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

DDTC Working Paper 1215
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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: http://www.imf.org/
external/pp/longres.aspx?id=4537.
3. See Jian Li and Alan Paisey, Transfer Pricing Audits in China (New
York: Palgrave Macmillan, 2007).