Revisiting ‘Prepaid Tax’ Schemes as the Root Cause of Tax Refunds
WHAT is going on with refunds? The discourse on the tax refund mechanism continues to generate much discussion. The government is busy ensuring refund disbursements are more ‘measured’ to prevent further depletion of the state treasury. Meanwhile, taxpayers are anxious their refund applications might be obstructed.
The question above, ‘What is Going On with Refunds?’, was also the title of a DDTCNews Tax Editorial back in April 2019. Despite a gap of 6 years, the pattern of challenges turns out to be the same: the government views refunds as a cause of weakening revenue performance.
This Tax Editorial therefore attempts to raise the recurring question: what is going on with refunds? Why is the government so keen to tighten the refund disbursement mechanism?
We may be able to understand the government’s concern surrounding he risk of abuse of overpayment claims. However, this line of thinking overlooks one fundamental point, namely that refunds are a logical consequence of the tax system design that has long been in operation in Indonesia. One of the main sources of refunds is the ‘prepaid tax’ mechanism.
In Indonesian tax practice, prepayment of tax is a commonly used instrument to guarantee state revenue. Through this scheme, the state does not need to wait until the end of the year to collect tax, but can instead collect it progressively throughout the year. The two most relevant instruments in this context are import Article 22 Income Tax and Article 25 Income Tax instalments.
Article 22 import Income Tax, for instance, is collected when goods enter the customs area. In many cases, this collection does not take into account the taxpayer’s actual profit or loss position. As a result, companies, particularly those in the trading sector with thin margins, often pay more tax than is actually owed. Consequently, when the year-end calculation is performed, the difference emerges as an overpayment. Read The Right Awaited Behind the Refund Process
A similar situation occurs with Article 25 Income Tax instalments. This scheme is based on the prior year’s tax liability, which is then divided into monthly instalments. Issues arise when business conditions deteriorate significantly during the current year. Taxpayers remain required to pay the same instalment amount, although their economic capacity has changed. Again, the end result is an overpayment.
An overpayment position should therefore be understood as a systemic consequence. It arises from a tax collection design that prioritises the state’s fiscal prudence principle. It is therefore inappropriate for the government to tighten refund disbursements, as if an overpayment were a mistake.
In the article Understanding VAT Refunds, DDTC Founder, Darussalam, emphasises that a refund is, in fact, a taxpayer’s right. Although Darussalam focuses on VAT refunds in that article, the manifestation is similar to income tax refunds.
Moreover, a refund is a correction mechanism to ensure that the tax paid by a taxpayer is in line with their actual liability. This principle is also enshrined in the Taxpayers’ Charter, which states the ‘right [of taxpayers] to pay no more than the correct amount of tax’.
Withholding or tightening the return of such funds is, therefore, tantamount to shifting the ‘fiscal burden’ from the state to entrepreneurs.
Perhaps the public also needs to understand the government’s cautious approach. Efforts to control refunds can still be pursued, but through a simpler and more rational approach.
The government needs to ensure that the prepaid tax mechanism is more closely aligned with actual business conditions, whether through flexibility in adjusting instalments or by facilitating exemptions from withholding or collection.
In principle, the scope for adjusting income tax instalments is already contained within the regulatory framework. However, the discretion remains entirely in the hands of the authorities. This is what makes flexibility for entrepreneurs in calculating Article 25 Income Tax instalments ‘limited’ and illusory.
This situation is consistent with the findings of the Tax Supervisory Committee (Komite Pengawas Perpajakan/Komwasjak in Indonesian) that Indonesian tax regulations vest a great deal of discretionary authority in tax officials. Read Authority's Broad Discretion from Tax Regulations: Narrowing Required?
To maintain a sound business climate, the adjustment of Article 25 Income Tax instalments should be directed towards becoming a more automatic, self-assessment-based mechanism. This implies that information submitted to DGT would serve merely as a notification, rather than an application requiring approval.
This approach is believed to reduce reliance on the authorities’ discretion, while also ensuring that tax instalment payments more closely reflect actual business performance. In line with this, the principles of administrative ease and legal certainty are also important pillars that need to be upheld. Read For Legal Certainty, Tax Should Be Applied Without Discretion
Ultimately, it is important to place refunds back in their proper context. A refund is not the source of the problem; it is the consequence. It arises from the prepaid tax mechanism.
If the government wishes to control the scale of refunds, what needs to be reformed is not the refund process itself, but the policy design that gives rise to it. Without upstream reform, every effort to tighten downstream processes will amount to nothing more than a false solution. (sap)