World Journal of

WJ E M S D
ENTREPRENEURSHIP, MANAGEMENT
AND SUSTAINABLE DEVELOPMENT

ISSN: 2042-5961 (Print) | 2042-597X (Online) WJEMSD V19 N1/2 2023

DOI: 10.47556/J.WJEMSD.19.1-2.2023.10

LITERATURE REVIEW

Income Tax Reconstruction on Construction

Services to Support Development in Indonesia
Henry Dianto Pardamean Sinaga
Law Doctoral Program
Diponegoro University
Semarang, Indonesia
Email: [email protected]

Yudha Pramana
Faculty of Economics, Udayana University
Denpasar, Indonesia
Email: [email protected]

Anis Wahyu Hermawan

Faculty of Law, Open University
Jakarta, Indonesia
Email: [email protected]

ABSTRACT
PURPOSE: The rapid development of construction companies is still dominated by various illegal acts including bribery,
embezzlement, and fraud, meaning that the proper tax income is not reported to the tax office. It is necessary to to produce
a reconstruction of the income tax provisions on development-based construction services.
DESIGN/METHODOLOGY/APPROACH: This paper applied a normative juridical method with an evaluative and
prescriptive thought.
FINDINGS: The applicable income tax regulations on construction services have not been able to overcome various illegal
acts, such as fictitious subcontractors, fictitious work units, replacement or deterioration of material quality, transfer of
lump-sum costs to material costs, tender collusion, personal use of project equipment, and money laundering.
RESEARCH LIMITATIONS/IMPLICATIONS: This paper requires in-depth study using a socio-legal approach, but can
enrich subsequent empirical research.

CITATION: Sinaga, H.D.P., Pramana, Y. and Hermawan, A.W. (2023): Income Tax Reconstruction on Construction Services to Support
Development in Indonesia. World Journal of Entrepreneurship, Management and Sustainable Development, Vol. 19, No. 1/2, pp. 125–136.
RECEIVED: 2 December 2021 / REVISED: 9 February 2022 / ACCEPTED: 20 April 2022 / PUBLISHED: 5 April 2023
COPYRIGHT: © 2023 by all the authors of the article above. The article is published as an open access article by WASD under the terms and
conditions of the Creative Commons Attribution (CC BY) license (https://creativecommons.org/licenses/by/4.0/).

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Sinaga et al.

ORIGINALITY/VALUE: It is important and urgent to renew income tax laws to overcome existing fraud in construction
services, including the regulation of the Construction Industry Schemes obligations together with sanctions for each
violation, revocation of final income tax on construction services, and the obligation to use the percentage-of-completion
method in construction services whose project completion exceeds a financial year.
KEYWORDS: Income; Tax; Construction; Contract; Illegal Act

INTRODUCTION
The construction industry has become a big business sector in Indonesia in recent years.
The Central Bureau of Statistics (2018; 2020a; 2021) reported that the total gross income from
construction industries from 2016-2019 has increased year on year, reaching Rp.938.36 trillion
(US$60,841,402), Rp.1,525.16 trillion (US$9,888,835), Rp.1,745.03 trillion (US$11,314,428), and
Rp.2,048.56 trillion (US$13,282,457), respectively. Gross income has increased tax revenues in the
construction sector in 2016-2019, amounting to Rp.57.08 billion (US$370,095), Rp.60.83 billion
(US$394,409), Rp.64.49 billion (US$418,140), and Rp.66.63 billion (US$432,015) respectively
(Directorate General of Taxation, 2019).
However, the increase has brought with it certain challenges, such as bribery, embezzlement,
and fraud that can occur at any stages of a construction project. Therefore, a strategy that focuses
on raising awareness that every illegal act can hinder the sustainability of development is needed
(Sohail and Cavill, 2008). This is because illegal acts are not only limited to the violation of the
law but also damage the morals, propriety, care, and prudence of the society (Sinaga et al., 2019).
It is clear that illegal acts in the construction sector led to improper income (Sinaga and Hermawan,
2021) as formulated in Article 4 paragraph (1) of Law Number 36 of 2008 concerning Income Tax
(UU PPh).
The fact that the challenges that occur in the construction sector are directly and indirectly
related to taxes can be seen, among others, in the court’s verdict on a fictitious project carried out
by five defendants in one of the State-Owned Enterprises construction companies, PT. WK, causing
state losses of Rp.202.29 billion (US$131,160). One of the methods used showed several companies
affiliated with several suspects as subcontractor companies undertake fictitious subcontractor work,
with the appointed fictitious subcontractor companies given a “flag borrowing” fee of 1.5%-2% of
the contract’s value (Ramadhan, 2020). In addition, various modes of fraud potentially occur in the
construction industry, such as bills for fictitious work units, fictitious vendors, replacing or lowering
the quality of materials, transferring lump-sum costs to material costs, tender collusion, personal
use of project equipment/equipment, and money laundering (Aprilliani, 2021).
The state must emphasise that the growth of tax revenue from the construction sector will
have a significant impact on the country’s economy and the state’s welfare (Setiawan and Erdogan,
2020). This would be in terms of energy absorption work, turning the supplier business wheel
related to the construction industry, and the income of construction workers. However, it must

