Foreign investors commonly fund their Indonesian subsidiaries through shareholder loans rather than additional equity. While this structure can provide flexibility and, subject to applicable tax rules, allow interest expenses to be deducted for income tax purposes, excessive reliance on debt can create tax and corporate issues. For a PT PMA, a debt-to-equity swap may be one option to address an overly leveraged capital structure.

Under Minister of Finance Regulation No. 169/PMK.010/2015 (“PMK 169/2015”), the maximum debt-to-equity ratio for taxpayers within its scope is generally 4:1 for income tax purposes. The calculation considers the taxpayer’s average debt and equity during the relevant fiscal year, rather than simply the amount of shareholder loans at a particular point in time. Where the applicable ratio is exceeded, the corresponding borrowing costs may not be fully deductible. Related-party interest must also satisfy other applicable Indonesian tax requirements, including the arm’s-length principle.

For example, assume a PT PMA has IDR 250 million in equity and IDR 3 billion in shareholder loans bearing interest at 10% per annum. On a simplified basis, a 4:1 ratio would support debt of up to IDR 1 billion. The excess IDR 2 billion of debt would generate approximately IDR 200 million in annual interest. Assuming a 22% corporate income tax rate purely for illustration, this could result in approximately IDR 44 million of additional annual tax cost if the relevant interest is not deductible. The actual treatment will depend on the company’s circumstances and the applicable tax rules.

A debt-to-equity swap converts all or part of the shareholder’s outstanding loan into equity in the Indonesian company. Although the term itself is not specifically defined in Indonesian company law, the mechanism can be implemented under Articles 34 and 35 of Law No. 40 of 2007 on Limited Liability Companies, which allow capital contributions in forms other than cash and permit certain claims against the company to be used to satisfy the obligation to pay for shares, subject to the required corporate approvals.

Using the example above, if IDR 400 million of the shareholder loan were converted into equity, equity would increase from IDR 250 million to IDR 650 million, while debt would decrease from IDR 3 billion to IDR 2.6 billion. On a simplified basis, this results in a 4:1 debt-to-equity ratio. However, because PMK 169/2015 uses average balances for the relevant period, the timing of the conversion can affect the calculation.

The 4:1 limitation does not apply to all taxpayers. PMK 169/2015 provides exemptions for certain businesses, including banks, financing companies, insurance and reinsurance companies, and certain taxpayers in the infrastructure, oil and gas, and mining sectors. Companies should therefore first determine whether the rule applies to them before restructuring their shareholder loans for tax purposes.

A debt-to-equity swap may also be considered where a PT PMA is experiencing financial difficulties. Instead of requiring immediate repayment, a shareholder or other creditor may agree to convert part of its claim into equity so that the business can continue operating. Where the company is unable to meet its debts as they fall due, debt restructuring may also be carried out through Penundaan Kewajiban Pembayaran Utang (PKPU) under Law No. 37 of 2004, subject to the applicable requirements and procedures.

The conversion is not merely an accounting entry. It may change the company’s issued and paid-up capital and shareholding structure and therefore requires appropriate corporate approvals, notarial documentation, and registration with the Ministry of Law. For a PT PMA, the company should also assess whether corresponding updates are required through AHU, OSS, and investment reporting systems, including LKPM.

The tax consequences should also be reviewed after the conversion. Before the swap, the foreign shareholder may receive interest from the Indonesian company. After the swap, its return will generally be derived from its equity investment, including dividends. Dividends paid to a non-resident are generally subject to Article 26 withholding tax at 20%, unless a lower rate or other treatment is available under an applicable tax treaty or prevailing regulations.

A debt-to-equity swap therefore involves more than simply converting a shareholder loan into shares. The company should consider the corporate, tax, investment, accounting, and regulatory implications before implementing the transaction. Proper coordination is important to ensure that the company’s corporate records, tax position, and regulatory filings remain consistent after the restructuring.

For a PT PMA with significant shareholder loans, an early review of the financing structure can help determine whether a debt-to-equity swap is appropriate and how it should be implemented. Schinder Law Firm can assist with reviewing shareholder financing arrangements, structuring the corporate transaction, preparing the required documentation, and coordinating the relevant corporate and regulatory filings. For further consultation, please contact Schinder Law Firm at info@schinderlawfirm.com.

Author:
Dewi Susanti