Employer of Record and Tax Legal Certainty Challenges

IMAGINE a start-up in Singapore wishing to recruit a software engineer based in Bandung. Incorporating a foreign-owned limited liability company solely to employ one person is clearly inefficient from a cost perspective.

Accordingly, the company engages an Employer of Record (EOR) service in Indonesia. The employment contract is signed between the worker and the EOR company, the salary is paid by the EOR, yet work direction and supervision remain in the hands of the Singaporean company.

At first glance, the arrangement above appears straightforward. However, once it enters the realm of taxation, a fundamental question arises. Who is the employer in that relationship — the party that also signed the contract, the party that pays the salary or the party that controls the work?

The answer to that question is crucial in determining the party obliged to perform Article 21 Withholding Tax, how a tax treaty is applied, when a permanent establishment (PE) status may arise and what the VAT treatment is in respect of the transaction.

The Unclear Legal Status of EOR

EOR is often conflated with outsourcing, yet the two are distinct. To date, there is no specific regulation governing EOR in Indonesia. The difference, however, lies in the type of work performed.

Minister of Manpower Regulations 7/2026 restricts outsourcing to supporting activities, such as cleaning, catering and security. By contrast, EOR is commonly used for core business positions, such as software engineers, data analysts, marketing personnel and even managerial roles.

Further, outsourcing is generally used by companies already operating in Indonesia, whereas EOR is widely utilised by foreign companies that do not yet have a legal entity in Indonesia.

The absence of specific regulation is the very source of the issue. In a conventional employment relationship, one party recruits workers, signs contracts, pays salaries, supervises work and at the same time benefits from the output. Under the EOR model, all of those functions are instead divided among several different entities.

From the perspective of Article 21 Income Tax, EOR service providers generally only carry out administrative obligations as the party paying income. However, when the employment relationship involves more than one jurisdiction, identifying the employer becomes considerably more complex.

That complexity affects the application of tax treaties, particularly the article governing the taxation of income from employment.

A similar issue arises in determining PE status. Pursuant to MoF Reg. 35/2019, the provision of services by an employee or another person for more than 60 days within a 12-month period may trigger the rise of a PE. The presence of workers through an EOR arrangement does not automatically give rise to a PE, but it must nonetheless be analysed alongside other constituent elements.

The OECD Model Tax Convention Commentary attempts to address that ambiguity by distinguishing between the legal employer, i.e., the party that formally acts as employer under the contract, and the economic employer, i.e., the party that substantively controls the work, assumes economic risks and directly benefits from the output of that work.

In many modern business structures, the two concepts may refer to different entities. This issue is not merely theoretical. In applying Article 15 paragraph (2) of a tax treaty concerning the 183-day rule, if the client company overseas is regarded as the economic employer, the assessment of the worker's period of presence and the allocation of remuneration to a PE must be viewed from the perspective of that client company, not from that of the EOR provider.

The Complexity of Domestic and International Tax on EOR Services

The VAT dimension is no less complex. Through Government Regulation (Gov. Reg.) 49/2022, the government grants facilities exempting labour supply services from VAT, provided four cumulative conditions are satisfied. One such condition is that the service provider does not pay wages, salaries, honoraria, allowances or similar payments to the workers supplied.

It is precisely this condition that in practice is most frequently unfulfilled under the EOR model. The very essence of the EOR model is that the service provider pays the salary to the worker. Consequently, if that provision is applied as written, EOR services potentially become subject to VAT in full.

The method of calculating VAT is governed by MoF Reg. 11/2025 through Alternative Tax Bases (dasar pengenaan pajak/DPP in Indonesian) mechanism, using the formula 12% × (11/12 × tax base). The tax base used is the total invoiced amount for the services rendered, excluding the labour remuneration component.

The question then becomes whether EOR can be fully equated with labour supply services as referred to in the VAT provisions, or not.

If the invoice clearly separates the EOR service component from the labour remuneration, VAT is imposed only on the service component. Conversely, if the entire invoice is consolidated, VAT may be imposed on the full consideration, including the salary component.

Without a standard definition, businesses and tax practitioners may potentially adopt different positions on transactions that are substantively identical.

That complexity increases further when the EOR service provider is a global platform domiciled overseas. In such circumstances, an overlap arises with the provisions on VAT collection on taxable services from outside the customs territory, together with the potential Article 26 Withholding Tax on payments to overseas parties.

Mo Reg. 112/2025 has indeed regulated the procedures for applying tax treaties, including clarification on PE status for non-resident taxpayers. However, that regulation does not yet specifically accommodate EOR usage scenarios.

EOR demonstrates that the evolution of the world of work is moving far more rapidly than the development of its regulation. This situation also presents an opportunity for the government to evaluate whether existing tax provisions are capable of accommodating modern business models such as EOR.

Clarity regarding the characteristics of EOR and its implications for income tax, VAT and international tax aspects will undoubtedly provide legal certainty for businesses whilst keeping Indonesia's investment climate competitive.

Whilst awaiting official guidance, realistic mitigation measures include structuring employment contracts, separating invoice components between worker remuneration and the EOR service fee, limiting the authority of EOR workers to prevent them from acting as agents binding the client company and consulting with the tax authority before potential disputes arise. (rig)

* This opinion article represents personal views and does not reflect the position of the institution where the author works.