In the realm of business activities, companies often seek to borrow money from various sources, such as banks, non-bank financial institutions, or other companies—both third-party and related parties. These borrowings play a crucial role in financing working capital and capital expenditure, essential for sustaining business continuity and fostering rapid business growth. At the heart of this financial landscape lies the intricate realm of taxes in borrowing costs, which demands careful consideration and strategic planning.
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In accordance with the principle of an arm’s length transaction, company borrowings have consequences, there is the obligation to pay the borrowing principal and interest expenses. Interest expense is a fee that needs to be paid by the company in return to the lender (the creditor). Interest expense is recognized in the statement of profit and loss, although in accounting standards there is an interest expense that can be capitalized so that it adds to the value of the assets financed by the related borrowing.
Borrowing interest expense may be recognized as an expense that can reduce income in the calculation of taxable income. The principle of deductible interest expense is as long as it meets the 3M criteria, namely costs identified for Memperoleh (Obtaining), Menagih (Collecting) and Memelihara (Maintaining) income. Interest expenses that have nothing to do with 3M’s efforts cannot be deducted, so positive fiscal corrections must be made, for example, interest expenses originating from shareholder personal borrowings.
Deductible and non-deductible interest expenses are stipulated in Law no. 36 of 2008, which regulates income tax. Interest expense can be deducted from taxable income if it is included in efforts to obtain, collect and maintain income, so that interest expenses arising from financing from other companies can be paid for by the company. For this interest expense, based on article 23 paragraph 1 letter a, the company is required to withhold income tax at a rate of 15% of the total interest expense paid. This mandatory deduction is excluded for interest expenses arising from bank loan. As taxpayer, a company are required to pay and report the withholding of Income Tax article 23 in the next tax month.
Fairness Principle Calculation Tax in Borrowing Costs: Debt-to-Equity Ratio (DER)
Interest expenses that can reduce income in taxes must come from a debt ratio that meets the principle of fairness stipulated in the Regulation of the Minister of Finance (PMK) of the Republic of Indonesia Number 169/Pmk. 010/2015 concerning Determination of the Amount of Comparison between Company’s Borrowing and Capital for the Purposes of Income Tax Calculation. For the purpose of calculating income tax, the ratio between debt and capital is determined for companies that are established or domiciled in Indonesia, whose capital is divided into shares.
Calculating Tax in Borrowing Costs Fairness: PMK No.169/PMK.010/2015
Borrowing referred to in this is the average balance of debt in one tax year or part of the tax year, which is calculated based on the average balance of borrowings at the end of each month in the relevant tax year; or the average borrowings balance at the end of each month in the relevant part of the tax year. The borrowing balance referred to includes long-term borrowing balances and short-term borrowing balances, including interest-bearing trade borrowing balances.
Capital referred to is the average capital balance in one tax year or part of the tax year, which is calculated based on the average capital balance at the end of each month in the tax year concerned; or the average capital balance at the end of each month in the relevant part of the tax year. The capital balance referred to includes equity as referred to in the applicable financial accounting standards and interest-free borrowings from related parties.
Based on PMK No.169/PMK.010/2015, borrowing fairness is calculated from the ratio of debt to equity (DER). The ratio between debt and capital is set at a maximum of four to one (4: 1). Taxpayers who are banks, financial institutions, insurance and reinsurance companies, in the oil and gas mining, general mining, and other mining sectors who are bound by production-sharing contracts, contracts of work, or cooperation agreements are exempted from the provisions on the comparison of debt and capital. The mining operation, and in the said contract or agreement, it regulates or includes provisions regarding the ratio limit between borrowing and capital; whose entire income is subject to final Income Tax based on separate laws and regulations; and Taxpayers who run businesses in the infrastructure sector.
If the DER ratio exceeds the 4:1 requirement, then the loan interest that can be charged must be adjusted to a maximum of 4:1. If the company’s DER ratio is 5:1, then taxable interest charges can only be charged at 4/5 of the commercially charged borrowing interest. The remaining 1/5 is corrected positive fiscal thus increasing taxable income compared to before commercial profit before fiscal corrections.
Treatment of Taxes in Borrowing Costs for Interest Expenses in Leasing Transactions
Payables other than money loans used to acquire fixed assets originate from leasing transactions. In leasing, there is a lease debt which results in the company having to pay interest expenses. Based on Minister of Finance Decree No.1169/KMK.01/1991 article 16, interest payments for leasing can be financed, including for leasing without option rights (article 17). For payment of expenses arising from the lease without option rights, based on the Decree of the Minister of Finance No. 1169/KMK.01/1991 article 17 companies are required to withhold income tax article 23.
The Connection Between Tax and Accounting Treatment of Interest Expenses
The company’s understanding of interest expense in taxation can avoid unnecessary tax payments or interest penalties. The tax treatment of interest expenses cannot be separated from the accounting treatment of interest expenses.
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