Guide to the US Indonesia Tax Treaty

Understanding the US Indonesia Tax Treaty is crucial for Americans living in Indonesia and to Indonesian residents who are non-US citizens with U.S. sourced income. This guide breaks down the treaty's provisions, offering clarity on how it affects personal taxation and helps avoid double taxation.

Executive Summary

• ​The U.S. Indonesia tax treaty offers mechanisms to prevent double taxation.

• The treaty includes a "Savings Clause" that maintains the US right to tax its citizens as per its domestic laws and not per the treaty with just limited exceptions.

• US-sourced passive income, such as interest, dividends, and pensions, may be taxed at reduced rates or exempted for Indonesian residents who are U.S. NRAs (non-resident aliens).

Introduction to the US Indonesia Tax Treaty

The U.S. Indonesia tax treaty, signed in 1988, serves as an agreement between the two countries for determining the taxation of income where both nations may have the legal right to tax according to their respective laws. The treaty covers, among many topics, avoidance of double taxation, residency tie-breakers and taxation of various forms of income, including business profits, dividends, interest, pensions, and capital gains. This article will focus on some of the key aspects of the treaty that hold particular significance.

Relief of Double Taxation

The Indonesia U.S. tax treaty provides mechanisms for relief from double taxation, ensuring that income earned in one country by residents or citizens of the other is not taxed twice. To avoid double taxation, the treaty allows U.S. citizens to claim a foreign tax credit for the income tax they pay on Indonesian sourced income to Indonesia against their U.S. tax liability. Conversely, Indonesia offers a credit for U.S. taxes paid on U.S. sourced income against its own tax liabilities.

Example

Andi Setiawan, a U.S. citizen living in Jakarta, Indonesia, earns an annual salary of $80,000. In Indonesia, he pays $25,000 in taxes for the year. Andi's U.S. tax liability for this income amounts to $22,000. Thanks to the relief of double taxation provision of the tax treaty, he is entitled to claim a foreign tax credit on his US taxes. Andi applies the $25,000 he paid in Indonesian taxes against his U.S. tax obligation, effectively reducing his U.S. tax liability to zero and even generating a $3,000 credit surplus, which may be carried over to subsequent tax years.

The Savings Clause

The Indonesia U.S. tax treaty contains a "savings clause" which preserves the right of the U.S. to impose taxes on its citizens according to its own laws, even if this contradicts the provisions of the treaty. As a result of this clause, the majority of the benefits and reductions offered by the treaty do not apply to U.S. citizens living in Indonesia.

Example

Ratna Sari, a U.S. citizen, resides in Jakarta, Indonesia, and works for an American bio-tech company. She performs all her work duties in Indonesia and has no physical presence in the U.S. Although the Indonesia U.S. tax treaty exempts such income from U.S. taxation on the basis that there is no permanent establishment in the U.S., the savings clause overrides this, requiring Ratna to declare and possibly pay U.S. taxes on her income. Nevertheless, Ratna can take advantage of the foreign earned income exclusion or foreign tax credits for the taxes paid in Indonesia to avoid being taxed twice on the same income.

​Expert Tip: It's crucial for U.S. citizens to familiarize themselves with the savings clause exclusions in the tax treaty to accurately determine which tax benefits they can utilize.

Tax Residency and the Tie-Breaker Rules

The United States and Indonesia have their own criteria for determining who is a resident for tax purposes. It's possible for someone to meet the residency requirements of both countries simultaneously. To prevent the problems that dual tax residency could cause, the U.S. Indonesia tax treaty provides a series of tie-breaker rules. These rules help to decide which country has the primary right to tax the individual's income.

• Permanent Home Test: The first consideration is whether the individual has a permanent home available to them in one of the countries. If a permanent home is available in only one country, that country is generally considered the individual's country of residence for tax purposes.

• Centre of vital interests Test: If the individual has a permanent home in both countries or in neither country, the treaty looks at where the individuals center of vital interests lies, in other words, where they have a closer personal and economic interests.

• Habitual Abode Test: If the individual has a center of vital interests in both countries or in neither country, the treaty looks at where the individual has a habitual abode; in other words, where they live regularly. This could be where they spend more time or where they have a regular presence.

• Nationality Test: If the individual has a habitual abode in both countries or in neither, the next factor considered is nationality. If the person is a citizen of only one of the countries, that country is typically considered their country of residence for tax purposes.

