Which Parties Constitute Tax Subjects?

Income Tax is a subjective tax, thereby, a tax subject has a very important definition in the implementation of the Income Tax system. This is because a tax subject is a party intended to be taxed. In addition, the determination of a tax subject is one of the benchmarks in determining whether a party is obligated or not to fulfil tax obligations on the income received or accrued.

The importance of determining the tax subject was also stated by Peter Harris. According to Harris, in his article entitled IFRS and the Structural Features of an Income Tax Law, the Income Tax law must identify parties constituting tax subjects for two main purposes.

First, to allocate Income Tax obligations, namely the parties obliged to pay taxes. Second, to identify the parties that may have income, thereby, the threshold of an entity obliged to pay taxes can be known (Harris, 2015).

Conceptually, a tax subject is a person (an individual and an entity) the Income Tax law aims to tax (Mansury, 1992). To determine who or the parties constituting tax subjects, the Income Tax Law must be drafted in such a manner that the provisions are clear and comprehensive, covering parties that must constitute tax subjects. This draft also includes the categorisation of each tax subject.

As such, which parties should constitute tax subjects to apply Income Taxes?

Parties Constituting Tax Subjects

Based on Avi-Yonah, Sartori, and Marian (2011), a tax subject is also known as a tax paying unit or tax unit. A tax paying unit consists of individuals, married couples, families, business entities and so forth, who earn taxable income. The tax paying unit is obliged to pay taxes and remit tax payable to the tax authorities.

The Income Tax Law generally categorises tax subjects based on the type of dominant person or entity stipulated under domestic regulations, namely individuals, companies and partnerships. In fact, in some countries that adhere to common law, tax subjects also include trusts.

Moreover, the Income Tax Law of several countries specifically mentions other types of entities, such as clubs, alliances, joint ventures, institutions and so forth as tax subjects. However, following the OECD and United Nations (UN) formulations, tax subjects are only categorised into two types, namely individuals and entities (Darussalam, Septriadi and Hutagaol, 2007). This OECD formula has been adopted by many countries in classifying their tax subjects.

In the OECD Tax Policy (2006), individual tax subjects are defined in two models. First, each individual is considered a separate tax subject and separate from other family members. In other words, a tax paying unit is an individual, thereby, each individual is required to fulfil their respective Income Tax obligations. Examples of countries that apply tax subjects with an individual model are Australia, Canada, Italy, Japan, Sweden, United Kingdom (UK), China, Brazil and India.

Second, a family where each family member is considered part of the family tax subject, thereby, the tax paying in this second model is the family. Based on this model, every individual is considered part of the family and the family is obliged to exercise Income Tax obligations. Belgium, France and Luxembourg are some of the countries that apply tax subjects using this model (Avi-Yonah, Sartori and Omri Marian, 2011).

In addition to the above two models, some countries, in fact, adopt a hybrid model in determining their tax paying units. In this hybrid model, elements from the individual model and the family model are applied simultaneously. Several countries that have adopted the hybrid model are the United States, Germany and Israel (Thuronyi, 2003).

On the other hand, the term entity has different definitions in each country. For example, in Canada. The Canadian Income Tax (CITA) as the Canadian Income Tax Law does not clearly define an entity. Section 248(1) of the CITA only states that entities also include incorporated companies.

The same does not apply to Canada. Italy is a country that clearly defines the parties constituting corporate tax subjects. Pursuant to the country’s Income Tax provisions, corporate tax subjects consist of joint-stock companies, partnerships or limited partnerships with equity in the form of shares, limited liability companies, joint ventures and other public entities other than companies.

One of the issues that frequently arise when discussing corporate tax subjects pertains to the status of partnerships. Undeniably, the difference in tax treatment in each country of these entities has led to this frequently discussed issue.

Basically, there are two types of treatments of partnerships for tax purposes. First, a partnership functions as a “transparent entity”, thereby, it is not treated as a tax subject. In this case, the partner is treated as a tax subject. This treatment is applied in several countries, such as Canada and Austria. Second, a partnership functions as a “non-transparent entity”, thereby, it is treated as a tax subject like any other form of company in general. Indonesia is among the countries that apply this treatment (Darussalam and Septriadi, 2017).

The same applies to joint ventures. The tax subject status of joint ventures is also frequently debated. In general, a joint venture as a form of cooperation between two or more entities (collective investment vehicle) is excluded as a tax subject, thereby, the income received by this business entity is only taxed at the level of each entity conducting the cooperation.

The exclusion of joint ventures as corporate tax subjects is inseparable from the underlying reason to avoid unfavourable tax treatment for the cooperating entities. For example, being subject to double taxation (Vermaulen, 2015).

Tax Subjects in Indonesia

Provisions on tax subjects in Indonesia are stipulated under Article 2 paragraph (1) of the Income Tax Law. Based on the formulation of this article, there are four tax subjects in Indonesia.

First, individuals. In principle, individual tax subjects in Indonesia adhere to the family model. This is stated in the Elucidation of Article 2 paragraph (3) of Gov. Reg. 74/2011. On the other hand, individuals constituting tax subjects are outlined in the Elucidation of Article 2 paragraph (1) subparagraph ‘a’ of the Income Tax Law, including individuals residing or are in Indonesia or outside Indonesia.

Second, undivided inheritance as stipulated under Article 2 paragraph (1) subparagraph ‘a’ number 2 of the Income Tax Law. Undivided inheritance is determined as a tax subject, thereby, income sourced from the inheritance continues to be taxed. This is because the inheritance left by the bequeather and has not been distributed to the heirs/heiresses may provide income even though the bequeather has passed away.

Third, entities. As a tax subject, an entity is defined as a group of people and/or capital that constitutes a unity that either conducts business or not. Entities may be in the form of limited liability companies, limited partnerships, other companies, firms, joint ventures, cooperatives and so forth.

Fourth, Permanent Establishments (PEs). A PE is a business entity used by non-resident tax subjects, both individuals and entities, that conducts a business or activities in Indonesia. Pursuant to the Income Tax Law, a PE is treated as a non-resident corporate tax subject whose tax treatment is the same as a resident corporate tax subject.

PEs are required to register to obtain a TIN, file Tax Returns to file the amount of tax payable in a tax year and taxes are imposed on taxable income using statutory rates as applicable to resident corporate tax subjects.