Taxes on digital commerce could shore up public finances but must not stifle innovation.

As restrictions intended to slow the spread of Covid-19 drive millions of people towards online working, shopping and entertainment, Indonesia is seeking to shore up public finances by speeding up the introduction of digital taxes.

On July 7th the authorities imposed a 10% value-added tax (VAT) on digital cross-border sales by technology firms including Amazon, Google, Netflix and Spotify.

The government estimates that the move will raise around Rp10 trillion (A$973 million) a year at a time when revenue is under extreme pressure from the Covid-19 economic shock and cuts to corporate taxes aimed at stimulating growth.

The tax will also start to level the playing field between local tech firms that pay VAT in Indonesia already and foreign ones that do not because their offices are located elsewhere.

Prospera, the Australian Tax Office (ATO) and the Treasury have all supported Indonesia to introduce the tax while cautioning against measures that could snuff out investment and innovation in one of the economy’s fastest-growing sectors.

“Indonesia is right to follow other countries including Australia in seeking to tax digital commerce,” said Paul Bartlett, Prospera’s lead markets adviser.

“The government faces fiscal challenges as a result of the coronavirus and consumption of digital streaming and other services should be taxed like any other economic activity.”

For decades a steady decline in the tax ratio has starved the economy of public investment.

In 2019 taxes fell to the equivalent of just 9.8% of GDP, the lowest since at least the 1970s, and they are expected to fall even further this year.

Indonesia’s digital economy could make an important contribution to raising the tax ratio and narrowing a fiscal deficit that officials expect to reach 6.3% of GDP in 2020 (though spending challenges mean the shortfall could be smaller).

Even before the coronavirus, the value of digital transactions was expected to increase to around US$130 billion by 2025.

Distancing rules aimed at slowing the spread of the virus have accelerated the pace of online adoption and boosted digital commerce as people shun crowded shops, offices and entertainment spots.

Digital investment and innovation
Indonesia’s new VAT applies to all firms with local digital transactions worth at least Rp600 million (A$58,400) a year or with 12,000 users a year.

At 10%, the tax is set at a level consistent with similar levies already in place in Australia, Japan, Malaysia and Singapore.

Governments across the world are wrestling with the problem of how to tax global technology firms that employ aggressive profit-shifting strategies to reduce their tax liabilities.

Instead of proceeding alone, Prospera is recommending to officials that Indonesia continue to work with its international partners through forums such as the G20 and OECD to arrive at a common global solution.

A tech-industry income tax imposed by Indonesia alone risks stifling investment and innovation as well as raising costs and reducing the competitiveness of local firms, said Mr Bartlett.

“This would limit Indonesia’s ability to deploy digital-transformation initiatives to support its growth into one of the world’s 10 largest economies by 2030.”