Income tax waived
When the five-year income tax holiday facility was abolished as part of the 1984 tax law reforms the Indonesian government persistently argued, in response to businessmen's complaints, that tax exemptions were not a primary factor influencing investment decisions. The tax holiday facility remained excluded from the tax laws enacted in the second major tax law reform in 1995, even though the competition from other ASEAN countries which offered such tax incentives had become increasingly keen.
But Government Regulation No.45/1996, issued last week, unexpectedly reintroduced the tax holiday incentive. Even though the regulation does not explicitly call the facility a tax holiday but couches it under the phrase " the income tax is borne by the government", the bottom-line effect is the same. The phrase is used simply to circumvent the tax laws which do not stipulate anything about income tax exemptions.
The new incentive is even more generous in that the income tax exemption is valid for 10 years for specified businesses on Java and Bali and for 12 years on other islands. The pre-1984 tax holiday lasted only for five years after the start of commercial operations. Obviously, the tax incentive is designed to be an additional stimulus to new investment. The incentive can serve as a tool to direct more investments to the areas the government gives top priority to for development.
Admittedly, as the government argued in the mid-1980s, income tax exemption is not among the primary factors considered by businessmen when making investment decisions, especially after the highest income tax bracket was lowered to 35 percent from 40 percent in the 1995 tax law reform. After all, tax is paid out of profits and is a fiscal tool which every businessman has to live with wherever he does business.
The most important factors that have the greatest influence on the siting of investment ventures are political stability, natural and human resources, consistency in economic policy, adequate basic infrastructure, legal certainty (adequate commercial laws and strong law enforcement), an efficient bureaucracy and a potential market.
Indonesia's weakest points, we should magnanimously acknowledge, are related to legal certainty, inefficient government bureaucracy and inadequate basic infrastructure, notably outside Java and Bali. The government is fully aware of these weaknesses but it also realizes that removing these disadvantages takes a lot of time and, in so far as the bureaucracy is concerned, also involves a gradual, educational process. The fiscal measure of the 10-12 year tax holiday could thus serve as an additional, instant incentive to offset the disadvantages of those weaknesses.
We don't share the fear that the tax holiday will adversely affect government revenues. As long as the incentive does stimulate new investment ventures, the new businesses will create jobs which in turn will generate greater public purchasing power. This should increase domestic market demand for services and goods and provide the government with additional revenue through value-added tax. One should also remember that the exemption only applies to income tax. The government can still generate revenue from income tax on the employees and from the value-added tax on the transactions undertaken by the new businesses.
The special team in charge of implementing the tax holiday facility has yet to select which business areas will be entitled to the incentive. We hope the facility will be granted to the kinds of businesses which will have the greatest positive impact on the economy: The development of infrastructure such as power generation, toll roads, seaports and airports; telecommunications; the agro-industry sector and businesses manufacturing basic and intermediate industrial materials which currently have to be imported.