Definition of tax

Table of Contents

THEORETICAL FOUNDATION

2.1Review of Tax

2.1.1Definition of tax

It is the matter of fact that tax is the biggest income for almost all countries, having said that, tax authority’s responsibility becomes even harder. Every approach should be done to reach the target. No matter the target is realistic or not, people’s awareness to pay taxes need to be improved with regard to the “self assessment” system. Higher government attention is needed to resolve tax issues.

Definitions of taxes have been defined by many of expertise, but having some basic and purposes:

“Tax is the citizens’ installment for government, (enforceable) payable by the tax payers according to the rules with not getting direct counter- achievement, which can be directly appointed, and which the function is to pay common cost related to country’s duty in running the government.” (Boediono, 2000: 8)

“Tax is a transfer of resources from the private sector to the government sector, not the result of violations of the law, but must be carried out under conditions previously defined, with no immediate reward and proportional to the government to carry out its tasks to run the government.” (Sommerfeld, at all, 1983)

From these various definitions of taxes, it can be inferred that the characteristics inherent in the tax definition, is as follows:

Tax is collected under the imposable Law and its implementing regulations;
Tax payment can not be shown by the existence of counter-individual achievements by the government;
Tax is collected by both state central government and local government;
Tax is state income to cover expenditures, where the surplus is used to finance public investment.

2.1.2Function of Tax

There are four taxes functions:

1. Budgeter function

Budgeter function is a public sector function to collect the tax money as much as possible in accordance with applied regulations that would in time be used to finance state expenditures.

2. Regulerend Function

Regulerend function is a function that the tax will be used as a tool to achieve certain goals, which were located outside the financial sector.

3. Democratic function

Democratic function is a function, which is an embodiment or a form of mutual assistance system, including government activities and development for society’s welfare.

4.Distribution function

Distribution function is a function emphasizing on the element of equality and justice in society. This can be seen, for example, from higher rate in progressive tax system for community who have large incomes and vice versa.

2.1.3 Tax Collection Conditions

Few Conditions should be considered during tax collection process:

1. Justice Terms (collection of taxes must be fair)

That is to be in accordance with the legal objectives, namely achieving justice, legislation and fair implementation tax collection. Fair in terms that laws and regulations is to impose a general and equitable tax, adapted to citizens’ respective abilities while, fair in its implementation is by accommodating the rights for taxpayers to file objections, delays in payments and to appeal to the Tax Advisory Council.

2. Juridical Terms

In Indonesia, the tax regulation is provided in the 1945 Constitution Article 23 Paragraph 2. This law guarantees to express justice, both for the Country and its citizens.

3. Economic Terms

Collection of taxes should not interfere production and trading activities to avoid the economic downturn.

4. Financial Terms

Accordance budgetary function, the cost of tax collection should be pressed, lower than the results of the collection.

5. Tax collection should be simple

Simple collection system will facilitate and encourage the community in meeting tax obligations. The new taxation law has met this requirement.

2.1.4 Theories that support tax collections

2.1.4.1 Adam Smith Theory

Adam Smith put forward a theory in the tax collection, which are:

1. Equality

Which means that taxes must be fair and equitable, which is charged to private persons in proportion to his ability to pay such taxes, and in accordance with benefits received. Taxing can be considered fair if all taxpayers contribute an amount to be used for government spending proportional to his/her ability and with the benefits received from the government.

2. Certainty

Tax regulation should be clear at the same understanding by taxpayer and the authority, otherwise it can be abused by both. Adam Smith puts four certainties that would be able to ensure justice in the establishment of the desired tax collection:

Certainty if the tax subject
Certainty of the tax object
Certainty of the tax rate
Certainty of the tax procedures

3. Convenience

Deadline of tax payout should be determined with regards to the convenience time of the tax payers.

4. Economy

Economic principles should be applied on the following subjects:

Cost of tax collection should be efficient
Tax should not prevent the payers to continue their business activity
Tax should be able to provide greater society benefits instead of burdening the society. (Smith, 1981: 350)

2.1.4.2 Hector S De Leon Theory

Hector S De Leon has a theory on three main principals of taxation system, which are:

1. The principle of adequacy of revenues

Source of tax revenue as a whole should be adequate as a source of the state budget. It can be seen from the current state income, that revenues from the tax sector are very adequate to be the source of the state budget.

2. The principle of justice

The tax burden should be proportional to the ability of the taxpayer to pay taxes. Fairness in taxation is divided into horizontal and vertical equality. A tax collection system is considered fair if the tax responsibility for every taxpayer is equal for every same level of income and burden, regardless of the income sources and type. In the horizontal and vertical condition, an income tax should be in accordance with the principle of justice for every added economic capability without differentiating the source and type of income.

3. Feasibility Principle Administration

All the tax rules should be administered with a good, easy, and effective way. Complete information and accountability is the key to an effective and efficient tax administration and efficient. Foundations for the implementation of good tax administration consist of 4 things:

First, the clarity and simplicity of the provisions of the Law allows for the administration to provide clarity for taxpayers.
Second, simplicity is good in juridical formulation, which can provide better process of understanding.
Third, the existence of a realistic tax reform should consider the ease of achieving efficiency and tax administration effectiveness.
Fourth, an effective tax administration and efficiency should be formulated with regards to the arrangement, collection, processing, and utilization of information about the tax subject and object of taxation. (Hector, 1993: 10-11)

2.4.1.3 Glenn P Jenkins Theory

Glen P Jenkins has a theory about nine principals of taxation.

1. Benefits PrincipleTunjukkan huruf latinBenefitB

Goods and services provided by government are public goods, which can be utilized by the community as a whole.

2. Paying Ability Principle

In determining the tax rate, government should consider the ability of the taxpayer.

3. Efficiency Principle

The tax rate must be imposed to create efficiency. Based on these efficiency principles, the imposition of tax on goods and services will raise the prices of goods and services by adding a certain percentage of the price; any price increase create the distortion on the selling price to consumers and production costs. Market distortion caused by the tax would be a loss in creating economic efficiency; high tax rates creates economic inefficiencies.

4. Principles of Growth of Economics

Taxation system should be able to affect economic growth in one country, and a good tax system should also give impulsion to create new jobs.

5. Revenue Adequacy Principles

Tax must be appropriate and adequate as a source of funds to finance government spending. Hence the acquisition tax must be greater than the costs incurred.

6. Stability Principle

A stable tax laws and rates will be an attraction for the private sector to invest. Tariff changes and unstable tax laws that are will cause difficulty in long-term planning for the private sector. The existence of an unstable tax structure and system create business risk and burdens, which eventually became the elements of economic inefficiency.

7. Simplicity Principle

A good tax system should be simple and understandable by the public. The simplicity to comply should be applied in the tax administration, which will help taxpayer to comply better.

8. Low Cost Principles

Tax collection and administration cost should not burden tax payers.

9. Neutrality Principle

A good tax system should eliminate the distortion in public consumption and production behavior and new foreign tax policy should encourage current investment and attract new foreign investors to invest in the country. (Jenkins, 1997:2-5)

2.2 Overview of Income Tax

National development is a continual activity to develop people welfare, both material and spiritual. National development needs financial support. By fact, tax is the major domestic financial source.

