The Indonesia-Netherlands tax treaty is one of Indonesia’s biggest tax leaks, new research shows
Public services and the people who depend on them are losing out to tax avoiding multinationals.
This article is part of ourEconomy's 'Decolonising the economy' series.
An in-depth analysis of court cases shows how the Dutch government is very reluctant to change its tax-friendly policies on multinationals and tax treaties, thus making it extremely difficult for developing countries like Indonesia to collect much-needed taxes.
Indonesia won its independence from the Netherlands in 1949, but the two countries are still bound to each other through numerous trade and tax agreements. One of these, the Double Tax Agreement (DTA) has a very negative impact on the Indonesian tax base and thus on public services and the people that depend on them, especially women and girls who need strong public health and educational services most.
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The DTA is often used by multinationals for purposes of tax avoidance, resulting in tax losses for the Indonesian government. Attempts by the Indonesian tax authority to stop tax avoidance, by bringing companies to the Indonesian Tax and Supreme Court, usually fail. The companies, new research shows, win most cases, and the Dutch government is very reluctant to act on requests coming from Indonesia to help tackle tax avoidance.
Despite its promises to improve the taxation rights for developing countries, the Dutch tax treaty with Indonesia remains one of the biggest tax leaks for Indonesia. Investors from outside Indonesia that want to invest in Indonesia do so via the Netherlands, to make use of the Dutch tax-friendly national policies towards multinationals. This behaviour, of selecting a specific country (such as the Netherlands) as hub for international investments (treaty shopping), is widespread among multinational corporations. As a result, many large multinational corporations around the world can avoid paying taxes and gain undue investor benefits.
Indonesian research organisation Prakarasa and the Dutch Centre for research on Multinational Organisations (SOMO) looked at 27 specific court cases brought before the Indonesian Tax Court and the Supreme Court in the period 2010-2015. All but two were won by multinationals. The research unravels the weaknesses in the tax treaty and other relevant factors that make the Indonesian-Netherlands tax treaty one of the biggest tax leaks for Indonesia.
The first tax treaty between Indonesia and the Netherlands was signed in 1973. The current tax treaty stems from 2002 and was amended in 2015. One of the main features of a tax treaty is regulating the taxation of so-called internationally distributed passive income, mainly dividends, interest, and royalties. Generally, countries tax international payments of passive income at the source (instead of taxing the receiver of the payment), through so-called withholding taxes. The Dutch-Indonesian tax treaty is one of the most favourable of all tax treaties signed by Indonesia. The withholding taxes are amongst the lowest and it does not include an anti-abuse measure. This makes the treaty very attractive for ‘treaty shopping’, and tax avoidance. Between 75% and 90% of all ‘Dutch’ investments in Indonesia are structured via 'letterbox companies' in the Netherlands - companies that have no actual (economic/business) presence in the Netherlands and are only located in the Netherlands for legal purposes (for example, to have access to Dutch tax treaties).
Multinational corporations use the Netherlands, which has nearly one hundred bilateral tax treaties in place, as a conduit country in order to structure financial flows from source countries to third countries. This is reflected in the fact that the Netherlands ranked number one in worldwide investment tables in 2017, with disproportionately large inward and outward capital flows compared to the size of its economy in terms of GDP. This shows that most foreign direct investment is not directed towards the Dutch economy, but is only channeled through the Netherlands for different reasons (such as tax avoidance).
SOMO and Prakarsa looked in-depth at court cases involving Dutch multinationals Akzo Nobel, Boskalis, Friesland Brands and Ecco and Indonesian companies like Indosat, and estimated that the Indonesian government lost over IDR 386bn (appr. EUR 24 million) in taxes for the 27 cases in the report. It is hard to calculate what the total tax loss for the 2010-2015 period is, but it is clear that it would be proportionally bigger.
Why exactly is the Dutch-Indonesian tax treaty so widely used by multinationals to avoid taxation?
- Withholding taxes are extremely low. The withholding tax on intercompany dividend payments is 5% (it used to be 10% until 2015). The withholding tax on interest payments related to loans with a term of more than 2 years is currently 5% (used to be 0% until 2015). This makes the Dutch tax treaty one of the most favourable of the, in total, 68 tax treaties currently entered into by Indonesia. In comparison, only the withholding taxes on dividend payments (substantial holdings) of the Indonesian tax treaties with Kuwait, Saudi Arabia and the United Arab Emirates are as low as the Dutch tax treaty with Indonesia. When it comes to interest payments on loans with a minimum term of two years, only Hong Kong’s tax treaty with Indonesia has an equally low withholding tax.
- There are almost no requirements for companies that want to make use of Dutch fiscal framework legislation. The requirements are so low that about 18,000 letterbox companies exist in the Netherlands, having no actual economic presence.
- There is no anti-abuse measure in the tax treaty. The 2002-2015 tax treaty contained a provision on ‘beneficial ownership’, but this could not be effectuated as no common definition could be formulated by the Dutch and Indonesian governments.
- The lack of sufficient resources at both the Indonesian tax authority and the Indonesian Tax Court. Indonesia is not able to properly research and demonstrate the facts related to tax avoidance cases. In some of the selected 27 tax cases, no representative from the Indonesian Tax administration was present. The lack of sufficient resources is also apparent when it comes to Indonesian judges. There are only 55 judges at the Indonesian Tax Court, leading to an average of 291 cases per year per judge. Court rulings therefore tend to support multinational companies, as there are not sufficient resources to research the case. Another related problem is the substantial incoherence among the relevant court rulings.
The Dutch and Indonesian researchers conclude that, in addition to the need for reform of the domestic laws in the Netherlands and Indonesia, critical reform of the Indonesia-Netherlands double tax treaty is necessary, including a strong anti-abuse provision. Furthermore, the Dutch government should aim for higher withholding taxes in the tax treaty and needs to fundamentally reform its legal framework that enables conduit structures, for example by demanding real economic presence for companies that want to make use of the Dutch fiscal framework (to prevent the use of letterbox companies). The Indonesian government needs to reform its domestic laws and implement anti-abuse measures, for example through ratifying the OECD’s instrument to combat treaty shopping (MLI).
It's time that western governments put a halt to policies enabling multinationals to drain global south countries of their much-needed tax revenues.
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