Due to the coronavirus pandemic that has continued since last year, the country's tax revenue shortfall is said to be worsening, and tax inspections may become even more severe in order to make up for the tax revenue shortfall. One of the points that tends to attract attention during tax audits is "royalties." If you are paying a large amount of "royalties" overseas, you should be careful as this item is likely to be targeted for denial. This time, I would like to explain about "royalties," which have a high tax risk.

１. What is royalty?
Royalties are payments made for the use of trademark rights, patent rights, and manufacturing (sales) know-how. The royalty calculation method is mainly based on sales and gross profit, and the amount is calculated by multiplying it by a certain rate.

2. Taxes on royalties
When a local subsidiary pays royalties overseas, 20% of the total royalty payment is taxed as PPH26. Therefore, 20% of the total royalty payment amount will be paid in Indonesia, and 80% will be remitted to the overseas royalty payment destination. If you have submitted your DGT (proof of residence) to the tax office, the preferential tax rate under the tax treaty will be applied, and the withholding tax rate will be a tax rate lower than 20%. This preferential tax rate varies depending on the country of payment, and is 10% in Japan. If you do not pay this withholding tax, your tax deduction will be denied, so you must pay the tax and file a tax return. Furthermore, in addition to the PPH26 withholding tax, VAT (value added tax) is also subject to taxation, and as VAT offshore, the total royalty payment amount is taxed at 10%, so the local subsidiary must pay the tax in Indonesia on behalf of the overseas company to which the payment is made.

３. Royalty tax risk
In tax audits, there is a strong view that royalties are consideration for the source of a local subsidiary's earning power, so if a local subsidiary is in the red or has a lower profit margin than other companies in the same industry, the tax office may view the royalties as payments unrelated to the business, i.e. payments that do not contribute to generating profits, and may be rejected. Whether or not the tax is denied depends largely on the judgment of the tax office, so if the tax is in the red, it is important to explain the special circumstances. The tax burden due to this denial extends to both income tax and value-added tax, and there are also penalties, which can be significant. To deal with these tax risks, it is important to prepare evidence that proves the consideration of royalties, and if the profit margin of a local subsidiary is low, consider reducing the royalty rate or excluding old products from being subject to royalties.Furthermore, if there is an obligation to prepare transfer pricing documents and there are royalties in related party transactions, it is important to use a database to verify the validity of the fee rate.It is also an important risk avoidance measure.

Related laws and regulations: Pasal 26 PPH Law、Law Number 42 Year 2009 Chapter 4 verse 1