Interest-to-EBITDA Rules as an Anti-Thin Capitalization Measure in Indonesia: Policy Trade-offs, Drivers, and Implementation Risks

Abstract

Indonesia introduced an interest-to-EBITDA ratio as a potential interest limitation rule through the Income Tax Law, as amended by the Law on Harmonization of Tax Regulations, and Government Regulation No. 55 of 2022. At the time the underlying research was conducted, however, the technical implementing regulation had not yet been issued. This study compared the interest-to-EBITDA ratio and the debt-to-equity ratio (DER) as anti-thin capitalization measures based on the principles of sufficiency and productivity, identified the factors underlying Indonesia’s adoption of the interest-to-EBITDA approach, and examined potential implementation challenges for the tax authority. This qualitative descriptive study drew on documentary research and nine in-depth interviews involving ten policymakers, tax administrators, academics, and practitioners conducted from May to June 2023. The findings showed that neither approach was uniformly superior. In terms of sufficiency, the interest-to-EBITDA ratio was better able to limit opportunities for tax avoidance but could restrict genuine business activities when earnings were low for reasons beyond taxpayers’ control. The DER approach was more predictable and better able to accommodate ordinary business financing; however, its balance-sheet variables could be manipulated, and Indonesia’s 4:1 threshold was considered overly permissive. In terms of productivity, the interest-to-EBITDA approach provided greater financing neutrality, whereas the DER approach was more familiar and easier for taxpayers to comply with. Indonesia’s adoption of the interest-to-EBITDA approach was driven by OECD BEPS Action 4, the global shift toward earnings-stripping rules, and perceived weaknesses in the DER framework. Key implementation risks included higher compliance and administrative costs, interest-rate volatility, disputes involving the substance-over-form principle, and differences between commercial and tax EBITDA. The study recommended calibrated limitation ratios, relief mechanisms based on average EBITDA, clear fiscal adjustments, and a sector-sensitive hybrid approach.