Determination criteria for thin capitalization and tax adjustments | Indonesian Tax Guide 2025 (50)
Indonesia
Weak capitalization
2025-03-24 08:42:00
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This issue's introduction
Determination criteria for thin capitalization and tax adjustments
Special Tax Adjustment Policy
Criteria for determining thin capitalization
1. Overview of Debt-to-Equity Ratio
The current regulations set out the maximum debt-to-equity ratio for corporate taxpayers established or registered in the United States.
(1) Debt means the average outstanding debt balance during a fiscal year or part thereof, calculated on the basis of:
② If the accounting period is less than one year, the average value of the debt balance at the end of the corresponding month. The debt balance includes the balance of long-term loans and short-term loans and interest on accounts payable.
(2) Equity includes the average capital balance of an accounting year or part of a period, which is calculated based on:
① The average value of the capital balance at the end of each month of the accounting year;
② If the accounting period is less than one year, the average value of the capital balance at the end of the corresponding month.
(3) Capital balance includes equity as described in financial accounting standards and interest-free loans obtained from related parties.
2. Debt-to-equity ratio
(1) The maximum debt-to-equity ratio prescribed by regulations is 4:1.
(2) This debt-to-equity ratio does not apply to:
① Banks;
② Financing institutions;
③ Insurance and reinsurance companies;
④ Oil and gas mining industry. General mining companies and other mining taxpayers must comply with the specific debt-to-equity ratio requirements agreed upon in their signed sharing contracts, work contracts or joint mining work agreements;
⑤ Infrastructure construction companies.
(3) Banks refer to banks and Indonesian banks specified in the Banking Law.
(4) Financing institutions refer to financing institutions engaged in providing funds or capital goods.
(5) Insurance and reinsurance companies refer to insurance companies, Islamic insurance companies, reinsurance companies and Islamic reinsurance companies mentioned in the Insurance Law.
Tax Adjustment
(1) When a taxpayer’s debt-to-equity ratio is higher than the statutory debt-to-equity ratio, financing costs should be deducted in the amount allowed by the maximum debt-to-equity ratio.
① Interest on borrowing;
② Discounts and premiums related to borrowing;
③ Additional costs related to borrowing;
④ Lease financing costs;
⑤ Loan guarantee costs;
⑥ Foreign exchange differences generated by the above interest expenses.
(3) Debt includes accounts payable that are subject to interest expenses, excluding debt related to tax-exempt income and debt related to final taxable income, as well as debt not acquired through commercial arrangements. Equity is defined based on accounting standards and includes interest-free loans from related parties. The debt-to-equity ratio is calculated as the ratio of the average month-end debt balance to equity during the tax year.
(4) When a taxpayer obtains a loan from a related party, the loan transaction should still comply with the arm's length principle.
(5) When the taxpayer's equity amount is equal to or less than zero, all financing costs are not deductible.
(6) Decree No. 7 of 2021 stipulates that EBIDTA (earnings before interest, taxes, depreciation and amortization) is also an acceptable method of limiting interest expenses.
(7) Government Regulation No. 55 of 2022 further introduced a new specific anti-tax avoidance rule for hybrid mismatch arrangements. The rule stipulates that if the payment made by a resident taxpayer to a non-resident taxpayer is not regarded as taxable income or as deductible expenses in the country or region where the non-resident taxpayer is located, the tax bureau has the right to refuse the taxpayer to deduct these payments before tax.
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