Tax Avoidance Undermines Developing Rather Than Developed Countries

JAKARTA, DDTCNews - Tax avoidance practices have a more significant impact on tax base erosion for developing countries than developed ones.

DDTC Director of Fiscal Research & Advisory Bawono Kristiaji outlined that this is on account of the substantial contribution of corporate income tax to tax revenues in developing nations. In contrast, developing countries rely more on individual income tax as the primary source of tax revenues.

“In Indonesia, approximately one-fifth of tax revenues are sourced from corporate income tax, whereas in Malaysia this figure stands at more than 30%, in African countries, it reaches a staggering 50%. This implies that even a slight disruption in corporate income tax can hit these countries harder,” said Bawono in capacity building entitled Empowering Civil Society: Guarding Taxes Towards Justice held by the Indonesian Fair Tax Forum (Forum Pajak Berkeadilan Indonesia/FPBI in Indonesian), Thursday (30/1/2025).

According to Bawono, a minimum of five factors contribute to tax non-compliance and facilitate tax avoidance practices. The five factors in question include, first, the issue related to the allocation of taxing rights or jurisdiction to tax based on the tax treaty (Persetujuan Penghindaran Pajak Berganda/P3B in Indonesian).

Bawono elaborated that the current global tax system allocates taxing rights bilaterally through a tax treaty entered into by two jurisdictions.

The majority of the tax treaties that have been agreed upon by the jurisdictions are based on a model designed by the Organisation for Economic Co-operation and Development (OECD), a multilateral organisation predominated by developed countries.

It comes to no surprise that taxing rights in tax treaties are significantly allocated to capital-exporting countries, which are, in essence, developed countries.

In a tax treaty, a jurisdiction obtains taxing rights based on the presence of a permanent establishment (PE or Bentuk Usaha Tetap/BUT in Indonesian). Unfortunately, the PE recognised in a tax treaty is a PE that has a physical presence in the source jurisdiction.

“The last battle of a source country to tax is when a PE exists. Unfortunately, this must be based on physical presence. As this requirement is tied to physical presence, it is difficult for the source and market countries, such as Indonesia, to collect revenues from digital giant companies,” remarked Bawono.

Second, the separate entity approach. On account of this approach, entities constituting part of a multinational enterprise group are treated as separate entities rather than a single economic unit.

As a result, a jurisdiction’s tax authority struggles to oversee a multinational enterprise group as a whole.

Third, deductibility of interest payment. Under the prevailing tax provisions in the majority of jurisdictions, debt financing receives more favourable tax treatment than equity financing.

Partiality towards debt financing arises because interest payments are treated as deductible expenses, whereas dividend payments are not classified as deductible expenses.

“Dividend payments are non-deductible. Debt payments to the parent, on the other hand, are deductible. The different treatment encourages multinational enterprises to opt for debt financing,” continued Bawono.

Fourth, the disparity in corporate income tax rates across jurisdictions. Bawono explained that each jurisdiction exercises fiscal sovereignty in setting its own tax rates.

Consequently, tax competition between jurisdictions surfaces either through outright tax rate reductions or partial measures, such as the granting of tax incentives. The rate reductions or incentives are granted assuming that lowering tax rates may attract foreign investments.

Although taxes are not the deciding factor for a multinational group to invest in a country, many countries still rely heavily on tax instruments to attract investments.

“There is an assumption that incentives play a crucial role to compensate other less favourable factors, for example, political stability, market share, legal certainty and so forth,” Bawono added.

Fifth, networks with tax haven jurisdictions. In general, a tax haven refers to a jurisdiction characterised by low tax rates or no taxes, lack of tax information exchange schemes or transparency in the legislative process and the absence of economic substance requirements in the case of establishing a business activity.

In addition to the above-mentioned four characteristics, tax haven jurisdictions implement regulations specifically designed to facilitate transactions by non-residents to avoid the obligation to pay taxes. This is reinforced by stringent confidentiality measures to conceal information related to the beneficiaries of such transactions.

“The orientation of tax haven jurisdictions is to cater primarily to businesses of non-residents, in other words, economic activities of non-residents,” Bawono continued.

Bawono highlighted the pivotal role civil society organisations play in reducing tax avoidance practices. For example, the implementation of country-by-country reporting (CbCR) that challenges the separate entity approach, a concept coined by an accountant and founder of the Tax Justice Network Richard Murphy.

Moreover, the global minimum tax, set to be implemented under Pillar 2: Global Anti Base Erosion (GloBE) was also made possible owing to the persistent efforts and campaigns of civil society organisations.

On a related note, the Indonesian Fair Tax Forum is a coalition of civil society organisations dedicated to taxation. The Indonesian Fair Tax Forum operates a flexible and open coalition of civil society organisations committed to establishing a fair tax system in Indonesia.

Civil society organisations constituting members of the Indonesian Fair Tax Forum include The Prakarsa, PWYP, Transparency International Indonesia, Lokataru Foundation, Seknas Fitra, Celios, Puskaha, Aksi!, Indonesia for Global Justice and Trend Asia. (sap)