RI property sector: How robust is the new tax regime?

Andhika Suryadharma, Analyst The Jakarta Post

The tax office has proposed a new tax system for property developers. For some companies the new legislation may prove to be a new year's gift; for others however it may turn out to be a handicap.

The new regulations would impose a 5 percent final tax on revenues for big developers and a minimum 1 percent tax rate for smaller developers. Currently, taxes for property development companies adhere to the corporate tax rate, which is 30 percent of pre-tax earnings.

This proposal may be viewed positively for stimulating the development of low-cost housing. A number of criteria, however, still need to be clearly defined.

The rational behind the new tax legislation is twofold: first it prevents developers from engineering profit numbers to minimize taxes. At present calculations for income and expense directly impact pretax profits.

Second, the new tax law strengthens the incentive for developers to build low-cost housing including apartments, as these projects are likely to be subject to the 1 percent minimum tax.

Low-income housing is generally defined as developments which have a maximum unit price of Rp 49 million. Freehold townhouses may also be defined as low-income provided their sale price does not exceed Rp 144 million.

The 5 percent final tax on revenues imposed on larger developers would be implemented for residential housing sales. The development of commercial properties for the generation of rental income (i.e. hotels, time-shares and other temporary accommodation) will bear a final tax of 10 percent.

Opportunities for confusion and perhaps systemic abuse may still persist under the proposed tax system. At the heart of this matter rests definitions related to scale. What distinguishes a big developer from a small one?

At the moment, the definition of small is not closely associated with low-income housing. If for example, the developer were to pursue a large-scale project to develop low-income housing, the overall size of the investment may outweigh the fact that the per unit cost meets the low-income definition.

Another key consideration is related to the property cycle. Residential property is sensitive to volatility in mortgage rates and purchasing power. This is compared to the more stable recurring income businesses.

The new tax system would provide little security for investors during periods of downward volatility in the property market. In such an event, property developers are left with no choice but to pass on the tax to consumers by increasing the prices of their products.

We try to examine which kind of property developer would benefit from the proposed system. Apparently the property developer with the highest portion of non-recurring business and margins will likely gain the most.

The ability of each developer to maintain margins is crucial. For example, one property developer that we cover would have to maintain its gross profit margin at about 19 percent in order to ensure this regulation.

Our own calculations show that a property developer must keep its pretax margin above 16.7 percent in order to benefit from the new tax regime. Below that margin, the current levy of 30 percent on pre-tax profit becomes more beneficial.

The proposed legislation has actually been in place before. The government implemented a similar law in April 1996, a year before the Asian financial crisis. Despite the ensuing devastation to Indonesia's property market that legislation survived for about three years, being changed in 1999 after the crisis

As the proposed legislation has been initiated by the tax office, there is a good chance it will be implemented this year. Of course it is impossible for tax regulation to satisfy all parties.

However, before this regulation is to be implemented, it is important for the government to clearly classify or define each developer in terms of the scale and location of the products they develop. This will ensure fair treatment for developers.

Furthermore, it is important to consider what will happen during a downturn in the property cycle. Previous mistakes in the real sector need to be avoided.

It is therefore necessary to determine whether it is sustainable for property developers to maintain their margins by passing fixed taxes onto consumers while a property slump is underway?

The writer is a research analyst at PT Bahana Securities