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be realised that there are challenges in construction business activities that intersect with many
regulations, such as construction service, environmental, land, investment, labour, tax, and many
other regulations (Lature, 2018). Therefore, it is important to keep the construction sector running
in a healthy, growing, and sustainable manner by minimising every illegal act; this all comes down
to income, which is the object of income tax.
Based on this thought, this study seeks to answer two main problems. First, what are the
current income tax regulations in the construction industry in Indonesia? Second, what are the ideal
provisions for PPh on construction services in the future? The existence of these two questions can
explain the imposition of income tax (PPh) and produce a concept of income tax on construction
services based on development in Indonesia. Development growth will significantly increase the
rule of law so it can significantly increase the level of prevention and control of illegal income and
expenses (Hermawan and Sinaga, 2020).

METHODOLOGY
This study uses a qualitative approach that is expected to produce a reconstruction of income tax
provisions on construction services based on future sustainable development. The urgency of the
reconstruction is based on the need for a philosophical and juridical study to tackle violations
or crimes that are detrimental to state finances; this should be done through actions or processes
that rebuild, recreate, or reorganise existing legal constructions, to be used as a solution that
prioritises output and outcome (Gardner, 2009; Sinaga and Sinaga, 2018; Sinaga et al., 2020).
The reconstruction is in line with the efforts of the juridical study as prescriptive thinking to obtain
suggestions to overcome the problems posed in research, and evaluative, namely to assess the
programmes being implemented (Soekanto, 2010).
In aligning with the research objectives, this normative juridical method will start from the
inventory of statutory regulations, laws in concreto, legal principles, and legal comparisons by
examining library materials or secondary data in the form of primary, secondary, and tertiary
legal materials. Primary legal materials consist of binding legal materials in the form of laws and
regulations related to taxation. Secondary legal materials include the use of textbooks, legal expert
opinions, articles, seminar results, and research results in the field of law and taxation, while tertiary
legal materials are materials that support information on primary and secondary legal materials,
including newspapers, dictionaries, and encyclopedia (Soekanto and Mamudji, 2007).

INCOME TAX ON CONSTRUCTION SERVICES

Income related to construction services is an object of income tax, as stated in Article 4 paragraph
(1) of the Income Tax Law; this emphasises that the object of income tax is “any additional
economic capability received or obtained by taxpayers, both from Indonesia and from outside
Indonesia, which can be used for consumption or to increase the wealth of the Taxpayer concerned,

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in whatever name and form”. Then, Article 4 paragraph (2) of the Income Tax Law stipulates that
income in the form of a construction service business is an object of final income tax.
Subsequently, Government Regulation (GR) Number 40 of 2009 concerning Amendments to
GR Number 51 of 2008 concerning Income Tax on Income from Construction Services Business
was issued; this is an explanatory regulation, the implementation of which regulates the payment of
income tax on construction services (Tjahjono, 2015). On income received or obtained by domestic
taxpayers and permanent establishments (BUT) from businesses in the construction service sector,
final income tax will be imposed for taxpayers who meet the qualifications as small businesses
and the procurement value is a maximum of Rp.1 billion (US$6,483,801). Non-final income tax
relates to non-small business taxpayers and/or where procurement is greater than Rp.1 billion.
The income from construction services business in the form of final income tax will be subject
to final withholding tax at the time of payment of advances and terms, or subject to final tax by
self-payment of income tax payable at the time of receipt of advance and term payments. The
amount of income tax payable must be deducted by the service user or paid by the service provider
taxpayer, in accordance with GR Number 40 of 2009, is 4% of the gross amount. This is received
by the taxpayer providing construction planning services, 2% of the gross amount, received by the
taxpayer of the construction implementation service provider, or 4% of the gross amount received
by the taxpayer of the construction supervision service provider.
Article 10 letter (a) number 1 (b) GR Number 40 of 2009 regulates non-final income tax on
income from businesses in construction services that are:

a) income received or earned by domestic taxpayers, and BUT is subject to withholding tax based
on the provisions of Article 23 of the Income Tax Law by service users in the event that the
service user is a Government entity, domestic Corporate Tax Subject, BUT, or an individual
as a resident Taxpayer appointed by the Director-General of Taxes as the withholding of
Article 23 income tax at the time of payment of advances and terms;
b) imposed based on the provisions of Article 25 of the Income Tax Law in the event that the
income provider is another service user other than as referred to in (a).

