1. Case Introduction

A Engineering Company is a Chinese resident enterprise. It signed a contract with DL Company in Indonesia (hereinafter referred to as “Indonesia”) to implement Project M and Project N. Both Project M and Project N are EPC projects (E refers to engineering design, P refers to project-related procurement, and C refers to construction). In order to implement the project, A Engineering Company established a branch in Indonesia as the execution entity of part of the project design work and all construction work (including installation). The English name of the branch is consistent with the name of A Engineering Company’s domestic head office. After the branch registered a tax registration number in Indonesia, it issued a legal bill to DL Company to confirm the receivables based on the engineering settlement quantity bill. In accordance with the relevant provisions of Indonesian domestic laws, DL Company applied a 3% tax rate to the construction service project and deducted the “final income tax on construction services” and paid the remaining amount to the branch. For the equipment procurement part of the contract, A Engineering Company uniformly tendered and purchased, organized shipment and handled the VAT refund in China. A Engineering Company issued a pro forma invoice to DL Company according to the contract quantity bill price. According to the payment node agreed in the contract, Indonesian DL Company paid the full amount of the invoice to A Engineering Company’s domestic account without deducting any final tax or withholding tax.

2. Focus of the Dispute

The Indonesian Tax Bureau believes that the contract income corresponding to the equipment procurement part of the M and N project contracts of Engineering Company A belongs to equipment procurement under the EPC contract and should be subject to “final construction service income tax” in Indonesia.

A Engineering Company believes that the equipment procurement was completed entirely in China by A Engineering Company and has no direct connection with its Indonesian branch. According to international rules and the China-Indonesia tax treaty, the relevant profits should be taxed only in China. The Indonesian tax bureau only imposed taxes based on the superficial form of “contractual obligations under the same contract”, ignoring the essence of the business, which is not convincing enough.

3. Final Decision

The Indonesian court finally ruled that the income from equipment procurement obtained by Engineering Company A was part of the overall construction services provided in Indonesia and should be subject to final tax in Indonesia. The main reasons were as follows:

First, although all equipment purchases under the EPC contract were conducted by A Engineering Company through bidding and shipment in China, the name of the equipment consignee on all shipping declarations was A Engineering Company instead of the owner Indonesia DL Company, proving that the branch of A Engineering Company was highly related to the equipment procurement behavior.

Second, A Engineering Company undertook the EPC contract to provide “turnkey” services to Indonesian DL Company, providing a complete power plant that realizes the designed functions, rather than a separate service that can be partially divided. All imported equipment is used for projects under construction. After receiving the imported equipment shipped from China, A Engineering Company installed, debugged and tested it in Indonesia to achieve the contract agreement and design requirements. Therefore, the equipment procurement behavior should be regarded as part of the overall construction services provided by A Construction Company in Indonesia and should be taxed.

4. Implications for “Going Global” Enterprises

First, pay attention to Indonesia’s “final income tax on construction services”. This is a withholding tax imposed on construction service providers by Indonesian domestic law. Residents and non-residents are treated equally. Different construction qualifications are subject to different tax rates and pay final tax according to total income. “Qualification” is determined by the relevant department based on the business scale of the construction company (i.e. small, medium or large). It should be noted that foreign construction companies operating in Indonesia through branches or permanent establishments are required to pay branch profit tax on taxable income (accounting profit adjusted for tax) after deducting the final tax on the construction industry.

Second, formulate a financial and taxation plan in advance to minimize compliance risks. Financial and taxation due diligence is the most basic and critical link for Chinese companies to manage tax risks in overseas contracting projects. In order to reduce major losses afterwards, “going out” companies should conduct a comprehensive tax due diligence on engineering projects before bidding, and conduct a relatively complete, detailed and effective investigation on the tax laws of the countries involved, the regulations of the target industry, financial standards, and the tax supervision environment.

Third, in combination with the policies of the host country, optimize and standardize contract arrangements and improve the ability to defend after the event. For the sub-contract arrangements of EPC contracts, it is recommended to conduct demonstrations based on the specific environment of the country where the project is located, clearly stipulate the contract terms, and the key contents and features of the contract such as the receiving entity and the customs clearance entity should strictly comply with the practices of international trade activities, thereby improving the company’s ability to defend after the event.

Fourth, formulate a reasonable response strategy to safeguard legitimate rights and interests to the greatest extent. First, strengthen communication and consultation with local tax authorities. If consultation fails, based on the actual situation of the problem, if it falls within the scope of the tax treaty, the two countries’ tax authorities can be requested to negotiate with each other; or it can be resolved through local administrative reconsideration, administrative litigation and other legal remedies in the territorial country.