Applying tax regulations to foundations Pahala Nainggolan, Jakarta
Foundations (yayasan) are treated as taxable entities by the inclusion of foundations in the 1994 Income Tax Law. This means all tax obligations apply to foundations such as book keeping to show income and expenses, the payment of income tax, filing tax returns and withholding income tax of employees and vendors.
The equal treatment of foundations and corporations has been criticized. On one hand, foundations, by nature, are established to do social work. They are not profit oriented. As a consequence, it is unfair to treat them in a similar manner to profit-making entities such as corporations. This treatment will discourage people to help the unfortunate or marginalized.
On the other hand, the government has found that many foundations are run as profit-oriented businesses. They generate profit using the foundation as their vehicle. This creates an unfair business climate. The treatment of foundations as taxable entities aims at fairness in terms of taxation.
Another reason is that social services such as health and education have become big businesses. They have established a new market segment for rich people. Luxury hospitals and educational institutions charging high fees aim at well-off customers and more investors have been engaged in these "social", yet lucrative endeavors.
By law, the revenue of foundations is not subject to income tax as long as it comes from donations or a grant and is not related to business, ownership or control between the parties concerned.
Such a simple regulation has created gray areas and inconsistencies. First, most members of the board of founders of the foundations are prominent people. They are rich or have a wide network to enable the foundations to get more donations. When they are the shareholders of companies, as is a common practice, they are expected to ask their companies to give donations to the foundations where they sit on the board of founders or management.
From the taxation point of view, those donations are not tax-exempted revenue due to cross-ownership. As a shareholder, he or she is the owner of a company. But as a member of the board of founders he or she is regarded as an owner of the foundation.
The application of the concept of ownership is not appropriate in this regard. The 2001 law on foundations, as amended by Law No. 28/2004, stipulates that the ownership of foundations is not in the hands of the board of founders. A good illustration of this is liquidation. When foundations are liquidated, for whatever reason, should there be any assets remaining, the board of founders cannot claim those assets. They belong to the government and must be distributed to other similar foundations.
Another misapplication of the concept is about expenses. By definition, expenses for taxation purposes are defined as all spending to generate, to maintain and to collect income. Raw materials, salaries and marketing expenses are paid to get the products or services to the market and to be sold. Thus it makes sense to tax the difference between its revenue and related expenses.
This concept, however, cannot apply to foundations. There is no connection between expenses and revenue. Foundations are not established to gain as much profit as possible by maximizing revenue and minimizing expenses. All their activities (reflected in their expenses) are carried out in connection with their mission. Linking the expenses to revenue for the calculation of tax is irrelevant. The spending is for social work, not directly for revenue generation.
A foundation with a social mission cannot be assessed by its financial results. Thus periodic assessment of its financial performance is not appropriate.
The fact that many foundations run businesses as corporations should not mean that the tax regulation should treat all foundations as profit-oriented corporations. There are still more foundations that work entirely with a social mission.
The new tax bills therefore should establish a more comprehensive regulation on foundations.They should be able to detect profit-oriented foundations and impose income tax on them, while at the same time, identify the foundations entirely devoted to social work and provide them with tax incentives. Those foundations with a social mission cannot be taxed as if they are profit-oriented missions. To achieve this, two steps could be considered.
First, the concept of revenue and expenses for foundations must be established differently from the profit-oriented sectors. Expenses of foundations should be regulated. Foundations could derive their revenue from various sources, including from for-profit activities. But the revenue should not be used as the basis for taxing them. When income tax is due it depends on how foundations spend their money. As long as their end clients or ultimate recipients of their services are the unfortunate or marginalized people they should not be taxed. But foundations also can operate luxury hospitals or schools. Whether they are profit-oriented or non-profit entities can be seen by how they use the surplus from their hospitals or schools. When the surplus is used entirely for social activities they are a social entity.
Second, a thorough survey of foundations must be conducted because they have different characteristics. There are foundations that can generate income from the services they provide such as health and education, while many others rely wholly on donations and grants. There are also the so-called grant-making foundations, which serve as an intermediary between donors and recipients. Their expenses are grants awarded to other foundations as recipients.
The findings of comprehensive field studies on foundations could be used as a reference for formulating comprehensive and appropriate tax regulations on foundations and for distinguishing non-profit foundations that have a purely social mission from the ones that make a lot of profit.
The writer is a public accountant, who is pursuing a doctorate degree in management science at the University of Indonesia School of Economics.
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