Income Tax Withold on Construction Services

Resident Taxpayers and Permanent Establishments qualified as small scale contractors have been potential to be imposed with Final Income Tax of Article 4 paragraph (2) or with Income Tax Article 23. This is based on the Government Regulation Number 140 Year 2000 and Regulation of Director General of Taxes Number PER-70/PJ./2007 (later referred to as PER-70). Final Income Tax of Article 4 paragraph (2) (later referred to as Final Income Tax) would be imposed if the procurement value per project executed is up to IDR 1 Billion. If the procurement value per project is more that IDR I Billion, Income Tax Article 23 would be imposed.

On the other hand, those qualified as medium and large scale contractors are only potential to be subject to Income Tax Article 23. Entrepreneurs rendering construction services but not qualified as contractors are also only potential to be subject to Income Tax Article 23. However, in contrast to the entrepreneurs already legalized themselves as contractors, the types of service rendered could not be categorized as construction services but as other services as meant in the appendix of PER-70.

In other words, Final Income Tax would only be imposed to small scale contractors having procurement value up to IDR 1 Billion. However, in practice, it is quite many taxpayers who would be confused in determining type of Income Tax to be imposed to construction service providers.

Definitely Final Income Tax

Now, PP No.140 Year 2000 has been revoked and replaced by PP No. 51 Year 2008 issued on 20 July 2008 and become effective since 01 January 2008. This new PP states that, “Upon income from construction service business, final Income Tax is imposed.” Further, this PP stipulates that, “Income Tax tariff for construction service business is as follows:

a. 2% (two percent) for Construction Execution conducted by service providers having small scale qualification;

b. 4% (four percent) for Construction Execution conducted by service providers having no business qualification;

c. 3% (three percent) for Construction Execution conducted by service providers other than those as meant in letter a and letter b;

d. 4% (four percent) for Construction Planning or Construction Supervisory conducted by service providers having business qualification; and

e. 6% (six percent) for Construction Planning or Construction Supervisory conducted by service providers having no business qualification.

From the above provisions, it can be concluded that whichever the criteria is, a construction service entrepreneur is now definitely subject to Final Income Tax. It is worth noting that the difference is in the tariffs applied. For those qualified as contractors, lower tax is imposed compared to those not qualified as ones. Entrepreneurs already legalized as contractors shall not be taxed more than 4%, whereas those who have not legalized/do not legalize themselves, can be taxed up to 6%.

Inevitably Paying Tax

One of the things that should be now considered by all construction service providers, is the condition that construction operating expenses can no longer be calculated as deductible expenses. It is because PP No. 138 Year 2000 stipulates that expenses related to income subject to Final Income cannot be deducted in Taxable Income calculation. It means that even in loss position, construction service entrepreneurs should still pay the tax. This is significantly different from those of the past time, where those subject to Income Tax Article 23 would still be able to calculate their operating expenses.

Separate Recording

Since expenses related to income subject to Final Income Tax cannot be calculated as deductible expenses, construction service entrepreneurs who also run other business not subject to Final Income Tax, should maintain separate recording of income and expenses from construction service with those from other business. This is highly important for the purpose of Corporate Income Tax calculation on other business if any. If there are assets/expenses difficult to be separated since they are related to both construction and other businesses carried out, the calculation of expenses can proportionally be made based on the percentage of income received from construction business and other business not subject to Final Income Tax.

Revision of Periodic Income Tax Return

In the Article 10 0f PP No.51 Year 2008, it is stipulated that upon contracts signed prior to 1 January 2008, the following provisions are applied:

· For payments of contracts/parts of contracts up to 31 December 2008, Income Tax imposition refers to the previous PP, which is PP No. 140 Year 2000;

· For payments of contracts/parts of contracts after 31 December 2008, Income Tax imposition is based on this new PP.

What is meant by the above provision is that, if contract is signed after 01 January 2008, the reference for Income Tax withholding is the provisions of PP No. 51 Year 2008. Thus, if a contract is signed after 01 January 2008 and the related taxpayer has already recognized the deductible expenses/paid construction service fee, tax that should be withheld is Final Income Tax. The revision to the Periodic Income Tax Return should be made if the related taxpayer has actually withheld Income Tax Article 23. The revision should also be made when a taxpayer has already withheld Income Tax Article 23 on construction service fee whose contract is signed before 01 January 2008 and already recognized it as deductible expense in year 2008, but has recently received the payment in year 2009.

No More Compensation Right

Another new matter stipulated in PP No. 5 Year 2008 is that any loss from construction service business which still remains up to Tax Year 2008 can only be compensated up to Tax Year 2008 as referred in its Article 10. For construction service entrepreneurs previously imposed with Income Tax Article 23 and having loss not yet compensated in a material amount, this provision may causes them to loose their right to compensate the remaining loss.

For example, if a medium scale contractor experiences a great loss in year 2007, referring to the previous tax provision, the loss would certainly be compensated with the business profit within the subsequent five tax years. Now, the loss may only be compensated in year 2008. So, if the business profit in year 2008 is lower than the loss in year 2007, there will be loss amount that cannot be compensated. In fact, if there is no business profit but loss in year 2008, there will be no chance to compensate the total amount of loss in year 2007.

PE: No Calculation of Expense?

PP No.51 Year 2008 affirms that construction service entrepreneurs with the status of Permanent Establishment (PE) could not get away from Final Income Tax imposition. PEs, which are only engaged in construction service business, accordingly could not also calculate their operating expenses. What seems to be the problem is that the PEs are required to pay Branch Profit Tax of 20% or the tariff under the Tax Treaty from their Taxable Income after tax.

The amount of Branch Profit Tax will not be obtained if a PE does not firstly calculate its Taxable Income, by deducting operating expenses from gross income. In other words, though already subject to Final Income Tax, PEs should still bear the obligation to calculate their operating expenses as accorded with the Article 6 and the Article 9 of UU PPh. After the Taxable Amount is acquired, based on the Decree of Finance Minister No.113/KMK.03/2002, Branch Profit Tax is calculated from the amount resulting from Taxable Income amount minus Final Income Tax.

Tips

As already informed above, entrepreneurs already qualified as contractors shall not be taxed more than 4%, different if compared to those not yet qualified which can be taxed up to 6%. Thus, it can be concluded that business qualification clearly determines which tax tariff to be imposed. The question is what is meant by the qualification it self?

According to the Article 3 paragraph (1) letter a of PP No. 51 Year 2008, business qualification is stratification determined based on the certificate issued by a Construction Service Development Institution. In practice, Gabungan Perusahaan Konstruksi Nasional Indonesia (GAPEKSINDO) is one of the institutions having the authorization to issue the certificate.

If you are a payer of construction service fee which should withhold Income Tax, in order to avoid bearing higher Income Tax tariff than the proper one, you should ascertain the existence of the certificate issued by a Construction Service Development Institution such as GAPEKSINDO. In the other hand, if you are a construction service provider, before being imposed with higher tax tariff than the proper one, you should provide the said certificate.

Another more important thing to be underlined is the same perception on the construction service itself. Both tax withholders and construction service providers ideally own the same perception on the definition of construction service. If not, it is possible that the tax withholders will impose tax tariff not in accordance with the provision of Income Tax on construction service business.