various national tax system- can have profit shifting
                   low tax  compliance, massive  informal sector  and   strategies  mainly via transfer  price  manipulation
                   institutional problems that Indonesia tax landscape   and thin capitalization,  should be addressed.
                   is  known  for.  Similar  with  other  developing   Further, in order to combat such practice, Indonesia
                   countries, one of the major tax  revenue sources   tax legislation should have effective anti-avoidance
                   in Indonesia is the corporate income tax (±40%). 1    rules  and  the  DGT  should  improve  their  tax
                     The  argument  is  simple:  most  of  the  firms  that   administration system on those particular issues.
                   contribute to corporate income tax operate in the   The detailed  rules  and  administration  strategies
                   formal  business  system;  however  a  substantial   will be beyond the scope of this article.
                   dependency  on revenue from corporation,
                   particularly  multinational  firms,  is  not  immune   2. Financial Loss in Business Framework
                   from risk and  challenges,  since they have more
                   sophisticated tax planning. 2                       When multinational firms suffer financial losses
                                                                    (negative profit); no tax should be paid by them to
                      Up to January 2015, there are more than 4,000
                                                                    the  government.  Unsurprisingly,  consistent  loss
                   multinational firms (firms with foreign entities as
                                                                    situation could trigger scrutiny from tax authorities.
                   shareholders or ultimate owners) in Indonesia that
                                                                    Yet, in business realities, multinational firms –like
                   suffered  losses.  Consequently,  such  multinational
                                                                    any other independent firms- could also have fiscal
                   firms have not paid any income tax in the relevant
                                                                    trouble. The following are some justifications why
                   tax  year.  There is a  speculation  as why such a
                                                                    multinational firms could have suffered losses.
                   significant  number  of  firms  have  suffered  losses,
                   some argued that  this is due to macroeconomic
                                                                       First, the profits of a multinational firm depend
                   downturn  and  business  environment;  but,  some
                                                                    on the functions performed,  assets (economic
                   also  suspect  that  multinational  firms  undertake
                                                                    and/or  legal)  owned  and  risks  assumed.  The
                   profit shifting behavior. The debate is not new and
                                                                    complexities of functions, assets and risks (FAR),
                   Indonesia is not alone.
                                                                    have a positive correlation with the expected profit.
                                                                    Please note, that there is no firm that will assume
                      In the mid 90’s, China struggled with the same
                                                                    to  suffer  financial  loss,  in  other  words  all  firms
                   issue. During 1988-1993, 35-40% of multinational
                                                                    operates with  the assumption  that  it  will  make
                   firms  that  operated  in  China  suffered  financial
                                                                    profits. However, at the same time, the complexities
                   losses.  The  figure  was  increased  to  60-70%
                                                                    of FAR will have a direct impact and influence on
                   during  the  next  five  years.  The  Government
                                                                    the  gap  between  the  expected  and  actual  profit.
                   of  China  estimated  that  nearly  60%  of  those
                                                                    Therefore,  actual  profit  is  more  volatile  under  a
                   multinational  firms  intentionally  created  losses
                                                                    complex FAR condition because in such a condition
                   by  using  transfer price manipulation  scheme. 3
                    The questions are: is it true that the multinational   Figure 1 - Relationship between FAR, Expected and
                   firms’ losses in Indonesia can be simply associated            Actual Profit (Loss)
                   with  any  effort  to  shift  profit  behavior  to  their   + Profitability
                   affiliation abroad just like in China? If yes, what are
                   the channels of this behavior? How should the DGT
                   (or Ministry of Finance) react to this problem?
                      This  article will  elaborate tax  and non-tax
                   1. If we divide the figure into both domestic and foreign firms, 10 – 11%   Expected profit  Volatility
                   of government revenue in developing countries or approximately around       of actual
                   US$ 725-730 billion, are contributed by multinational enterprises each     profit (loss)
                   year. Estimation based on contribution method and FDI-income method.
                   See UNCTAD, “FDI, Tax and Development – The Role of Multinational
                   Enterprises:  Towards Guidelines  for Coherent International  Tax and                  Function,
                   Investment  Policies,”  UNCTAD Investment and Enterprise Division     Loss            asset, risk
                   Working Paper (26 March 2015): 13-15.
                   2. Carlo Cottarelli, “Revenue Mobilization in Developing Countries,” IMF   -
                   Staff Paper 8 March 2011: 9. Available online at:
                   3. See Jian Li and Alan Paisey, Transfer Pricing Audits in China (New
                   York: Palgrave Macmillan, 2007).
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