The non-final income tax rates for construction service businesses in accordance with Article 3
of GR Number 51 of 2008 are:

• 4% for construction implementation carried out by service providers who do not have business
qualifications;
• 3% for construction implementation carried out by service providers other than that carried out
by service providers who have small business qualifications and service providers who do not
have business qualifications;

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• 4% for construction planning or construction supervision carried out by service providers who
have business qualifications; and
• 6% for construction planning or construction supervision carried out by service providers who
do not have business qualifications.

In the event that the service provider is a permanent establishment, the income tax rate referred
to above does not include income tax on the remaining profits of the permanent establishment after
the final income tax.

AGENCY RELATIONSHIPS OF THE CONSTRUCTION WORK

CONTRACTS IN THE INCOME TAX FRAMEWORK
As the entire contract document that regulates minimising the occurrence of tax avoidance and tax
evasion in the construction industry, the Construction Work Contract is important in understanding
the contractual relationship between the parties involved in the contract considering Article 46 and
Article 49 of Law Number 2 of 2017 concerning services. Construction (Construction Services
Law) stipulates that the working relationship between Service Users and Service Providers, as well
as between Service Providers and Service Sub-Providers, must be stated in the Construction Work
Contract. Furthermore, Article 1 point 8 of the Construction Services Law confirmed the legal
relationship between Service Users and Service Providers in the implementation of Construction
Services. The Construction Work Contract must at least include, clear identities of the parties, the job
formulation, the implementation, and maintenance period (which is the responsibility of the Service
Provider), equality of rights and obligations between the Service User and the Service Provider, the
obligation to employ certified construction workers, payment methods, default, dispute resolution,
contract termination, force majeure, building failure, worker protection, protection of third parties
(other than the parties and workers), environmental aspects, guarantees for risks that arise, and
legal responsibility to other parties in the implementation of Construction Works or as a result of
Building Failure, and construction dispute resolution options (Emirzon and Sinaga, 2021).
The arrangement of the Construction Work Contract implies that the scope of construction is
legally very broad; it contains the totality of legal problems that may arise from certain business fields
(Bailey, 2011), including engineering, economics, and taxation. This can be seen from construction
products that do not only produce building and infrastructure products, which are public goods
(such as roads, bridges, airports, ports, dams, and dams) as well as private goods (such as residential
houses, hotels, offices, condominiums, shopping malls, and factories), but also construction sector
products that become inputs for other sectors (Central Bureau of Statistics, 2020b), such as the
industrial sector (cement, roofing, aluminum, wood, and ceramics), the equipment sector -heavy
equipment, fuel oil sector, and technology sector. In addition to referring to the Construction Services
Law, contractual relationships in the construction industry must refer to tax provisions in terms of

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carrying out their tax rights and obligations. Article 4 of Law Number 16 of 2009 concerning
General Provisions and Tax Procedures to Become Law (UU KUP) states that taxpayers who have
fulfilled subjective requirements must fill out and submit the Tax Return correctly, completely,
clearly, and signed by the taxpayer or an attorney with a special power of attorney.
The existence of the obligation to make contracts in the construction industry shows that a good
contractual relationship cannot be separated from the implementation of agency theory. Agency
relationship problems often arise when the principal, who is the party that mandates the agent to
carry out all activities on behalf of the principal (Gardner, 2009), is unable to check whether the
agent has behaved appropriately or not. The existence of potential fraud in a construction company
shows that agency theory is appropriate to solve the problem of tax avoidance and tax evasion as the
Construction Work Contract will be evidence for each party. This is in line with Eisenhardt (1989)
and Adams (1994), who show that agency theory is very useful in knowing:

a. the wishes or goals of the conflicting principal and agent;

b. the occurrence of information asymmetry between principals and agents; and
c. how to examine external or internal factors of a particular community (business) that are
indeed very complex and generally hidden.

These contractual relationships and agency theory will be the main concerns to minimise
tax avoidance and tax evasion in the construction industry. They refer to certain things, such as
construction service revenues that do not exceed costs, fulfillment of the demand for construction
services, the fulfillment of financial resources in financing the project until the payment terms are
received from the customer, the fulfillment of a skilled workforce, and overhead costs that meet the
projected workload (Schaufelberger, 2009).

