Mind the Gap! Underreporting in Indonesia's Tax System

By Revanza Almaas, a Directorate General of Taxes officer

Tax collection is a critical pillar for any government, providing the resources needed to fund essential services and infrastructure. However, a persistent challenge exists: the tax gap. This term refers to the difference between the taxes that should be collected under full compliance and the amount actually received by the government. Estimating the tax gap offers a window into the effectiveness of a tax system and reveals the extent of non-compliance.
Understanding the tax gap goes is critical. It sheds light on the various ways taxpayers may fail to meet their tax obligations. Here, there are three key component.

1. Non-filing
   Non-filing occurs when taxpayers fail to report taxable events altogether. Imagine a scenario where an individual receives substantial income but neglects to file a tax return. This lack of reporting contributes significantly to the tax gap. Tax administrations grapple with identifying these unreported transactions. They rely on data matching, third-party information, and risk-based audits to uncover such cases.
2. Underreporting
   Underreporting is the most substantial contributor to the tax gap. It involves taxpayers providing incomplete or inaccurate information on their tax returns. Examples of under-reporting include (a) incomplete asset declarations: taxpayers may omit certain assets intentionally or unintentionally. For instance, they might not fully disclose offshore accounts or investments, (b) incorrect assessments: mistakes in assessing the value of assets or income can lead to under-reporting. Taxpayers might undervalue properties or underestimate their earnings, (c) improper tax credits: some taxpayers misuse tax credits or deductions, leading to lower tax liability. Addressing under-reporting requires a multifaceted approach. Tax authorities employ data analytics, risk modeling, and targeted audits to detect discrepancies.
3. Non-payment
   Non-payment occurs when taxpayers file their returns but do not remit the tax liability within the voluntary payment period. Reasons for non-payment include financial constraints, deliberate evasion, or administrative inefficiencies. Tax administrations strive to improve voluntary compliance by streamlining payment processes, offering incentives, and enforcing penalties for late payments.

Individual income tax is a significant contributor to the tax gap in most countries. Self-employed individuals and businesses often underreport their income. The complexity of business transactions and the use of cash payments contribute to this phenomenon. Freelancers, gig workers, and independent contractors may also not fully report their earnings. Income generated in the informal sector is challenging to track and tax effectively.

A study by Siti Nuryanah and Christine (2009) offers valuable insights into the factors contributing to underreporting, a significant component of Indonesia's tax gap. Their research identified factors of the discrepancies.

• Evidentiary Shortcomings: When taxpayers fail to maintain proper documentation to substantiate their tax calculations, it often leads to adjustments. The absence of invoices, receipts, and other supporting documents makes it difficult to verify the legitimacy of deductions and claimed expenses.
• Absence of Bookkeeping: Businesses without a well-organized bookkeeping system hinder transparency and make it difficult for both the taxpayer and the tax authority to accurately assess tax liabilities. Inefficient record-keeping practices can obscure income streams, inflate deductions, and create inconsistencies that trigger tax audits.
• Difference in Interpretations: Limited understanding of tax regulations among taxpayers can lead to misinterpretations and errors in tax filings. Complexities in tax codes, particularly around areas like depreciation schedules, allowable deductions, and treatment of specific transactions, can leave taxpayers vulnerable to unintentional mistakes.
• Related Party Transaction Challenges: Complexities surrounding transactions between related parties (e.g., companies with shared ownership) can create confusion and potentially lead to underpayment. Strategies to minimize tax burdens, such as transferring profits to subsidiaries in low-tax jurisdictions or manipulating transfer pricing between related entities, require careful scrutiny by tax authorities to ensure compliance.

The study also highlights the impact of discrepancies between accounting standards and tax regulations. These inconsistencies can further contribute to the need for tax corrections by auditors. For instance, an expense considered deductible under accounting principles might not be recognized for tax purposes, leading to adjustments during audits.

The findings from Nuryanah and Christine's research open a broader discussion on addressing Indonesia's tax gap. Here's a breakdown of the main reasons for tax corrections identified in the research, along with additional considerations.

1. Strengthening Taxpayer Education: Enhancing taxpayer knowledge of tax regulations and best practices can significantly reduce technical errors in tax filings. This education should extend beyond those directly involved in tax matters to include company management, who make decisions with potential tax implications. Government-sponsored workshops, online learning modules, and tax advisory services can all play a role in empowering taxpayers.
2. Promoting Robust Documentation Management: Taxpayers must prioritize maintaining and storing complete documentation to support their tax calculations. This ensures they can readily respond to auditors' requests for evidence and minimize the risk of adjustments. Investing in digital record-keeping systems and implementing document retention policies can streamline this process.
3. Enhancing Bookkeeping Practices: Implementing and maintaining a clear and organized bookkeeping system streamlines the audit process for both tax authorities and taxpayers. This allows for easier verification of tax calculations and reduces the likelihood of corrections. Standardized bookkeeping practices aligned with tax regulations can help ensure transparency and minimize discrepancies.
4. Addressing the Discrepancy between Accounting Standards and Tax Regulations: Harmonizing accounting and tax regulations can reduce confusion and inconsistencies that lead to tax adjustments. Collaboration between tax authorities and accounting standard-setting bodies can pave the way for a more unified system.
5. Leveraging Technology for Improved Compliance: Tax authorities can utilize data analytics tools to identify patterns of underreporting and target audits more effectively. Additionally, electronic filing systems can streamline the tax filing process and reduce administrative burdens for both taxpayers and the government.

By addressing these factors, Indonesia can move towards a more efficient and transparent tax system. This collaborative effort requires proactive steps from taxpayers in improving their practices and a commitment from the government to enhance tax education, potentially harmonize accounting and tax regulations, and invest in technological solutions. Ultimately, a narrower tax gap translates to increased government revenue for vital public services and a fairer tax environment for all Indonesian businesses and individuals.

*) This article is the author's personal opinion and does not reflect the attitude of the agency where the author works.

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