Jakarta. Finance Minister Sri Mulyani Indrawati signed the multilateral instrument (MLI) on Subject to Tax Rules (STTR) on Sep. 19. This move made Indonesia one of the document’s first signatories,  joining a group of early adopters that includes Belgium, Portugal, Romania, Turkiye, Thailand, among others.

Overview of STTR

The STTR is part of the Pillar Two Global Agreement that has been agreed by more than 140 members of the Inclusive Framework (IF) on Base Erosion and Profit Shifting (BEPS). Pillar Two consists of Global Minimum Tax (GMT) and STTR. 

While the GMT is implemented through the domestic legislation of each country, the STTR is enforced through the signing of the MLI. As of 2024, the GMT has been effectively implemented by more than 40 countries worldwide. However, the MLI STTR is still awaiting implementation, as the signing ceremony for the MLI STTR had only taken place last week.

The STTR grants the source country --namely the resident country of the payer-- a right to tax certain cross-border intra-group payments up to 9 percent if these payments are taxed below 9 percent in the recipient’s country. The STTR-covered income includes royalties, interests, services, guarantee fees or financing fees, payments for distribution rights for a product or service, insurance or reinsurance premiums, and rental payments for industrial, commercial, and scientific equipment. 

For the source country to impose STTR top-up tax, two conditions must be met: (1) the aggregate STTR-covered income within a fiscal year must exceed 1 million euros (materiality threshold); (2) for income other than royalty and interest, the mark-up costs must exceed 8.5 percent (mark-up threshold).

Even though the resident country tax is below 9 percent, if the withholding tax imposed by the source country on the STTR-covered income tops 9 percent, there will be no STTR top-up tax.

The source country should only collect the STTR top-up tax if the total tax in the resident and source countries is less than 9 percent. 

The amount of the top-up tax will be the agreed minimum rate of 9 percent minus the resident country tax and the source country withholding tax, multiplied by the STTR-covered income.

Here is an example: Indonesian resident company PT A pays $3 million in royalty to A corp in the United Arab Emirates (UAE). The UAE does not tax the royalty income. The royalty tax rate under the Indonesia-UAE tax treaty is 5 percent. So the STTR top-up tax will be calculated as 9 percent minus 0 percent (UAE tax) and 5 percent (withholding tax in Indonesia), multiplied by 3 million, resulting in a top-up tax of $120,000.

How STTR Affects Indonesia’s Tax Treaties

The MLI STTR will affect Indonesia's existing tax treaties with 29 partner countries. As a result, the intragroup payment of STTR-covered income to the residents of those 29 countries might be subject to STTR top-up tax if the total tax in the resident and source countries is less than 9 percent -- provided that the materiality and mark-up thresholds are met.

The tax treaty rate on the STTR-covered income mainly surpasses 9 percent, so we might not see STTR being implemented as often. Considering those thresholds, the STTR top-up tax might not have a major impact on taxpayers. Only certain incomes are covered and only those that meet the materiality threshold and mark-up threshold are subject to STTR top-up tax. Therefore, the compliance costs for the taxpayers are expected to be less burdensome.

What Benefits Does the Document Offer?

The adoption of STTR into the current tax treaties offers several advantages for Indonesia. By signing the MLI, the government can encounter the profit-shifting arrangements and gain additional tax revenue at once. The anti-tax avoidance rules can be added to the current tax treaties without having to undergo the time-consuming bilateral negotiation for each treaty. The MLI’s signing can also be a boon to Indonesia as it seeks full membership in the Organization for Economic Cooperation and Development (OECD).

Entry into Force

Despite the signature, the STTR still has to undergo a ratification process before it can enter into force. Indonesia has to ratify the STTR MLI through a presidential decree to make it legally binding. This ratification instrument shall be exchanged afterward. Accordingly, considering the time required for the ratification process, the MLI on STTR might enter into effect no earlier than 2026.

As an early adopter of the MLI STTR, the Indonesian government demonstrates its commitment to implement global tax reform under Pillar Two. The government aims to ensure a more equitable tax system while safeguarding the country's attractiveness for foreign direct investment.

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Melani Dewi Astuti and Zainul Arifin both work for the Center for State Revenue Policy of the Finance Ministry's Fiscal Policy Agency. Melani is the body's senior international tax analyst, while Zainul is the policy analyst. The views expressed in the articles are those of the authors.