• Mutual Agreement Procedure: In the rare case that the individual is a citizen of both countries or of neither, and the above tests do not resolve the issue of residency, the competent authorities of the United States and Indonesia will determine the individual's residency through a mutual agreement, taking into account the person's facts and circumstances.

Taxation of US-Sourced Passive Income

Passive income from U.S. sources, which is not tied to a U.S. trade or business, is generally taxed at a flat rate of 30% if earned by a non-resident alien. However, the US Indonesia tax treaty lowers this rate and in some cases totally exempts it from US taxation for certain types of income. We've summarized some of the tax treaty rates in the table below. It's important to note that that these rates generally do not apply to U.S. citizens due to the savings clause mentioned earlier.

	Tax Rate	Treat Article Citation
​Interest	10%	12(2) / P2
​Dividends - Paid by U.S. Corporations	15%	11(2) / P1
Dividends - Qualifying for Direct Dividend Rate	10%	11(2) / P1
Pensions and Alimony	15%*	21(1)
Social Security	30%**	22

*The rate applies to both periodic and lump-sum payments.

**Tax rate applies to 85% of the social security payments.

Income Earned While Temporarily Present in the US

Generally, income earned from work performed in the US would be considered US source income and would be subject to US taxation. However, the US Indonesia tax treaty lists certain exemptions where such income is not subject to US taxes. It's important to note that these exceptions generally do not apply to U.S. citizens because of the savings clause mentioned earlier. We've summarized some of these exceptions in the table below:

Income Type	Maximum Presence in U.S	Required Employer or Payer	Maximum Amount of Compensation	Treaty Article Citation
Employee	119 days	Any foreign resident	No limit*	16
Contractor	119 days	Any contractor	No limit**	15
Public entertainment	No limit	Any U.S. or foreign resident	$2,000	17
Scholarship or fellowship grant	5 years	Any U.S. or foreign resident	No limit***	19(1)
Teaching	2 years	U.S. educational institution	No limit****	20
​Full-time students - remittances or allowances	5 years	Any foreign resident	No limit	19(1)

*The exemption does not apply if the employee's compensation is borne by a permanent establishment (or in some cases a fixed base) that the employer has in the United States.

***Exemption does not apply to the extent income is attributable to the recipient's fixed U.S. base.

***Grant must be from a nonprofit organization.

****Does not apply to compensation for research work primarily for private benefit.

Social Security Taxes

Self-employed U.S. citizens in Indonesia are subject to U.S. Social Security taxes, in addition to their obligations to the Indonesian social security system. This is due to the absence of a totalization agreement between Indonesia and the United States, which would otherwise prevent the double taxation of social security in such situations.

State Taxes and Tax Treaties

Numerous states within the United States impose income taxes on their residents. The adherence to the Indonesia U.S. tax treaty varies by state, some may recognize them, while others may not.

​Expert Insight: Always check with a tax professional about how state tax laws interact with the treaty, as this can vary significantly from state to state.

Need Help Navigating the US Indonesia Tax Treaty?

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Frequently Asked Questions

Does Indonesia have a tax treaty with the US?

Yes, Indonesia and the U.S. have a tax treaty to prevent double taxation for U.S. expats in Indonesia. However, the treaty includes a 'savings clause' that allows the U.S. to tax its citizens as if the treaty doesn't exist, except for certain income items that are excluded from this clause. This clause is crucial for U.S. expats to understand as it can significantly affect their tax obligations.

Does Indonesia have a totalization agreement with the US?

Indonesia does not have a Totalization Agreement with the United States. Totalization agreements are designed to prevent dual social security taxation for individuals who might otherwise be subject to taxes in both countries.

Do Indonesian citizens pay tax on US capital gains?

Non-resident alien (NRA) Indonesians are generally not liable for US tax on capital gains from US investments, except for real estate located in the US. However, Indonesian citizens residing in the US are subject to US capital gains tax. They must also report and may need to pay taxes on these gains in Indonesia.

Article by Lewis Grunfeld, CPA

Lewis is a seasoned expert in international and U.S. expat taxation. With over 10 years of international tax experience, he specializes in applying tax treaties to benefit expats, handling complex tax scenarios and ensuring significant tax savings for his clients. Lewis's expertise in international compliance and U.S. expat tax returns has made him a trusted advisor in the expatriate community.