LITERATURE REVIEW OF INCOME TAX ON CONSTRUCTION

SERVICES IN INDONESIA
The total value of the global construction market, which is estimated to have reached a value of
US$3,200 billion per year (Rp.45,920), cannot be separated from fraud in several forms, such as
corruption, misappropriation of assets, tax irregularities, and bribery. The American Society of Civil
Engineers stated the amount of corruption in the construction industry in the world has reached the
range of US$340 billion per year (Rp.4,879 trillion).
The challenges of economic crime in the construction sector are quite significant and can
occur at any stage of a construction project (Sohail and Cavill, 2008). This is also true in the
Indonesian construction and real estate sectors; these sectors have a low tax ratio that was only
6.72% of Gross Domestic Product (GDP) in 2019. Therefore, appropriate policy changes are
needed, namely through changing the applicable tax rates in the final PPh regime or implementing
a general scheme in imposing PPh on income received by the construction sector (Wildan, 2020).

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The occurrence of tax fraud in the industrial sector must be of special concern to the government
in Indonesia considering the complexity has been very worrying; the fraudsters disguise income
with the intention of deceiving the state (Martin, 2011, Skalak et al., 2011), or carry out hidden
activities.
In the case of fraudulent invoices for fictitious work units, fictitious subcontractors, material
quality degradation, transfer of lump-sum costs to material costs, personal use of project equipment/
equipment, tender collusion, and money laundering, the Tax Authority must be able to implement
agency relationships on obligations in the construction contract; this should be done by requiring
all contractors to report and register their Construction Industry Scheme (CIS), including certain
financial databases, recordings, and bookkeeping, who must report tax returns (Sinaga, 2021). The
tax office must have a database of construction companies that have truly verified data, reports, and
information, such as companies, management, board of commissioners, shareholders, company
qualifications, and a list of certified labour workers (HM Revenue & Customs, 2014). It is necessary
to study the rules for withholding income tax on multi-storey construction services carried out
by the main contractor to subcontractors, namely the main contractor deducting income tax on
their payments at a higher rate to contractors/sub-contractors who are not registered with the Tax
Office (HM Revenue & Customs, 2014). The obligation to report this CIS can prevent fictitious
transactions, borrowing flags, fictitious vendors, and misuse of fees into personal interests, because
before a contractor can make payments to subcontractors for construction work, the contracting
company must verify with the tax office that the subcontractor is registered. Each month, the
contractor must send a complete list of all payments that the contractor has made under the scheme
to the tax office. The reporting or return of the list to the tax office includes details of subcontractors,
details of payments and any withholdings that have been made, statements on the status/progress of
work of all subcontractors, statements that all subcontractors have been verified (HM Revenue &
Customs, 2014). The tax office will then check whether the subcontractor is registered and notify
the contractor which tax withholding rate should be applied when the contractor makes payments
to the subcontractor (HM Revenue & Customs, 2014).
The existence of the rules of the CIS shows that there is a shared responsibility between
the people and the state so that taxes are fair; this can restore the functioning of the market and
produce a healthier construction industry (Doree, 2004). The CIS regulations are expected to be
one of the solutions in bridging the interests of state revenues in minimising economic crime in the
construction sector through increasing the role of taxes; this is because taxes (which are basically
non-discriminatory (Soemitro and Sugiharti, 2004)) must be able to realise voluntary compliance
to all taxpayers. The imposition of taxes on construction services meets the principles of equity,
certainty, convenience, and efficiency, with reference to a good taxation system that must be fair,
and collected according to the ability of the taxpayer to pay (Matarirano et al, 2019). Taxpayers
know about their tax compliance obligations, and the time and method of tax payment must be
the most conducive and not excessive. The principles of certainty and convenience are then fully

