PMK 112/2025 Strengthens DGT Authority Over Test Avoidance of Permanent Establishment Status Related to Tax Treaty
The Directorate General of Taxes (DGT) now has stronger authority to assess compliance with the implementation of Double Taxation Avoidance Agreements or Tax Treaty, including in determining the existence of a Permanent Establishment (PE). This is stipulated in Minister of Finance Regulation (PMK) 112/2025, which was issued and has been effective since 31 December 2025.
The regulation aims to ensure non-resident taxpayers are unable toavoid PE status. This is because, in practice, non-resident taxpayers often establish business arrangements that formally do not meet the PE criteria, while substantively conducting economic activities in the source country.
As a result, such non-resident taxpayers may avoid taxation by the Indonesian government. A PE essentially functions as a taxation nexus. Therefore, the existence of PE is the legal basis for the source country to impose tax on business profits earned by a foreign taxpayer.
Schemes for Avoiding PE Status
Avoidance of PE status is generally carried out through three main schemes, including fragmentation of business activities, the use of commissionaire arrangements, and claims that activities are preparatory or auxiliary in nature.
1. Project Fragmentation
Under this scheme, a non-resident taxpayers divides a single project that is economically integrated into several contracts or phases. For example, the project is divided into construction, installation, or assembly activities.
Each contract or phase is arranged to fall below the PE time threshold. In addition, affiliated entities may be engaged to carry out different portions of the same project. The objectives are the same, namely to ensure that each project appears standalone and does not meet the duration of PE status determination.
2. Use of Agents
PE status may also be avoided by using agents who are formally independent but substantively perform the principal role in concluding transactions. In practice, the agent in Indonesia may not formally sign contracts. However, the agent habitually plays the principal role, leading to the conclusion of contracts that are subsequently approved without material modification by the non-resident taxpayers. The purpose is to avoid classification as a dependent agent in PE.
3. Claim of Preparatory or Auxiliary Activities
Non-resident taxpayers claim that activities carried out in Indonesia are preparatory or auxiliary in nature, whereas in substance, such activities constitute an integral and significant part of the core business. Avoidance may also occur by fragmenting business functions across several related entities or locations so that each appears to qualify for the exemption criteria.
Preventive Measures Introduced by the DGT
Accordingly, PMK112/2025 introduces four key approaches to be applied by the DGT in preventing PE status avoidance.
1. Application of the Project Period Aggregation Principle
Article 23 of PMK 112/2025 confirms that the duration of a non-resident taxpayer’s project must be aggregated with the duration of projects carried out by closely related persons at the same location.
This approach effectively closes the loophole of project fragmentation and affirms that PE assessment is based on the economic reality of the project, rather than merely on contractual structuring.
2. Expansion of the Substance-Based Dependent Agent Concept
Article 24 of PMK 112/2025 broadens the scope of dependent agent PE by including circumstances where an agent does not formally sign contracts but habitually plays the principal role leading to the conclusion of contracts. This provision reflects a shift from a formalistic approach toward a substantive approach, in line with Base Erosion and Profit Shifting (BEPS) Action 7.
3. Anti-Fragmentation Rule
Article 25 of PMK 112/2025 clarifies that the PE exemption applies only where activities are genuinely preparatory or auxiliary when viewed as a whole. The assessment must consider all activities conducted in Indonesia by the non-resident taxpayer and closely related parties, preventing artificial use of exemptions.
4. Affirmation of the Closely Related Person Concept
PMK 112/2025 adopts the definition of “closely related” as provided in the multilateral instrument (MLI). This emphasizes control or ownership relationships, including a threshold of more than 50% direct or indirect ownership.
This definition requires a higher degree of control compared to the related party concept used for transfer pricing purposes under Article 18 paragraph (4) of the Income Tax Law.
Accordingly, the clarification of the closely related definition in PMK 112/2025 confirms that the existence of a domestic related-party relationship does not automatically establish a PE. Instead, the relevant control criteria under the applicable tax treaty and the MLI must be fulfilled.
Relevance of Tax Treaties as Lex Specialis
The issuance of PMK 112/2025 is inseparable from the international framework established through BEPS Action 7 and MLI. Accordingly, the regulation serves as a mechanism to internalize MLI principles into domestic tax administrative practice.
International reforms do not remain merely at the normative treaty level but can be effectively operationalized by the tax authority. In this context, PMK 112/2025 functions as an operational tool for the DGT in applying an anti-avoidance approach to PE that is aligned with OECD standards.
Substantively, the provisions of PMK 112/2025 demonstrate consistency with the MLI, particularly in assessing the role of agents, the closely related person concept, and limitations on the preparatory or auxiliary exemption.
Nevertheless, as PMK 112/2025 is a domestic regulation, potential differences in interpretation with applicable tax treaties may still arise. The difference is particularly related to treaties that have not been, or have not been fully, modified by the MLI due to differing matching positions between treaty partners.
In this context, the characteristic of tax treaty provisions as lex specialis becomes relevant, given that tax treaties’s position generally prevail over domestic provisions.
The primary challenge arises, namely to ensure that the administrative authority granted under PMK 112/2025 is not exercised to override or nullify the existing tax treaty provisions. Rather, the authoirty should function as an interpretative and substantive testing instrument that aligned with the objectives of the treaty.
Accordingly, PMK 112/2025 should be understood as a means of upholding the spirit of tax treaties in the post-BEPS era, not as a basis for unilaterally setting aside treaty provisions. (ASP/MIT/NAT)