Tax plays important role in national development. In short, tax is a lifetime sponsor of a State. There are various types of taxes imposed by State to the citizens who are registered as taxpayers. One of them is the income tax (Pajak Penghasilan – PPh). Income tax Law as stipulated in the Income Tax Act 1984, set the tax on income (earnings and profits) obtained by either individuals or corporate.

2.2.1 Subject of Income tax

Income tax is imposed to tax subject related to their income within the fiscal year. According to the Income Tax Act 1984 Article 2, paragraph (2), tax subject is defined into two groups; local tax subject and foreign tax subject. Income Tax Act 1984 Article 2 paragraph (3) defined the local tax subject as follows:

1. Individuals

Individual is a tax subject, could be resident or non resident.

2. Inheritance

An undivided inheritance is a tax subject to represent the heirs due to inheritance is not yet divided.

3. Entity

Entity is a group of people and/or capital which is a unity conducting or not conducting business that includes a limited liability company, commanditair venootschap (CV), other companies, state or local owned enterprises with any name or form, firms, partnerships, associations, pension funds, partnerships, associations, foundations, mass organizations, social political organization, or any similar organizations, institutions, permanent establishment, and other forms of entity. (Income Tax Act, 1984: Article 2 paragraph 3)

Income Tax Act 1984 Article 2, paragraph (4) defined foreign tax subject as follows:

Individual who is not residing in Indonesia or stays in Indonesia no more than 183 (one hundred and eighty three) days within 12 (twelve) months period, and entities that are not established and not domiciled in Indonesia, which carries on business or conduct activities through a permanent establishment in Indonesia.
Individual who is not residing in Indonesia or stays in Indonesia no more than 183 (one hundred and eighty three) days within 12 (twelve) months period, and entities that are not established nor domiciled in Indonesia who can recieve or derives income from Indonesia not from doing business or conduct activities through a permanent establishment in Indonesia. (Income Tax Act, 1984: Article 2, paragraph 4)

2.2.2 Object of Income Tax

Refer to 1984 Income Tax Act Article 4 paragraph (1), tax object is income, and income could be defined as every additional economic capability received or acquired by taxpayers, derives from Indonesia or outside Indonesia, which can be used for consumption or measuring tax payer asset at any names and forms. (Income Tax Act, 1984: Article 4 paragraph 1)

2.2.3 Income Tax Payment

Taxpayers could settle or pay their outstanding income tax by filling out ‘Surat Setoran Pajak’ (SSP) at the following time:

1. During the Fiscal Year

The settlement of the Income Tax can be done monthly or other period determined by the Minister of Finance. (Income Tax Act, article 20, paragraph (1))

2. Post Fiscal Year

Refer to the Income Tax Act 1984 section 28, 28A, and 29, settlement of taxes post fiscal year is allowed only if the amount of income tax payable for the defined fiscal year is bigger than the amount of tax credits for the related fiscal year. This must be settled no later than the 25th of the third month after end of the fiscal year, before submission of SPT. (Income Tax Act, 1984: section 28, 28A, and 29)

3. When Surat Ketetapan Pajak (SKP) and or Surat Tagihan Pajak (STP) is formally received.

Settlement of tax is due when SKP and or STP issued by Directorate General of Tax and received by taxpayer. Therefore, the taxpayer must immediately submit the SPT to the related Kantor Pelayanan Pajak (KPP) and pay the outstanding tax payable.

2.2.4 Corporate Income Tax Return

Income Tax Act 1984 in Article 1 paragraph (10) stated that the Corporate Tax Return (Surat Pemberitahuan – SPT) is a letter used by taxpayers to report tax collection and or tax payment, the tax object and / or not the tax object and / or asset and liabilities, as stated on the Tax Law.

Annual SPT of Income Tax is a tool for taxpayers to self assessed the amount of tax payable, by way of:

To report and take responsibility of the tax payable calculation
To report self assessment of tax payment on the specified fiscal year or part of fiscal year.
To report withholding or collection of tax done by the other parties during specified fiscal year.

(Income Tax Act, 1984: Article 1 paragraph 10)

2.2.5 Tariff of Corporate Income Tax

Act of 2000 Income Tax basically adopt progressive rates. The meaning of progressive is “the higher the income the higher the percentage of tax rates”. Progressive tariff is in line with the tax function to achieve the equality distribution of people income .Tax rate was set in Law number 17 of Year 2000 Article 17 paragraph (1) and applies to the specific taxable income of domestic permanent establishments. The rates are as follows:

Table 1

Indonesia Corporate income tax rate 2008

Taxable Income	Tariff
Up to Rp 50.000.000,-	10%
Above Rp 50.000.000,- to Rp 100.000.000,-	15%
Above Rp 100.000.000,-	30%*

In 2009 the highest rate decreased to 28%, and in 2010 will decrease to 25%

In comparison, below is the Singapore Corporate Income Tax for the same fiscal year:

Table 2

Corporate Income tax rate of Singapore as per 2008

Taxable Income	Tax Rate
First $10,000	4.50%
Next $290,000	9.00%
More than $300,000	18%

It is the matter of fact that Singapore tax rates are much lower than Indonesia.

2.3 Concept of Income and Expense by Indonesian Tax Regulation

2.3.1 Concept of Income

The concept of income in the commercial accounting is different from tax point of view. This happens because taxation is related to vertical and horizontal justice, and used as an instrument in economic and social policy, Not in the case of commercial accounting.

2.3.1.1Definition of Income

1984 Income Tax Act Article 4 states that income is: "Every additional economic capability received or acquired by the taxpayer, whether originating from Indonesiaor outside Indonesia, which can be used for consumption or to increase the asset of the taxpayer atany names and forms". (Income Tax Act, 1984: Article 4)

Meanwhile, the Indonesian Accountant Association (Ikatan Akuntan Indonesia – IAI) defines income as: "Economic benefits during an accounting period in the form of income or assets increase or decrease in liabilities that result in an increase in equity that are not derived from the contribution of capital investment". (SAK 2002; PSAK; 23 Paragraph 26). Earnings may include income or profit. Income is derived from the implementation of regular activities and known differently as sales, service income, interest, royalties, dividends, and rent.