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related to compliance costs, while equity and efficiency require that compliance costs be ignored so
as not to violate the principles of a good tax system (Matarirano et al., 2019).
CIS obligations will be of key importance in presenting financial reporting consistently from
year to year, from project to project, and from month to month in each project. This is based on
the consideration that in order to report costs and profit projections consistently, the contractor
must at least have a reliable financial management system, especially with regard to cost control.
Holm (2019) suggested that construction project teams must follow several basic rules to have
an effective cost control system, that is cost reporting data must be timely and accurate. More
specifically, in terms of income tax rates on construction services, it is necessary to abolish
the imposition of final income tax rates for the entire construction industry in order to minimise
efforts to break up subcontractors into small category companies. Contractor’s bookkeeping must
be kept consistent and accurate during the multi-faceted construction process, relying heavily on
audits as an examination of the contractor’s financial accuracy. The basis for revenue recognition at
the contract stage is recorded by using a certain percentage of completion supported by evidence,
such as the results of an internal review related to the achievements of the project progress, or the
existence of independent party evidence (such as professional surveyors) about project uncertainty,
showing that it is impractical to assess the percentage of completion (Inland Revenue Authority of
Singapore, 2021).
The income recognition of contractor companies has been briefly explained in the Elucidation
of Article 4 of GR Number 47 of 1994 concerning Calculation of Taxable Income and Payment
of Income Tax in the Current Year; this is known as the percentage contract method or the
percentage of completion method and completed contract methods. The use of one of the two
income recognition methods will result in different amounts of income from year to year, and
differences in the calculation of the income tax payable for each tax year. The “percentage of
completion method” calculates the income tax payable every year on the basis of the income earned
periodically (proportionately) during the completion stage of the work, while the “completed
contract method” calculates the income tax payable when the work is completed, because income
is only recognised at the end of the year the work is completed. During the completion stage of the
work, no income tax is calculated. Furthermore, the Elucidation of Article 4 of GR Number 47 of
1994 confirms that the percentage of completion method is an accrual method commonly found in
construction companies or building contractors who work on projects that take several years, with
considerations:

a) equalising the tax burden in every tax year during the period of completion of the work that can
ease the burden on the taxpayer, because the tax payment in a tax year is in accordance with the
income obtained proportionally during the stage of completion of the work, and the tax burden
does not accumulate at the end of the year of completion of the work;

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b) obtain uniformity in income recognition for all taxpayers engaged in construction contractors
or building contractors; and
c) provide equal treatment for taxpayers engaged in the same business.

However, since GR Number 47 of 1994 has been revoked by GR Number 45 of 2019, the
obligation to use the percentage of completion method for long-term construction is not explicitly
regulated in laws or government regulations. In fact, many developed countries require the
implementation of the percentage of completion methods, such as the Inland Revenue Authority
of Singapore (2021) and the Internal Revenue Service of the United States (26 U.S. Code § 460
Special rules for long-term contracts). The use of the percentage of completion method for long-
term construction contracts will make it easier for the tax office to periodically recognise and
monitor revenues and expenses, not when the project is 100% complete.

CONCLUSIONS, IMPLICATIONS, AND LIMITATIONS OF THE RESEARCH

This study produces two conclusions. First, the current income tax regulations in the construction
industry in Indonesia, in which the imposition of income tax is final and non-final, could not
overcome the fraud that still occurs. The prevailing tax law can justify the financial fraud of certain
entities (such as the number of construction companies breaking up the contract value below Rp.1
billion (US$65,333,834), and the mode of making a “dummy construction company/subcontractor”
to legalise fictitious costs) by legalising the payment of income tax at very low rates (only 2% of the
contract revenue). These illegal acts will only harm sustainable development given the low quality
of buildings and/or mark-up on contract values and/or loss of state’s tax revenue. Second, the ideal
provisions for income tax to overcome the fraud on construction services must be done through
income tax law reforms. These must include the regulation of CIS obligations (rules that require the
reporting and registration of the CIS for all contractors and a database of the construction company
that has truly verified data, reports, and information). Also, there must be sanctions for each
violation, revocation of final income tax regulations on construction services, the obligation to use
the percentage of completion method in construction services whose project completion exceeds a
financial year, and the rules that apply the withholding of income tax on multi-level construction
services carried out by the main contractor to subcontractors. Hopefully, the implication of the
renewal of income tax regulations on construction services will tackle practices that can justify fraud
that are detrimental to state finances. This should be through increasing the voluntary compliance of
taxpayers, including carrying out tax rights and obligations in a complete, clear and correct manner
in the construction service sector.
This research is still limited to a normative juridical study. It is necessary to deepen the research
in the form of socio-legal research to find laws that live in the community/society that can improve
tax law compliance of construction sector taxpayers.

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BIOGRAPHY
Henry Dianto Pardamean Sinaga is an experienced tax researcher and auditor.
Currently, Henry is a PhD student in the law doctoral programme of Diponegoro
University, Semarang, Indonesia. Henry has completed three online courses organised
by the UN System Staff College from 2019-2021 related to Sustainable Development.

Yudha Pramana works as a tax auditor at the Ministry of Finance of the Republic of
Indonesia, and can also be credited with contributions to tax research and tax policy.
Yudha has a Master’s degree in accounting from the University of Udayana.

Anis Wahyu Hermawan works as a tax auditor at the Ministry of Finance of the
Republic of Indonesia, and can also be credited with contributions to tax research and
tax policy.

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