Tax anomaly in Batam
After unnecessarily putting trade activities in Batam and its two neighboring islands Bintan and Karimun in uncertainty for almost 10 days, the government finally decided to postpone, for the fourth time over the past four years, the imposition of a value-added tax (VAT) and luxury sales tax on domestic transactions in the bonded areas until the end of March 2003.
It is hard to understand why the government has delayed its decision on such an important policy matter to the point of causing confusion and uncertainty.
After all, the government had decided as early as last October to go ahead with its policy measure adopted in 2000 to impose the two indirect taxes on domestic consumption on the three islands beginning early this month. The program was also approved by the House of Representatives and was accounted for in the estimate of tax revenues for the 2002 state budget.
The government should have known months ago whether the tax policy was administratively and politically enforceable or not, and then decide accordingly on the status of the policy long before it was supposed to take effect on July 1.
The move had been planned since 1998 to correct a misguided tax policy measure, which had been overlooked since 1978 when the government aggressively promoted Batam -- later expanding to Bintan and Karimun -- as an industrial bonded zone to attract foreign investment.
There is nothing wrong with the bonded zone concept. It is the right strategic policy that has also been pursued by many other countries bent on bolstering exports. A bonded area allows manufacturing companies to bring in capital goods, raw and intermediate materials without paying import duty, VAT and other indirect taxes normally imposed on trading transactions.
The mistake, though, is that in terms of tax treatment, Batam and the other two islands were from the outset mistakenly treated as a free trade area, not as their original status as a bonded zone. Different from the tax treatment in a free trade area, tax and import duty exemptions in a bonded zone are granted only to export-related activities and not to domestic sales. Companies are entitled to tax and duty relief as long as their imports are meant for the processing of goods for export.
However, as the people and businesses in bonded areas have taken the VAT and duty exemptions for domestic sales for granted for more than 20 years, they are strongly opposed to the new tax policy, warning that investors will flee the area if the two indirect taxes are collected from domestic sales. The government succumbed to the strong protest and decided to postpone the 1998 policy decision and again deferred it in 1999 and again in 2000.
Instead of having to face the risk of making another embarrassing postponement next March, the government is considering making a total correction by preparing a bill that will make the three islands a free trade area. This will abolish the need to apply differential tax treatment to domestic and export transactions.
Moreover, it is a discriminative policy if the government maintains the three islands as a bonded zone but continues to treat them as being outside the national trade regime. In a bonded area, only export-oriented companies are exempt from paying VAT and the luxury sales tax, while domestic sales transactions must be subject to indirect taxes as other Indonesian areas are.
Applying differential tax treatment could also scare off businesses and new investors in view of the notoriously inefficient and corrupt tax and customs services.
Now that the government has decided to make the three islands a free trade area, the biggest challenge that lies ahead is how to expedite the legislation to that effect. Unfortunately, law- making seems to be at the bottom of the agenda at the House, which is now struggling with a backlog of almost 30 bills that are badly needed to support the reform movement.
Legislating the three islands as a free trade area has now become more urgent after the government accepted an offer from the United States and Singapore to include Bintan island in the integrated sourcing initiative within their free-trade agreement (FTA).
Indonesia would benefit greatly from the initiative because under this framework almost 100 categories of information technology products manufactured in Bintan could be exported to the U.S. under preferential treatment granted within the Singapore-U.S. FTA.
However, without the status of a free trade area, more efficient tax, customs and immigration service and more stable labor management, it will be impossible for Bintan to participate in the integrated sourcing initiative.