2.3.1.2 Income Related to the Tax Object

Income Tax Act 1984 states that income that could be classified as income tax object is as follows:

Compensation or remuneration related to employment or services received or acquired, including salaries, wages, allowances, honorarium, commission, borrows, gratification pension fund, or other forms of remuneration, unless stipulated differently in the Law;
Rewards from lottery or work or activities, and awards;
Commercial Profit
Profits from the sale or transfer of asset, included;

Profit from the transfer of asset to a corporation, partnership, and other bodies as shares or capital substitution;
Profits derived from corporate, partnerships, and other bodies for the transfer of asset to shareholders, partners, or members;
Profit from commercial liquidation, merger, consolidation, expansion, separation, or acquisition;
Profits from transfer of asset in the form of grants, aid or donation, except in the case that it’s given to blood relatives of one degree straight lines descendants, and religious bodies or agencies or educational charities or small businesses including cooperatives established by the Minister of Finance, as long as there is no commercial connection with business, employment, ownership, or control between the parties concerned;
Tax refund which have been charged as an expense;
Interest income included premiums, discounts, and compensation for taking debt guarantees;
Dividends, at any names or forms, included dividends from insurance companies to policy holders, and the distribution of the remaining business of the cooperative;
Royalties
Rent and other income related to the asset usage;
Acceptance or obtaining periodic payments;
Profit from debt relief, except up to certain amount stipulated by Government Regulation;
Foreign exchange gains;
Profit from revaluation of assets;
Insurance premiums
Contributions received or acquired by the association of members consisting of tax payers who run businesses or freelance.
Additional net asset which comes from income which is not yet taxed (Income Tax Act, 1984)

2.3.1.3 Income not related to the tax object

1984 Income Tax Act Article 4 paragraph (3) states that income that can not be classified as tax object are:

Aid contributions, included zakat received by zakat amil established or authorized by the government and entitled recipients of zakat;
Granted asset received by the blood relatives in a straight line one degree descendants, and by religious bodies or educational charities or small businesses as intended cooperatives established by the finance ministers along with no business relationships, employment, ownership, or control between the parties concerned
Inheritance
Property referred to deposit cash received by the agency referred to in Article 2 paragraph (1) letter b, in lieu of shares or as a substitute for capital;
Replacement or compensation in connection with employment or services received or acquired in kind and or enjoyment of the taxpayer or the government;
Payment from the insurance company to an individual in connection with health insurance, accident insurance, life insurance, insurance dual-purpose, and insurance scholarships;
Dividends or profits received or acquired as a limited liability company tax payers in the country, cooperatives, state owned enterprises, or local owned enterprises, the capital of the company that was established and domiciled in Indonesia, provided:

Dividend income derived from the reserves held; and
For limited liability companies, state owned enterprises, and regional-owned enterprises that receive dividend, stock ownership in the entity that provides dividend, ownership of shares in the entity that provides the lowest dividend of twenty-five percent of the total paid-up capital and must have an active business outside of the stock ownership;

Contributions received or acquired pension fund whose establishment was approved by the minister of finance, whether paid by the employer or employee;
Earnings from capital invested by pension funds as referred to in the letter (g), in certain areas defined by the finance minister’s decision;
Part of profits received or acquired by a member of the alliance partnership that capital is not divided into shares alliances, associations, firms, and partnerships;
Interest bonds received from members of the mutual fund companies during the first five years since the founding of the company or the granting of business licenses;
Income received or acquired in the form of venture capital firm profits from the body parts business partner, founded and run the business or activities in Indonesia provided such business partner agencies:
A small company, medium, or carry out activities in the business sectors as stipulated by the finance minister’s decision, and
Shares are not traded on the Jakarta Stock Exchange in Indonesia. (1984 Income Tax Act Article 4 paragraph 3)

2.3.1.4 Loss Compensation

Referring to Gunadi (2004), gross income is the sum (consolidation or aggregation) of all the elements (categories) income (additional economic capability) that received or acquired by company in a tax year if there is one element of negative amount (loss), the numbers can be calculated (set off) by other elements in the same year. In accordance with the provisions in the tax laws in 2000 regarding Income Tax in Article 6 paragraph (1) part (d), it is stipulated that negative amount can be loss suffered from sales and transfer of goods and/or possessed rights and used in the company (business asset) of that is possessed to acquire, collect, and preserve income. Thus the loss of the transfer of non-business assets (private property) and or nonoperating asset (property that has not been used) can not be calculated with the elements of income (positive) the other. If in one fiscal year from the sum of all elements was obtained loss of income, in accordance with the Income Tax Act 1984 Article 6 paragraph (2), the loss can be counted against profits for the next five years (respectively). In accordance with the provisions of article 31A, the body that invest in economic sectors that have high priority in the national scale, especially those encouraging exports, and which operate in certain areas (remote) can be compensated for losses to a maximum period of ten years. (Gunadi, 2004)

Because of the limited time loss compensation (five years) for the means of taxation, the amount of retained earnings available for dividends cumulatively will not be the same with the amount of taxed profit reduced by tax load in the calculation of commercial accounting. This is acceptable because of the difference in compensation for damages done by accounting firm is forever until it dissolved, while the tax is limited to five years.

2.3.2 Concept of Cost

In accordance with the provisions of Income Tax Act 1984 in Article 6 paragraph (1) in general, deductible expenses, including fees that meet the requirements for obtaining, collecting, and maintaining the income. In accordance with the explanation of this article, the (direct) relationship between the costs or expenses and income determines whether costs can be deducted from income.

2.3.2.1 Definition of Cost

Suandy (2003) states "Cost is all deduction against income. In connection with the use of expenditures accounting period divided between capital expenditure is the expenditure that provides more benefits than one accounting period and recorded in the assets, while the expenditure is the revenue expenditure that benefits only for one accounting period concerned that is recorded as an expense". (Suandy, 2003)

Costs or burdens according to the basic framework of the preparation and presentation of financial statements in 2004 PSAK point 78, the definition includes losses and costs incurred in conducting normal business activities include, for example, cost of sales, salaries, and depreciation. Expenses are usually in the form of outflow or decrease in cash assets (and cash equivalents), inventory and fixed assets. Cost is usually divided into three groups:

Costs associated with income in that period
Costs associated with a particular period that is not associated with income
Costs for practical reasons that can not be associated with any period.

2.3.2.2 Cost that can be deducted

In chapter 6 of Income Tax Act 1984, the amount of taxable income for taxpayers in the country and the permanent establishment, is determined based on gross income minus:

Cost to obtain, collect and maintain income, including the cost of purchase for raw materials, the cost in regards to employment or service referred to wages, salaries, bonuses, and allowances given in the form of money, interest, rents, royalties, travel expenses, the cost of waste processing, insurance premiums, administrative costs, and taxes except income tax.;
Depreciation of expenditures to acquire tangible assets and amortization of expenses to obtain the right and the other costs that have a useful life of more than one year referred to in Article 11 and Article 11A;
Contributions to a pension fund which establishment has been approved by the minister of finance;
Losses due to the sale or transfer of property owned and used in company-owned or for obtaining, collecting, and maintain income;
Foreign exchange losses from foreign currency;
Costs of research and development company that conducted in Indonesia
Cost of scholarships, internships, and training
Credits that obviously can not be charged, provided that:
Have been charged as an expense in the income statement of commercial;
Has submitted the case to the district court billing or business entity receivables and auction (Badan Urusan Piutang dan Lelang Negara – BUPLN) or a written agreement regarding the elimination of debt or debt relief between creditors and debtors in question;
Has been published in general or specific publication;
Taxpayers must submit a list of debts that can not be billed to the Directorate General of Taxation, which shall be further conducted by the Decision of General Director of Tax. (Income Tax Act, 1984: chapter 6)

2.3.2.3 Additions regarding the cost that can be deducted

KEP-220 / PJ / 2002 about the treatment of income tax on the cost of mobile phone usage and company vehicles. The provisions as set forth in the tax director general’s decision number KEP-220 / PJ / 2002 dated 18 April 2002 applies to expenses or the cost of mobile phone use and car companies made on or after 18 April 2002. The tax treatment of expenses or the cost of mobile phone usage and car companies made before the date 18 April 2002 is basically the same except for the determining of costs to as much as possible based on actual facts.

