In the business, debt is something we can’t avoided. Debt in financial management is to leverage or to improve financial performance. If Companies only rely on their own capital or equity, certainly, the company will have difficulties for business expansion that needs additional capital. Well this is where the role of debt is very helpful for business expansion. But, if the amount of debt already exceeds the amount of equity, then company’s risk from liquidity perspective is increasingly high.
Liquidity shows how liquid or how fast for an asset to be converted into cash and cash equivalents. Liquidity can also describe company’s ability to settle the debts or liabilities with maturity not more than 1 (one) period.
To assess liquidity risk, analysis is required to review financial performance using Debt to Equity Ratio (DER). DER is ratio that compares total liability to total equity. The higher the number of DER, it is assumed that the company has a higher risk for the company’s liquidity.
DER : Total Debt
Debt to Equity Ratio For Tax Purpose
Although the debt can be used to help in company’s expansion, but it doesn’t mean there is no negative impact from debt. Generally any debts definitely have interest to be paid, and this is an expense for the company.
Because of interest expense in income statement can be used as deduction from income in determining taxable income, and therefore if interest expense increase then it will reduce taxable income that affects on lower income come tax expense.
The amount of interest expense is affected by amount of debt, therefore for tax purpose, Directorate General of Taxes are concern to determine debt to equity ratio. According to Tax Law (UU) No. 36 of 2008 article18, that the financial minister is authorized to issue provision regarding debt to equity ratio for the purposes of income tax calculation.
According to Financial Minister Regulation (PMK) of Republic Indonesia No. 169/PMK.010/2015 article 2, the maximum ratio between debt and equity (capital) shall be 4:1. The definition of debt and equity are as follows:
1. Loan is:
2. Capital is: the average balance of capital at the end of the month in the relevant fiscal year or part of fiscal year.
The balance of debt mentioned before is short term and long term debt, including trade payable which charged by interest. If the ratio between debt and equity exceeds 4:1, then cost of fund that can be used as deduction of taxable income must be accordance to ratio 4:1.
The Exception from Provision of Debt to Equity Ratio
The provision of debt to equity ratio is not applicable to all companies. There are companies that are excluded in the application of this provision, are as follows:
The Effective Date of This Provision
The provision regarding ratio between debt and equity for income tax calculation as regulated in Financial Minister Regulation (PMK) of Republic Indonesia No. 169/PMK.010/2015 is valid start from fiscal year 2016.