US-Indonesia Tax Treaty Rules for Individuals & Businesses

The U.S.-Indonesia tax convention, established in 1988 and later amended, addresses double taxation and prevents fiscal evasion. The agreement creates clearer tax regulations for individuals and businesses operating in both countries. It sets out rules for determining which country has the right to tax various types of income, preventing the same income from being taxed by both nations.

Determining Treaty Eligibility

Qualification for the U.S.-Indonesia tax treaty benefits hinges on being a “tax resident” of one or both countries. For an individual, tax residency is determined by factors establishing a connection to a country, such as being present in Indonesia for 183 days or more in a 12-month period. Corporate residency is established by the company’s place of domicile or effective management.

When an individual qualifies as a tax resident in both countries, the treaty provides “tie-breaker” rules to assign residency to a single country for treaty purposes. The first test is where the individual has a permanent home. If a home exists in both, the next test is the individual’s “center of vital interests,” meaning where personal and economic ties are closer. If that is inconclusive, residency is determined by their “habitual abode” and, finally, by citizenship.

Taxation of Personal Income

The treaty establishes regulations for taxing various forms of personal income to limit the tax imposed by the source country. The agreement covers several categories of income, each with distinct stipulations.

Dividends and Interest

The treaty caps the withholding tax the source country can levy on income paid to a resident of the other country. For dividends, the rate is limited to 15 percent, but it is reduced to 10 percent for a company holding at least 25 percent of the voting stock of the paying company. For interest income, the source-country tax is limited to 10 percent, with an exemption for interest paid to the other country’s government or its agencies.

Royalties

Royalties include payments for the use of patents, trademarks, copyrights, and for the rental of industrial, commercial, or scientific equipment. When a resident of one country earns royalties from the other, the source country’s tax is limited to 10 percent.

Capital Gains

The rules for taxing capital gains depend on the asset sold. Gains from the sale of real property may be taxed in the country where the property is located. For other types of capital gains, taxing rights are assigned to the seller’s country of residence.

Income from Employment

For income from employment, the treaty includes a “120-day rule.” A resident of one country performing work in the other is exempt from tax in the host country if their stay is 120 days or less in a twelve-month period. This exemption applies if the employer is not a resident of the host country and the compensation is not paid by a permanent establishment in that country.

Taxation of Business Profits

The treaty’s rules for business income center on the “Permanent Establishment” (PE) concept. An enterprise from one country can only be taxed by the other on profits attributable to a PE located there; otherwise, profits are taxed only in the enterprise’s country of residence. A PE is a fixed place of business, such as a branch, office, or factory. A construction or installation project also constitutes a PE if it lasts for more than 120 days.

Certain activities do not create a PE, even if conducted through a fixed place of business. These exceptions involve preparatory or auxiliary activities. For example, using facilities only for storage, display, or delivery of goods, or maintaining a fixed place of business for purchasing goods or collecting information, does not create a PE. These provisions ensure that businesses can engage in limited activities in the other country without automatically becoming subject to its income tax.

Claiming Treaty Benefits

To claim treaty benefits, an Indonesian resident earning U.S. source income must provide Form W-8BEN to the U.S. withholding agent before the income is paid. This form, “Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Individuals),” certifies the person’s foreign status. Failure to provide a timely Form W-8BEN will result in tax being withheld at the full 30% statutory rate instead of the reduced treaty rate.

U.S. citizens or residents who use the treaty to overrule or modify an internal revenue law must disclose this on their tax return. This is done by filing Form 8833, “Treaty-Based Return Position Disclosure Under Section 6114 or 7701,” with their income tax return. Failing to file Form 8833 when required can lead to penalties.

Relief from Double Taxation

An objective of the treaty is to mitigate double taxation through a foreign tax credit. This mechanism allows a resident of one country to reduce their domestic tax liability by the income taxes already paid to the other country on foreign-source income. For a U.S. resident, the treaty allows a credit for Indonesian taxes paid against their U.S. income tax liability. This credit is subject to U.S. law and cannot exceed the U.S. tax that would be due on that foreign income. The treaty provides a reciprocal credit for Indonesian residents against their Indonesian tax for U.S. taxes paid.