A. Cell Phones

On the cost of acquiring or purchase of mobile phones which owned and used by the company for certain employees because of their position or job, may be deducted as business expenses for fifty percent of the total cost of acquiring or purchase of fixed assets through depreciation. On subscription fees or phone credit recharge and cell phone repair cost which owned and used by company for certain employees because of their position or job, may be deducted as business expense for fifty percent of the total cost of acquiring subscription fees or credit recharge fees, or cell phone repair cost in their fiscal year.

B. Bus, Minibus

On the cost of acquisition or the purchase or repair of the vehicle bus, minibus, or the like which are owned and used the company to shuttle employees between, could be borne entirely by the company as depreciation expenses of fixed assets. The cost of routine maintenance or repair the vehicle bus, minibus or a similar company owned and used to shuttle employees between, could be borne entirely as corporate expenses in their fiscal year

C. Sedan

On the acquisition costs and purchase or repair of vehicles or similar cars owned and used by the company to certain employees because of the position or job, may be deducted as business expenses for fifty percent of the total cost or the purchase or major improvements through depreciation of fixed assets. The cost of routine maintenance or vehicle repairs owned and used by the company to certain employees because of the position or job, may be deducted as business expenses for fifty percent of the total cost of vehicle maintenance, also referred to routine expenditure for the purchase or fuel consumption. (KEP-220 / PJ / 2002)

2.3.2.4 Cost that can’t be deducted

According to the Income Tax Act 1984 Article 9, things which can be categorized as a cost that can not be deducted are:

Profit distribution with any form of title and form such as dividends, including the dividend paid by insurance companies to the policyholders, and the distribution of the remaining business income of cooperative;
Expenses charged or incurred for personal benefit of shareholders, partners, or members;
Formation or accumulation of reserve funds except for receivables reserve that is uncollectible for bank business and leasing with options, reserve for insurance business, reserve for the cost of mining reclamation, which the terms and conditions set by the finance minister’s decision.
Health insurance premiums, accident insurance, life insurance, dual-purpose insurance, and scholarship insurance, which paid by individual taxpayers, unless paid by the employer and the premium is calculated as income for the relevant taxpayer;
Replacement or compensation related to work or services with provided in kind and pleasure, except for the provision of food and beverages for all employees as well as reimbursement or compensation in kind and the pleasure in certain areas and relating to the implementation of the work assigned by the finance minister’s decision.
Amount exceeds the standard paid to the shareholders or to the parties having a special relationship as compensation in connection with work performed;
Donated property, assistance or donations, and inheritance as mentioned in Article 4 paragraph (3) ‘letters a and b, except zakat on income actually paid by individual taxpayers Islamic religion or the taxpayer and the domestic entity owned by the Islamic religion to the agency or institution Amil Zakat charity established or authorized by the government;
Income taxes
Expenses charged or incurred for personal interests or those taxpayers who become dependents
Salaries paid to members of the partnership, firm, or limited partnership whose capital is not divided into shares;
Administrative sanction in the form of interest, fines, and increase criminal penalties and fines instead related to the implementation of legislation in the field of taxation. (Income Tax Act, 1984: Article 9)

2.4 Overview of transfer pricing

2.4.1 Definition and concept of transfer pricing

Transfer pricing is an issue that is relevant to a business activity and tax. The majority of multinational companies view that transfer pricing is the most important issues in international taxation. (Hamaekers, 2001: 30) Transfer pricing is part of business and taxation in order to ascertain whether the prices applied in transactions between companies that have a special relationship, has been based on the principle of fair market prices or ‘arm’s length price’ principle. In addition, transfer pricing can also be applied in the context of transactions between an organizational unit to another organizational unit within a company or between head office and branch offices, or between one branch office with other office that are still in the same company. (Larking, 2005: 442). For economic purposes, transfer pricing is defined as determining the price of goods or services by an organizational unit of a company to other organizational units within the same company. (Horngren, at all, 1996). While Lyons defines transfer pricing as the price charged by a company for goods, services, intangible asset to the company that has a special relationship. (Lyons, 1996: 312)

Understanding transfer pricing as it is above the neutral sense. However, the term transfer pricing is often connoted as something that is not good, namely the transfer of taxable income from a company owned by multinationals to countries that low tax rates (tax haven) in order to reduce the total tax burden from business group these multinationals. (Haemakers, 2004: 3). In connection with abuse of transfer pricing, Lyons define it as an inappropriate allocation of income and expenses is intended to reduce taxable income. (Lyons, 1996: 313). While other writer, Eden, using the terminology of transfer pricing manipulation to express the abuse of transfer pricing. The terms of transfer pricing manipulation is defined as activities to increase or lower the cost of the bill that aims to minimize the amount of tax payable. (Eden, 2001).

Thus, the manipulation of transfer pricing can be done by increasing or decreasing the cost of the selling, through transfer pricing mechanisms to reduce tax payments. Thus, the manipulation of transfer pricing occurs by setting the transfer price to "too big or too small" in order to minimize the amount of tax payable.

2.4.2 OECD Transfer pricing guidelines

Organization for Economic Cooperation and Development (hereinafter referred to OECD) is an organization of economic cooperation between developed countries which was established in 1960. At this moment there are 30 OECD countries as members. The field of taxation in the OECD is handled by the Committee on Fiscal Affairs (CFA). Related to transfer pricing, CFA through its subgroup of working party no. 6 have published OECD Transfer Pricing Guidelines (hereinafter referred to as the OECD Guidelines) as a guide for multinational enterprises and tax authorities in matters of transfer pricing. OECD Guidelines is currently the development and consolidation of the OECD Transfer Pricing and Multinational Enterprise in 1979 and 1984, and most of Indonesia law related to transfer pricing is referring to this OECD guidelines.

OECD Guidelines provides guidance to tax authorities and the multinational companies in dealing with transfer pricing issues. Thus, OECD Guidelines is made with the intent to assist the tax authorities and multinational companies in dealing with transfer pricing issues. Thus, the OECD Guidelines is made with the intent to assist the tax authorities (not only to member countries but also countries that are not members ORCD) as well as multinational companies, in providing guidance on how to transfer pricing dispute resolution mutually beneficial relationship between each respective tax authorities, and between the tax authorities with multinational companies. (OECD Guidelines, paragraph 15). In other words, the purpose of setting the OEDC Guidelines is in order to share the revenue earned by multinational companies is the fair (true Taxable income) to countries where these multinationals operate.

To avoid that multinational companies are not subject to transfer tax revenues through transfer pricing mechanisms in ways that are not natural, it is very important for a country to have the authority or authorities to perform the calculation again, or make corrections (primary adjustment) above the price set by the parties having a special relationship that if the transaction price does not represent taxable income is in each country to impart basically grouped into the following:

Few countries apply the provisions of a comprehensive transfer pricing, transfer pricing provisions apply only to transactions of a particular business activity.
Some countries follow the transfer pricing provisions contained in the OECD Guidelines.
Many countries do not yet have specific provisions governing the transfer pricing in the domestic law, but they refer to the rules on anti-tax evasion (tax anti avoidance rule). (Rohatgi, 2002: 420)

2.4.3 Special Relationship or Related Parties

A country’s tax authorities are empowered to make corrections (primary adjustment) for transactions that do not reflect the fair market price during the transaction was conducted by parties having a special relationship. (Rotondaro, 2000, page 2). In other words, a country is allowed to conduct a primary adjustment, as long as these transactions are not in accordance with the principle of fair market value (arm-length principle) and transactions conducted by parties having a special relationship.

