You’ve worked your butt off all year to increase your wealth, but now it’s time to hand the final chunk to the tax man. How can you ensure you don’t give away more than you need from that hard-won new wealth?
As a small business owner, you have choices on how you pay yourself. The two key choices are as salary or as Dividends from your business Net Profit. But many people don’t understand those options nor how to use them to minimize their tax bill and take home more of the loot.
In the examples we work on this article, the tax paid out can vary from Rp 196 million (30% of available owner withdrawals) to Rp 80 million (12%.) That’s an awful lot of money to leave on the table just from not knowing your options.
To generate the examples I created an Excel worksheet (the BizTax Tool) to apply the business rules for Indonesian Company and personal tax rates.
Understand Company Tax Options.
- If you are a business with gross earnings (ie sales) of less than Rp 4.8 billion (approx $480,000) per year then you pay tax (every month) at a rate of 1% of the gross earnings (sales) of the previous year. Professional services businesses not included.
- If your business has annual sales of less than 50 billion ($5 million) per year then your tax rate is 25% less 50% discount or net 12.5%
- A flat tax rate of 25% applies to other companies in Indonesia.
Impact of the New 1% Tax
The 1% tax rate was introduced during 2013 to simplify the calculation of tax to be paid, in order to get more businesses paying tax.
Certain businesses are not eligible:
- Professional services including accountants, coaches, teachers, musicians.
- Businesses with demountable infrastructures, such as street hawkers or circuses.
So in effect, pretty much all small businesses in restaurants, entertainment, travel, retail or manufacturing will be required to pay a tax rate of 1% on their gross sales.
If you are a new business then the annual gross earnings are based on your first month sales. So, maybe better to use a soft launch for the first month…
At first glance, you might say, oooooh! Wonderful, I’m paying less tax! But that might not be the case – it depends on the Net Profit Margin you are already earning. If you look at the following table you can see that the more net profit you earn, the better off you are – compared to the current 12.5% tax on Net Profit. The break-even point is a Net Profit figure of 8%. If you are earning less profit than that then you will be paying more tax than before.
90% of SME’s generate less than 10% Net Profit.
(SME = Small and Medium Enterprises.)
So, if you have never had an incentive before to boost your net profit margin then maybe this tax change might do it for you, as the benefit is all for you, not the tax man!
Your strategy should be to grow net profit before you grow sales, to keep under the tax change thresholds.
Understand Key Personal Tax Variables.
- After you have paid tax on your sales or profits you have the balance available for two key uses – retained earnings and shareholder dividends.
- Retained Earnings is money you want to keep in the business to fund growth and replace your assets – land, buildings, production machinery, computers. Your budget plan DOES include the use of Retained Earnings, doesn’t it!
- Dividends are amounts paid to shareholders. In a small business, the shareholders are the owners, including your Indonesian partner in a PT.
- Dividends paid are taxable at a flat 10% for shareholder residents. If you have a KITAS then you are in effect a resident.
- Personal income tax rate is variable and progressive. In other words, you pay increasing percentages on lump sums of income as the amount increases. The tax break percentages are 5%, 15%, 25% and 30%. So the more salary you pay yourself, the higher the average personal tax rate is.
- Each salary earner is entitled to tax deductions, called Main Personal Relief. These include a minimum salary exemption, deductions for a spouse, a deduction for each dependent, occupational expenses, Jamsostek employee payments, and tension maintenance.
Utilising the Tax Variables
You reduce your tax by how you use the following factors:
- The split of money withdrawn between salaries and dividends.
- The split of salaries between partners.
- Optimising your deductions.
Our Sample Base Input
We need some base data to set up the worksheet in our sample. Your base data would come from your own Profit and Loss Report for the year.
|Net other Income & Expense||50|
|Profit Avail. for Distribution||1,050|
|Retained Earnings Required||400|
|Profit Available for Owners||650|
In our example, our owner has a spouse and two dependent children.
The 1% Business
1% Company Tax
This is straightforward – 1% of Rp 4 billion is Rp 40 million. This will apply regardless of any personal income taxes.
“1%” Personal Income Tax
This is where it starts to get interesting. The trick is to optimize your salary payments to minimize tax over 10% net, with the rest paid as dividends at the 10% rate.
Tax Allocation Options
Using the BizTax tool, we analyzed these options for Owner Withdrawals (OW), including the 1% company tax:
|Option||Total Tax||% of OW|
|All Salary 1 Income||100||15%|
|Dividends and Salary||100||15%|
|All Salary 2 Incomes||68||10%|
The Net Profit Tax Business
Remember, this applies to professional services, also where capital assets are being built. These owners can play with one additional factor, as what they pay themselves as salaries get deducted from assessed income for company tax.
Using the same tax allocation options as above, we had the following net tax results:
|Option||Total Tax||% of O.W.|
|All Salary 1 Income||148||23%|
|Dividends and Salary||123||19%|
|All Salary 2 Incomes||80||12%|
The Impact of Splitting Salaries
Splitting salaries between a couple achieve two things: it reduces the net amount subject to the highest progressive tax rate, and it increases the potential for deductions from personal salary. The current cost of a KITAS is around Rp 20 million per year, so if you can gain more than that from splitting income then give your partner a KITAS and a job.
In the example we have used here, the best results you get are from planning your withdrawals from the business as salaries, not as dividends. But your own business could have quite different results depending on your inputs.
Get a Tax Calculator for your own business.
You can use this calculator to revise your current year taxable income and also help plan your coming year budget. If you want a copy BizTax Tool for your own business, order a copy ($15) by sending me an email and make sure you include your own name, position, business name, industry, and location.