Other BriefingsShould Intercompany Fees in Indonesia Be Classified as Services, Royalties, or Cost Recharges?
The way Indonesia classifies intercompany fees shapes how a PT PMA’s transactions with its foreign affiliates are taxed. The Directorate General of Taxes (DGT) looks beyond contract wording and focuses on the economic substance of each arrangement, applying withholding tax under Articles 23 and 26, VAT and digital VAT rules, customs valuation principles, permanent establishment tests, and Indonesia’s transfer pricing framework. A single misclassification can lift withholding from 5 percent to 20 percent, turn a service charge into a non-deductible cost, or trigger an ex-ante pricing adjustment.
With tighter scrutiny of software licensing, brand-related payments, and regional service arrangements, classification is now a strategic decision that directly affects tax efficiency and how robust a company’s position will be during an audit.
How Indonesia determines the nature of an intercompany payment
Indonesia distinguishes services, royalties, and cost recharges by analyzing the precise benefit received by the Indonesian entity. A payment is treated as a service when a foreign affiliate performs managerial, technical, advisory, or operational functions that create measurable value.
It is treated as a royalty when the Indonesian entity uses intellectual property, software, operating manuals, trademarks, or proprietary systems owned offshore. It is treated as a cost recharge only when a foreign affiliate incurs a third-party cost directly related to Indonesia and passes it through without adding value.
These distinctions reflect long-standing DGT practice, where economic reality overrides contractual wording whenever the two diverge.
How classification shapes withholding, VAT, and customs exposure
Once the fee is classified, the tax treatment becomes clear. Payments made within Indonesia fall under Income Tax Article 23, which applies a 2 percent withholding on most service fees and a 15 percent withholding on royalties paid to resident recipients. Payments to foreign affiliates fall under Income Tax Article 26, with 20 percent withholding unless a tax treaty allows a lower rate and the Indonesian payer holds a valid certificate of domicile. Treaties with Singapore, the Netherlands, Germany, and Japan frequently bring the effective rate for services and royalties into the 5–15 percent range, provided the beneficial ownership criteria are met.
VAT then shapes the indirect tax profile. Indonesia applies 11 percent VAT on domestic transactions and requires self-assessed VAT when Indonesian entities consume services or intangible goods from abroad, such as cloud platforms or software licences. Foreign digital providers that meet Indonesia’s turnover or user thresholds must register as Electronic Trading System (PMSE) VAT collectors. When a royalty forms part of the conditions of an import transaction, customs rules may add it to the customs value, increasing import duty, import VAT, and income tax at the border. As a result, classification influences not only the withholding on the outbound payment but also the broader tax burden embedded in the Indonesian supply chain.
Classification, therefore, affects both the outbound payment and the broader tax profile of the Indonesian supply chain.
Substantive thresholds for services, royalties, and recharges
A service fee is defensible only when the Indonesian entity can demonstrate, with real evidence, that the foreign affiliate actually performed work that benefited Indonesia. This typically includes deliverables, correspondence, workflow records, governance documents, and functional analysis. When foreign staff are directing, steering, or exercising control over Indonesian operations, boards also need to assess whether this crosses into permanent establishment territory, which shifts taxation from Article 26 withholding to Indonesia’s 22 percent corporate income tax.
A royalty classification applies when the Indonesian entity depends on offshore intangibles. Because Indonesia defines royalties broadly, and the DGT enforces the rules strictly in technology-heavy arrangements, payments connected to software platforms, brand systems, data tools, or other IP-embedded assets often fall within royalty scope unless the documentation clearly shows that the foreign affiliate is merely passing through a third-party cost.
A cost recharge is only acceptable when the foreign affiliate has incurred a vendor cost on Indonesia’s behalf and passes it through without adding value. The allocation basis — headcount, usage, or revenue — must reflect how the underlying cost was consumed and must be supported by documentation prepared in advance. Once the foreign affiliate configures, customizes, supports, or implements the system or service, the arrangement is no longer a recharge; in substance, it becomes a service or royalty, and Indonesia will tax it on that basis.
Transfer pricing alignment and Indonesia’s audit expectations
Indonesia’s transfer pricing rules require companies to prepare a master file, local file, and, when relevant, a country-by-country report once they cross certain activity levels. The obligation applies when annual revenue is above IDR 50 billion (US$3.0 million), or when related-party transactions exceed IDR 20 billion (US$1.2 million) for tangible goods and IDR 5 billion (US$300,000) for services, financing, or intangible use. These documents must be ready within 4 months of year-end and provided within 30 days if the tax authority asks for them. Under Regulation 172/2023, the pricing behind these transactions also needs to be supported upfront, at the time the transactions take place, rather than assembled later during an audit.
DGT audits now focus heavily on intra-group services, intangible-heavy arrangements, and regional hubs. Audit teams analyze whether functions, assets, and risks in the master and local files match operational reality; whether fees reflect arm’s length value; whether services are duplicative or shareholder in nature; and whether intangible returns follow control over development, enhancement, maintenance, protection, and exploitation. Inconsistency across agreements, invoices, internal governance, and documentation is the greatest trigger for recharacterization.
For long-term or high-value arrangements, Indonesia’s Advance Pricing Agreement and Mutual Agreement Procedure frameworks provide certainty, but they require that classification and documentation remain coherent and defensible.
How multinationals should structure the classification decision
Determining the right classification starts with understanding where the economic value comes from. When the Indonesian entity benefits mainly from access to technology, brand systems, or data platforms owned offshore, the payment usually reflects a royalty. When the foreign affiliate contributes expertise, analysis, or day-to-day support, the substance leans toward a service. And when the foreign affiliate is simply passing through a vendor cost without adding anything further, the arrangement is closer to a recharge.
Companies then need to look at the full Indonesian tax impact, not just the withholding rate. The real cost depends on how the fee interacts with VAT or digital VAT, customs valuation, and deductibility rules under the Income Tax Law. A structure that keeps withholding low for the parent company can still be inefficient if Indonesia ends up shouldering non-deductible expenses, VAT leakage, or customs uplift.
Running scenarios helps clarify these trade-offs. For example, a PT PMA paying US$1,000,000 each year for a combined software and support package might face 10 percent withholding under the Singapore treaty if the fee is treated as a service.
But if the DGT determines that 50 percent of the value relates to IP usage, that portion becomes a royalty — triggering treaty withholding, self-assessed VAT, and, if linked to imported goods, customs uplift. Splitting the software license and support work into separate agreements often results in a structure that better reflects the underlying substance and carries lower audit risk.
When structures must be revisited
Intercompany structures must be reassessed whenever business models, technologies, or regulatory frameworks evolve. New software platforms, rebranding, centralized analytics, IP migrations, or shifts in the Indonesian revenue scale alter the economic substance and require an updated classification.
Indonesia’s current audit focus on cloud licensing, platform access, and regional service hubs means older arrangements may no longer reflect operational reality and should be proactively reviewed.
Strategic implications for cross-border structures in Indonesia
Regardless of the route a company chooses, the classification must be consistent across the master file, local file, intercompany agreements, and the ex-ante price-setting analysis. Even a single inconsistency across these documents is enough for the Indonesian tax authority to reclassify the transaction.
This article first appeared on ASEAN Briefing, our sister platform.