Therefore, the definition of special relationship is very important in the context of transfer pricing. Discrepancy definition of what is meant by the parties who have a special relationship between countries with other countries will lead to double taxation. (Rotondaro, 2000). Therefore, the definition of related parties or related parties is an important factor in the transfer pricing context. (Rotondaro, 2000, page 9).

Article 9 OECD Model, sets about special relations or related parties in the context of transfer pricing. Special relationship under Article 9 paragraph (1) OECD Model, in principle can be explained by the following situations: (Hamaekers, 2008).

Company A in country A "participates either directly or indirectly in the management, control, or ownership of capital" from company B in country B.
The same side (can be formed as an individual or company) "participates either directly or indirectly in the management, control or ownership" of the state A in company A and company B in country B.

Related to the definition of special relationship, whether article 9, paragraph (1) OECD Model or the OECD Guidelines does not provide clear definitions of what is meant by "management control either directly or indirectly, and control over the company through share ownership." (IFA, 2003). According to David Grecian, in a congress held by the International Fiscal Association (IFA), control is included has the authority to make decisions related to financial and operating policies of an enterprise, and has the leverage to determine the price set . While it mean to participate in a management is involved in making decisions on a company’s operations. The management is here is the level of director or manager level, while the definition of participation is the ownership of shares in a company. (Grecian, 2003). As for how much percentage of share ownership that can be expressed will cause a special relationship between countries with other countries is very varied.

Based on article 9, paragraph (1) OECD Model, the authority to tax authorities can make corrections if it meets the requirements stipulated that the price does not reflect the fair market price, and the parties to a transaction are parties having a special relationship. Thus, although the prices charged do not reflect the fair market price, the tax authorities of a country should not make a correction if the transaction is conducted by parties who have no special relationship.

“Related parties” is also described in the Statement of Financial Accounting Standards (Pernyataan Standar Akuntansi Keuangan – PSAK). All the parties have a special relationship is the parties considered have a special relationship when one party has the ability to control other parties or have a significant influence over other parties in decision-making financial and operational.

Transactions between the parties having a special relationship are a transfer resources or obligations between the parties having a special relationship, without regardless of whether a price calculated.

Control is the direct ownership through its subsidiaries with more than half the voting rights of a company, or a substantial interest in the voice and power to direct the financial policies. (IAI, PSAK no7, 1994)

2.4.3.1 Income Tax Act Article 18

The special relationship matter is also discussed in the Indonesia Income Tax Act Article 18:

The Minister of Finance is authorized to issue a regulation on debt equity ratio for the purposes of computing tax payable in accordance with this law. (Indonesia Income Tax Act Article 18: 1984) This law gives power to the minister of finance to prescribe the company’s liability to equity ratio which will be valid for tax purposes. If the debt to equity ratio is higher than the arm length’s debt to equity ratio, the company may not in the good condition economically.
The Minister of Finance is authorized to determine as when dividends acquired by a resident Taxpayer on participation in an offshore company other than public companies, provided that one of the following condition is met:

the Taxpayer owns at least 50% of the voting stock of the company; or
the Taxpayer together with other resident Taxpayers own at least 50% of the voting stock of the corporation. (Indonesia Income Tax Law Article 18: 1984)

In these economic enhancement and international trade days, taxpayers may invest in the foreign company. This law was made to minimize the tax avoidance by giving those powers to the minister of finance.
Director General of Taxes is authorized to reallocate income and deductions between related parties and to characterize debt as equity for the purposes of the computation of taxable income to assure that the transaction are those which would have been made between independent parties.
Director General of Taxes is authorized to conclude an agreement with a Taxpayer and with tax authority from other countries on transfer pricing method between related Taxpayers referred to in paragraph (4) which may cover a certain period and to evaluate it as well as to renegotiate after the agreement is expired. (Indonesia Income Tax Act Article 18: 1984)
When the special relationship exists, there may be possibilities that the income is understated or overstated, for that reason, the director general of taxes those power to prevent the tax avoidance due to the existence of special relationship.
The term related Taxpayers referred to in paragraphs (3), (3a), and (4) of Article 8, paragraph (1) (f) of Article 9, and paragraph (1) of Article 10 means:

a Taxpayer who owns directly or indirectly at least 25% of equity of the other Taxpayers or a relationship between Taxpayers through ownership of at least 25% of equity of two or more Taxpayers, as well as relationship between two or more Taxpayers concerned;
a Taxpayer who controls other Taxpayers; or two or more Taxpayers are directly or indirectly under the same control;
a family relationship either through blood or through marriage within one degree of direct or indirect lineage. (Indonesia Income Tax Act Article 18: 1984)

The special relationship between two parties may exist because of an ownership and participation in technology or management, and also by blood or marriage. A special relationship because of an ownership occurs if the ownership is at least 25% or more of equity. A special relationship because of participation in technology or management occurs if the two entities are controlled by the same person, or the relationship between the two entities is controlled by the same person. The relationship by blood within one degree of direct lineage vertically means children of parents, while horizontally mean relatives. The relationship by marriage within one degree of direct lineage vertically means parents in law or step children, while horizontally means relatives in law.

2.4.3.2 Value Added Tax Act article 2

The special relationship matter is also discussed in the Indonesia Value Added Tax Law article 2:

If the Sales Price or Consideration is influenced by special relationship, the Sales Price or Consideration shall be calculated on the basis of a fair market price at the time of a supply of Taxable Goods or the rendering of Taxable Services. (Indonesia Value Added Tax Act Article 2: 2000)
The Director General of Taxes has given power to adjust sale price to a fair market price applying in the market to prevent the influence of special relationship which may has possibility to set the price below the market price.
A special relationship is deemed to exist:

where a Firm owns direct or indirect participation of 25% (twenty-five percent) or more in another firm; likewise, between two or more firms where there is direct or indirect participation of 25% (twenty-five percent) in each of those firms by another firm; or
A Firm has control over another firm, or two or more firms are under the same control, whether directly or indirectly; or
There exists a family relationship either through blood-line or through marriage within one degree of direct or in direct lineage. (Indonesia Value Added Tax Act Article 2: 2000)

The special relationship exists when there is an ownership of 25% or more, either direct or indirectly. It also applies when an entity has control over other similar entities.

