Taxing consumers in Batam

Taxing consumers in Batam

The government must strongly oppose an initiative by the House
of Representatives to turn the entire island of Batam, about 30
kilometers southeast of Singapore, into a free trade zone, even
in the face of threats by a number of investors to move their
businesses off the island to other countries.

As a shortsighted initiative to gain votes in Batam during the
upcoming presidential runoff, making the island a free trade
zone, as proposed in a House-sponsored bill, could significantly
boost local support for President Megawati Soekarnoputri.

However, such a step would be economically and fiscally ill-
advised for the long-term good of the national economy, and could
set a dangerous precedent that could trigger demands from people
on other islands for similar tax facilities.

Putting Batam back under the national tax regime now would
unlikely be met with as fierce an opposition as in the late
1990s. There was, after all, little protest when the government,
after five postponements since 1998, moved earlier this year to
impose in Batam a value added tax (VAT) and a luxury sales tax
initially on motor vehicles, tobacco, cigarettes and liquor, and
beginning in March, on electronic goods. And to our knowledge,
not a single investor has left Batam simply because of the tax
imposition based on Government Regulation No.63/2003.

People and investors in Batam seem to have increasingly
realized that returning the island to the national tax regime
would be aimed only at correcting a major mistake that has been
overlooked since 1978, when the government began to promote Batam
as an industrial bonded zone to attract foreign investors.

A bonded zone is an economic concept designed to boost exports
by allowing industrial firms to bring in capital goods and raw
materials without paying import duties, VAT and other indirect
taxes normally levied on such transactions. However, the tax and
duty exemptions in a bonded zone are effective or granted only to
export transactions and do not apply to domestic sales or
domestic consumption.

This means that industrial companies are entitled to such
exemptions only if their imports are materials for their export
goods, and if their products are entirely destined for the export
market.

However, Minister of Industry and Trade Rini Soewandhi argued
during the deliberation of the Batam bill on Monday that unlike
other bonded zones in the country and overseas, Batam has also
developed into a city of more than 500,000 people with a mixture
of residential areas, industrial complexes and commercial
centers. Hence, manufacture is only part of the mainstream
economic activities on the island.

The best solution, therefore, is to restrict the free trade
zone to major industrial areas/estates in Batam by classifying
them as enclave bonded zones (isolated from residential and
commercial areas), similar to other bonded areas such as the
Nusantara bonded zones at Cakung in Jakarta and Belawan in North
Sumatra. All of these bonded zones are located outside
residential areas. Such a tax treatment is also applied in
Singapore, Hong Kong and most other areas operating bonded zones.

Minister Rini said there were seven industrial areas in Batam
that could be developed into enclave bonded zones (isolated from
residential areas), and since only 40 percent of these industrial
estates were currently being used there was still room for new
industrial plants.

A continuation of different tax treatment for Batam not only
could make the island a beachhead for smuggling but, as Minister
of Finance Boerdiono said on Monday, it would also be unfair to
people on other islands in the country. Why should the people of
Batam enjoy such special privileges?

The government, however, should address the great concern
among investors (as expressed in an essay on page 7) over the
likely ramifications of bonded zones under an enclave system.
What really worries investors, notably foreign manufacturers, is
not the imposition of the taxes itself, but rather the integrity
and technical competence of the bureaucratic machinery -- the tax
and customs services -- and the other law enforcement agencies
that will administer the taxes and duties and oversee the
movement of goods from one area to another on the island.

It is therefore imperative for the government to develop an
effective system to ensure the flow of goods into and out of the
enclave bonded zones remains smooth, while domestic
trade/consumption outside these bonded zones is properly taxed.