Cost Recovery vs Tax Deductible Expense

PSC is a cooperation contract between Government of Indonesia (SKK Migas) and the PSC Contractors. Cooperation contract is sits on private law area which regulate each parties involved in the contract. In the contract, between parties agree to share production (practically the profit) as a result of PSC activities. On traditional profit split, Government entitles for 85% net profit split while 15% net share goes to Contractors. The 85% Government net share is including Corporate Taxes and Dividend (Branch Profit Taxes) payable by Contractors on their equity resulting from PSC operations.As per above descriptions, payment of Corporate and Dividend taxes (simply called as Petroleum Taxes) is also mean fulfilling sharing obligation to satisfy Government net share for the respective PSC. Payment of Petroleum Taxes is part of Government net share or revenue. In order to guarantee the satisfaction of net profit share agreed in the tender, usually each PSC Agreement has its owned tax regime. The other important thing is application of uniformity principle. In uniformity principle, cost recoverable allowed as per PSC provision shall be the tax deductible expense for Petroleum taxes calculation. It was common that cost recovery items may not in line with general tax provisions.Under GR 79, Government made integration in which cost recovery as per PSC shall be accordance to general tax deductible expense rules with some adjustment to PSC specific industry cost rules. GR 79 provide a clearer application of uniformity principle in which cost recovery are also tax deductible expense for Petroleum Taxes calculation with no exceptions. In line with the concept, any bonuses paid to Government are no longer tax deductibles expense.The integration (or uniformity implementation) is reflected in formulation of allowed cost recovery which is following general tax expense rules. GR 79 stipulates that operating costs can be recovered in the calculation of production sharing and income tax as long as they meet the following requirements:

  1. incurred to obtain, collect and maintain income pursuant to applicable laws and regulations and are directly related to petroleum operations within the working area of the Contractor in Indonesia;
  2. use a reasonable price that is not influenced by related parties as intended in the Income Tax Law;
  3. implement petroleum operations in accordance with good business and good engineering practices;
  4. petroleum operation activities are in accordance with the Work Program and Budget that have been approved by BPMIGAS.

The integration is also reflected in 24 types of costs that cannot be recovered which is following the general tax rules as below:

  1. costs that are charged or incurred for personal interest and/or the family of employees, management, participating interest holders and shareholders;
  2. formation and accumulation of the reserve funds, except for the mine closure and abandonment costs which are deposited in a joint account between BPMIGAS and the Contractor at a public bank of the Government of Indonesia located in Indonesia;
  3. granted assets;
  4. administrative sanctions in the form of interest, fines, and criminal sanctions in the form of fines in relation to the implementation of laws and regulations in taxation, and claims or fines arising from a Contractor’s mistake, either intentionally or through negligence;
  5. depreciation cost of the goods and equipment used which are not owned by the state;
  6. incentives, pension fund payments, and insurance premiums for personal interest and/or the families of expatriate employees, management and shareholders;
  7. costs for expatriate employees who are not in compliance with the Expatriate Manpower Utilization Plan or do not have an Expatriate Work Permit;
  8. costs for legal consultation not directly related with petroleum operations under a PSC;
  9. costs for tax consultant;
  10. costs for the marketing of a Contractor’s share of oil and natural gas, except for the marketing cost of natural gas approved by the Head of BPMIGAS;
  11. costs for representation, including costs for meals under whatever name or form, except if accompanied with a list of nominated benefit recipients and their tax identification number;
  12. costs for environmental and community development during the exploitation period;
  13. costs for the technical training of expatriates;
  14. costs associated with mergers, acquisitions, or the transfer of a participating interest;
  15. costs for interest on loans;
  16. employee tax borne by the Contractor or paid as a tax allowance and deductable, or collected income tax from third party income borne by the Contractor or grossed-up;
  17. procurement of goods and services and other activities not in accordance with reasonable and good engineering principles, or exceeding the value of authorized expenditure by 10% of such authorized expenditure;
  18. surplus inventory due to inaccurate planning and purchasing;
  19. book value and operation costs of used assets no longer operable due to Contractor’s negligence;
  20. any transaction which:
    • causes loss to the Government;
    • does not use a tender process in accordance with regulations, except under certain circumstances;
    • is contradictory to applicable rules and regulations.
  1. bonuses paid to the Government;
  2. costs incurred prior to contract signing;
  3. incentives on interest recovery; and
  4. commercial audit costs.

With the cost unification, all cost recoverable for profit sharing calculation as per PSC rules shall be the same to the tax deductible expenses for Petroleum taxes calculation purposes without any exceptions. Older PSC, as per GR 79 request, have to make adjustment to the new rules 3 months after commencement of GR 79 which is mean by March 20, 2011 all PSC shall apply the GR 79 provision.