2.4.3.3 Indonesia – Singapore Tax Treaty Article 9

The special relationship matter is also discussed in the Indonesia – Singapore Tax Treaty article 9 about associated enterprises, where:

An enterprise of a Contracting State participates directly or indirectly in the management, control or capital of an enterprise of the other Contracting State; or
The same persons participate directly or indirectly in the management, control or capital of an enterprise of a Contracting State and an enterprise of the other Contracting State;

and in either case conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, any profits which would, but for those conditions, have acquired to one of the enterprises, but, by reason of those conditions, have not so acquired, may be included in the profits of that enterprise and taxed accordingly. Any profit made by the related parties company will be acquired to on of the enterprises.(Indonesia – Singapore Tax Treaty Article 9: 1990)

2.4.4 Arm-length term principal and methods

The principle of fair market value (arm’s length principle) is a criterion for determining the value of transactions between the parties that having special relationships. According to the arm’s length principle, the transaction between the parties having a special relationship should refer to the fair market price, the price is determined happen if the transaction carried out by the parties which have no special relationship.

Theoretically, the arm’s length principle is based on the same transaction and in the same conditions by the parties who have no special relationship. However, the transaction and the same conditions as those in practice rarely or never happened. Therefore, in the application, the determination of arm’s length principle is based on comparable transactions and in conditions that can be compared when there is no transaction actually the same. (Feinschreiber, 2004, page 41).

If the arm’s length principle is not applied in transactions conducted by parties who have a special relationship, then the tax authorities can make the correction (primary adjustment) for the transaction to reflect the fair market price of the real. There are several methods that can be used to determine a fair market price. The purpose of these methods is to verify whether a set price in transactions between the parties having a special relationship has been done consistently in accordance with the arm’s length principle. In general there are three methods of arm’s length principle:

Traditional methods:

Comparable Uncontrolled Price (CUP)
Cost Plus
Resale Price

Transactional Profit methods:

Profit Split
Transactional Net Margin

Other methods:

Formulary Apportionment
Global Profit Split

OECD Guidelines do not allow any other method as the method of determining the price of transfer pricing transactions, since this method does not reflect the principle of fair market price. According to the OECD Guidelines, the traditional methods are preferred to be applied in comparison with other methods. However, in these traditional methods, it is very difficult to get a comparative market price. Therefore, if methods other than traditional methods will be used, then the question is the conditions and terms of how other methods can be used. (OECD Guidelines, paragraph 2.49).

Associated with the application of the method arm’s length principle, the OECD Guidelines states that:

There is no correct method to be used in any situation.
Taxpayers are not required to determine the fair market price through various methods of approach that already existed
As already mentioned earlier, traditional methods of CUP, Resale Price, and Cost Plus are more preferable than the Transactional Profit methods.

This will be presented the following explanation of each method of arm’s length principle:

1. Comparable Uncontrolled Price (CUP)

In traditional methods, an important element in determining the fair price of transfer pricing is the availability of comparative data. Thus, if there are comparative data, the use of CUP is very appropriate. In the CUP method, fair market pricing is done by comparing the prices applied by the parties having a special relationship and the parties who have no special relationship. (OECD Guidelines, para. 2.6). CUP method is widely used in oil mining company, iron ore, wheat, and other types of goods in the commodity markets. This method is also applied to buffer industrial goods which can not be applied to the automotive industry companies that make products that are not spare parts sold to independent companies. (Arnold and Mc Intyre, page 63). If the comparison data are not available, then the CUP method can not be used to determine a fair market price. (Hinneken, 2006, page 11). Thus if the CUP method can not be used, taxpayers can use other traditional methods, the Cost Plus method or the Resale Price method. The main difference between CUP method and the Resale Price or Cost Plus method is the thing that is compared in CUP method is the price of goods or services, while Cost Plus in the resale price method or the method of comparison is the level of margin (percentage) certain profit that is expected in return from corporate functions performed, assets used, and the risk incurred. (Bernstein, 1999).

2. Cost Plus Method

Based on the cost plus method, fair market price is determined by adding the gross profit margin to the cost of goods sold. This method is applied to the following conditions:

Goods that are bought and sold by parties who have a special relationship are semi-finished goods;
The contract of sale of long-term;
Service delivery activities;
Agreement on the joint facility. (OECD Guidelines, para 7.31).

OECD Guidelines also give types of activities that can implement these methods such as cost plus contract manufacturing, research charging, and charging administrative costs. (OECD Guidelines, para 7.40 – 7.42). Problems that need attention is the application of this method is how cost plus determines the gross profit percentage to be added to the cost of goods sold and determine the cost elements that make up the cost of production.

3. Resale Price Method

In this method, the determination of a fair market price is based on products that purchased from affiliated companies and then resold to an independent company. Then, determination the fair market price on the basis of this method is calculated by subtracting the resale price by a certain gross profit margin; which those gross profit margins are derived from gross profit margins from the similar companies that conduct transactions with related parties that have no special relationship. Resale Price method is well suited for application in a company engaged in the marketing field. (OECD Guidelines, para 2.14.)

4. Transactional Profit Methods

Transactional Profit Methods is used when there is no comparative data or not enough data. If we compare transactional profit methods with the cost plus and resale price method, there are similarities in the use of “margin”. However, the cost plus method and the resale price method is using comparable of “gross margin”, while the transactional profit methods, the comparison is the "net margin" Transactional Profit Methods is divided into two, the profit split and transactional net margin method.

Profit split method is used when there is no comparable data. In the approach to this method, profits from transactions between the parties having a special relationship can be determined by analyzing the function of doing business.
Transactional Net Margin Method is used to test the fairness of the net profit on the transaction between the parties having a special relationship. The approach is comparing net income with the cost of production, sales or assets used to produce the net profit. After getting the net margin, then the net margin is compared with net margins of similar companies that conduct transactions that can be compared with those who did not perform transactions that can be compared with those who have no special relationship.

2.4.5 Tax Avoidance and Tax Haven Countries

Tax revenue is often the mainstay for the developing countries, including Indonesia. However, even tax revenues from this sector often experience erosion due to tax evasion activities, either through avoidance or evasion. Theoretically, these two are different because usually avoidance is still in the corridors of law. If the taxpayer violates the anti-avoidance rules, the violation did not belong to the criminal action and sanctions in the form of fines. The influence of tax avoidance on tax revenue itself large is considered to be moderately big.

There are several scenarios frequently used to avoid tax, such as by manipulating the transfer price. Transfer price is basically the price that is attached to provide value to a product that is exchanged between companies that are still belong in one field of group. By manipulating the transfer price, multinational companies can arrange a way so that the income for subsidiary company in its group located in the country that has the lowest tax rates can be as high as possible The profit of manipulating the transfer price is bigger if the difference between the source and residence country is bigger. The situation may be different if between the two countries is inserted ‘tax haven’, which usually does not impose any tax or, if there is any, very low tax rates. If it’s so, then the rate difference between the source and residence country can be no longer relevant because the taxpayer would shift most of his income to the tax haven.

Although the problem was not only faced by developing countries, but the result will be more severe to the developing countries. This is because developed countries have a legal device that is more complete, such as various anti-deferral rules. Besides the tax authorities also have sufficient ability to detect such techniques. On the other hand, developing countries often do not have adequate regulations. Even if the rules are there, they usually do not have enough tax authorities that are able to detect and counter transfer pricing. In addition the data needed to determine the arm’s length price is difficult to obtain. Even if there is transfer pricing cases that had been identified, the solution often takes a long time. The small number of tax treaty network can also be influential because it means the means of data exchange become more limited, especially if there is a tax haven countries involved.

