Tax anomaly in Batam

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.