To fix this, developing countries can unilaterally implement training to improve the tax authorities. They also can make the rules of anti-avoidance for further strengthening the legal basis. Multilaterally, the OECD has called on its members to carry out coordinated efforts which include thin capitalization, rejected the charges paid to the parties that came from a tax haven, as well as limit and cancel the tax treaty with countries involved in harmful tax practices. (Danny and Darussalam, 2008, page 59-61)

2.4.5.1 Abuse of Transfer Pricing through Tax Haven Countries

International tax evasion is often carried out with various schemes. The scheme is often done with transfer pricing, treaty shopping, thin capitalization and controlled foreign corporation. The fourth scheme is mostly done by involving countries that classified as a tax heaven or often known as the tax haven countries, or a tax paradise called in France, or called Tax Oasis in Germany. (Orlov, 2004, page 96). The researchers in the field of international taxation in general, tax haven countries divided into four groups as follows:

Classical tax haven, which states that no income taxes at all or apply income tax rates low.
Tax Haven, the state tax exemption applies to income received from abroad (no tax on foreign source of income).
Special Tax Regime, which states that provide special tax facilities for certain areas in the country.
Haven Tax Treaty, the treaty states that have a very good network and apply a low tax rates for withholding tax on passive income. In general, these countries will be used as an intermediary for the state rate reduction to get facilities provided by a tax treaty.

Thus, it can be said that the definition of tax haven countries is countries that deliberately giving tax facilities to other state taxpayers to income taxpayers other countries and transferred to their country (tax haven) to be taxed less or not subject to tax at all. In other words, the presence of tax haven countries will encourage other countries taxpayer to make tax evasion or avoidance in the country where the taxpayer is running the actual business activities. Thus, the existence of tax haven countries is certainly a big issue for other countries because it would threaten their tax revenue. It will be even worse if other countries are very weak provisions of the anti tax-avoidance. (Danny and Darussalam, 2008, page 63-64)

2.4.5.2 Definition of Tax Haven Countries

OECD states that tax haven countries can not be precisely defined because it is a tax haven country is very relative, depending on the conditions of each country in defining it. According to the OECD, a country could be called a tax haven by other countries if the country is called to give an incentive in the economic activity in a particular region in the country. Therefore, a country would be classified as a tax haven country or not by other countries depending on the definition of tax haven countries that provided by other countries are. (OECD, 1987, page 23).

While the International Tax Glossary, tax haven countries defined as countries that impose a tax with low rates or not impose any tax at all, and so maintain the confidentiality of tax information from taxpayers who are domiciled in the country. (Larking, 2005, page 403)

2.4.5.3 Indonesia Tax Regulation Related to Transfer Pricing

There are several tax provisions related to the Indonesia tax haven countries, namely KMK-650/KMK.04/1994 makes the list of countries categorized as a tax haven countries. As these countries are as follows:

Table 3

Tax Haven Countries based on Indonesia Taxation Regulation

1	Argentina	11	Cook Island	21	Nicaragua	31	Greece
2	Bahamas	12	El Salvador	22	Panama	32	Zambia
3	Bahrain	13	Estonia	23	Paraguay
4	Belize	14	Hong Kong	24	Peru
5	Bermuda	15	Liechtenstein	25	Qatar
6	British Isle	16	Lithuania	26	St. Lucia
7	British Virgin Island	17	Macau	27	Saudi Arabia
8	Cayman Island	18	Mauritius	28	Uruguay
9	Channel Island Greensey	19	Mexico	29	Venezuela
10	Channel Island Jersey	20	Nederland Antilles	30	Vanuatu

There was also SE-04/PJ.34/2005 of criteria guide "beneficial owner" as stated in the double taxation avoidance agreement (Penghindaran Pajak Berganda – P3B) between Indonesia and other countries. The contents of these circulars is that passive income revenue are also "special purpose vehicles" in a "conduit company", "Paper Box Company", "pass-through company" and other similar sites, then the recipient’s income is not meant in the sense of "beneficial owner "who can receive the facilities provided by the relevant P3B.

In addition to these two provisions, there are more other provisions relating to tax haven countries, namely the handling instructions SE-04/PJ.7/1993 of cases transfer pricing. In the circular stated that transfer pricing can occur between domestic taxpayer or the taxpayer in the country with foreign parties, particularly those based in tax haven countries.

2.5 Indonesia Tax Prevention and Investigation Process of Transfer Pricing

One way to suppress the rise of transfer pricing practice is to conduct an audit on transfer pricing by multinational companies. The value of the transfer of goods and services between companies within a group is expected to be in accordance with the principle of arm’s length, so that income shifting does not occur between countries and will create a fair tax climate.

In order to prevent tax evasion, among others through the pricing is not reasonable, in the tax legislation Indonesia, has found the provisions which essentially authorized the officers to make corrections to transactions that are not fair to others who have a special relationship.

2.5.1 Decision of the Director General of Taxation Number: KEP-01/PJ.7/1993

Decision of the Director General of Taxation Number: KEP-01/PJ.7/1993 on Tax Examination Guidelines Against Taxpayers who have a special relationship, is intended to overcome the decline in the amount of tax that is paid through transfer pricing practices:

2.5.1.1 Learning the taxpayer files and data files.

This stage is done by studying the notaries’ document and amendments. Must be investigated whether the ownership structure of stocks is examined taxpayer was of a special relationship as referred to in Article 18 paragraph (4) of Law no income tax. 10 of 1994 and the Law no.11 of the value added tax Article 2 paragraph (1). The goal is to find a general picture that the taxpayer, including:

About business and corporate characteristics
Regarding the ownership structure, whether there is the possibility a special relationship between the shareholders and the audited taxpayers.
Study the organizational structure of related companies. Sought wherever possible organizational chart describing the companies that have a special relationship and economic relationship with the audited taxpayers who describe the image and location of activities.
Studying the nature and type of business taxpayers. Described possible taxpayer business activities since the order until the completion of orders, whether it is regarding the purchase or sale.
Study the possibility of over or under invoicing. Purchases or sales or import or export by taxpayers who have special relationships with suppliers and customers are mainly located in Tax Haven Countries, should be studied the possibility of over and under invoicing.
Studying the previous inspection report. It aims to find out the things referred to in paragraph b, c, and d above letter that can be used as clues in the investigation to be conducted. (KEP-01/PJ.7/1993)

2.5.1.2 Analyzing Income and Tax Financial Reports.

The purpose of this analysis is to detect irregularities of sale or the purchase price between the parties having a special relationship, using the arm-length principle methods:

Comparable market price method or Comparable Uncontrolled Price (CUP)This method can be used in the case:

There are sales or purchases to the existing special relationship, as well as to those who do not have a special relationship.
Types of products as objects of relatively the same transaction.

Things that must be considered in using this method are:

Markets are geographically distinct
Sales chain from producers to consumers
Sales chain from producers to consumers
Discounted price and quantity discount (discounts and rebates)
Quality goods
Insurance

2. Resale Price Method

This method can be used in terms of:

There are no transactions with parties who do not have a special relationship that can be used as a benchmark example of the marketing system with a single agency.
There are data resale price of goods that are not influenced by special relationship.
There is no change in the process of value-added goods
The buyer and seller in a special relationship do not increase the price of great influence on the value of the goods.

3. Cost plus Method

Things that need to be considered in the use of this method are:

Allocation of costs to cost of goods
Determination of direct-costing method in the sale price
The use of technology that can save materials and hours of work
Request price from the buyer

(Departemen Keuangan Republik Indonesia Direktorat Jendral Pajak, 1993)

2.6 Foreign Investment

2.6.1 Economic Integration Theory

Regional economic integration, that is the goal of countries in a region, is considered to be an important policy because:

The member States will gain a mutual benefit by joining in one community
Increase bargaining position in international trade
Reduce tariff
Increase price transparency and transnational competitiveness

Before reaching an integrated economy, a region must conclude a roadmap of integration as a sign of establishing the process of transnational economic and political cooperation starting from the grassroots to the highest level of integration. This roadmap of integration could form a political integration, while usage of a single currency has a very close correlation with political and economical integration.

A classic theory concerning the establishment of single currency was brought forward by Mundell, which was called Optimum Currency Area (OCA). OCA is defined as a geographical area where State parties are united to gain profit by using a single currency system. Requiring factors for countries to be able to use a currency collectively are:

Economical diversification degrees
The presence of symmetric shock among member States
Price and wages flexibility
Economical transparency and measurement
Similarities in inflation rates
Financial development degrees
Political and fiscal integrity

Among requirements that have been stated above, economical transparency measurement refers to many aspects, including trades and investments. Economical transparency regarding the flow of capital shows a country’s efforts in achieving economic integration. Conveniences on the flow of capital into the real sectors in the form of foreign direct investments can be an indicator to see the economical transparency in a country to make an integrated economy happen.

2.6.2 Definition of Investment

Term investment comes from the Latin: "investire" (wear). The experts have different views about the theoretical concepts of investing. Fitzgeral defines investment as:

"Activities that related with withdrawal of business funding sources used to make capital goods in the present, and the capital goods will be produced flow of new products in the future" (Murdifin Basalamah Haming and Salom, 2003: 4)

In this definition, investments constructed as an activity for:

Withdrawal of funding sources used for the purchase of capital goods
Capital goods would be produced a new product

Another definition of the proposed investment Kamaruddin Ahmad:

"Put the money or funds with the hope to obtain additional or specific advantages of money funds” (Kamaruddin Ahmad, 1996: 3)

In Encyclopedia of Indonesia, the investment is defined as:

"Investment money or capital in the production process (with the purchase of buildings, machinery, material reserves, cash administration and development). Thus the enlarged capital reserves so far things no capital goods should be replaced" (Encyclopedia of Indonesia, tt: 1470)

Above definitions can be refined into the following:

"Investment is the investment made by investors, both foreign and domestic investors in various business fields open to investment, in order obtain the benefits" (Salim and Budi Sutrisno, 2007: 33)

2.6.3 Legal Aspect of Investment

In the legislation we can’t find the notion of investment law. To find legal terms of investment, we must seek the views of experts and legal dictionaries. Ida Bagus Putra Vyasa, et al., Conveying the notion of investment law as follows:

"Legal norms of the possibilities to do investment, investment requirements, and most importantly the protection order directing the investment can bring about prosperity for the people" (Ida Bagus Putra Wyasa, at all, 2003: 54-55)

Another definition proposed by T Mulya Lubis;

"Not only in law, but in laws and other rules that apply next related issues of foreign investment." (T. Mulya Lubis, 1992:29)

It is stipulated in the investment law the relationship between the investor and the recipient of capital. Status of investors can be classified into two kinds; foreign investors and domestic investors. Foreign investor is the investment coming from abroad, while domestic investor is that investment comes from within the country. Business sector is a field of activity permitted or allowed to invest. Procedures and requirements are things that must be met by investors to invest. Usually, the countries that receive investment are the developing countries.

From the description above, can be made legal elements of investment:

There is a rule of law
Existence of subject where the subject in the investment law is the investor and the investment recipient country
The existence of the business sector is allowed to invest
Procedures and requirements to invest,
Country.

2.6.4 General Condition of Foreign Companies in Indonesia

Multinational Enterprises in Indonesia was represented by the taxpayer in the form of foreign investment (Penanaman Modal Asing – PMA). Foreign companies are generally moving in a variety of industries and services. Because income tax rates entities in Indonesia is quite high, then the foreign companies in Indonesia are generally used as cost center. The trick is Indonesian PMA companies are conditioned to buy raw materials or semi-finished goods from the parent company or affiliated companies with high price. Usually, raw materials or semi-finished goods imported do not have a benchmark price in the international market. Then the raw materials or semi-finished goods are processed into finished goods which will be exported back to the parent company or affiliated companies in other countries with the price margin is very thin or even lower than production costs. Indonesian PMA companies simply act as a "tailor" the level of benefits that have been defined by the parent company abroad.

Several features of the company principals have transfer pricing on most of the financial statements Indonesian PMA companies. For example PMA taxpayers tend to report taxable income is lower than similar companies, or even in a loss position, the amount of royalties and other services paid to the parent company abroad tend to be large, and foreign taxpayers have affiliated companies in tax haven countries.

The fact that many foreign companies Taxpayers who are in a condition even a loss for years, it is contradictory with the general purpose of incorporation make a profit. When viewed from the conditions that amounted to a loss is relatively large, should not be easy for foreign companies to continue to survive.

Here is a picture of PMA companies that reported losses on trading companies. Foreign companies engaged in trade, both exports and imports, many also reported losses. Value losses ranged approximately five hundred billion rupiah. While the average effective tax rate in 2005 and 2006 corporate tax PMA trade respectively for 40.27% and 16.40%.

Based on common practice, should not trade the company will incur a loss. Regardless of the increase or decrease the price of goods, the trading company will sell the base price plus profit margin. Moreover, many foreign companies trading in Indonesia, is a distributor of goods produced abroad. In other words, goods sold are a relatively goods which have a name and brand. (Singh, 2007)

2.6.5 Foreign Direct Investment (FDI)

According to Moss (2007), direct investment (or foreign direct investment – FDI) consists of the purchase in a companies share that is done trans-nationally, that is big enough (usually more than 10 percent), allowing the purchaser a new foreign control in the managerial system of the company. (Moss, 2007)

Pillbeam (2006) elucidated that foreign direct investment (FDI) is a means for developing countries to receive funding from foreign party. This investment can be in the form of acquiring a domestic company’s share to be a multinational company, or a foreign investor making a new branch in a developing country. FDI is a popular decision made by a multinational company to invest in a developing country in order to gain ownership and control towards the established and acquired business. (Pillbeam, 2006)

Foreign Direct Investment, in its classic definition, is defined as a company from one country making a physical investment into building a factory in another country. The foreign direct investment in its classic definition is in contrast with making a portfolio investment, which is considered an indirect investment. The given rapid growth and change in global investment patterns, has made the general notion of it broadened to include the acquisition of a lasting management interest in a company outside the investing in a joint venture. Foreign Direct Investment plays an extraordinary and growing role in global business. The investment policies, the regulatory environment globally in the past decade, including trade policy and tariff liberalization, the deregulation and privatization of many industries, has probably been the most significant catalyst for FDI’s expanded role.

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