Transition from EOR to legal entity in Indonesia


Many foreign businesses opt for an Employer-of-Record (EOR) to streamline their expansion into Indonesia. The Employer-of-Record (EOR) such as MAM Corporate Solutions facilitates foreign businesses to swiftly penetrate the Indonesian market and remain compliant with Indonesian payroll and tax regulations without having to establish any legal entity. Throughout the period in which employees are engaged through the EOR in Indonesia, foreign businesses can circumvent concerns pertaining to human resources and payroll. However, this dynamic undergoes a shift when businesses decide to Transition from EOR to legal entity in Indonesia.

Once the foreign business has fully established its operations in Indonesia, most businesses then decide to transition from EOR to legal entity in Indonesia. The employees hired through the EOR must then undergo a transition to become part of the newly established legal entity in Indonesia. Navigating this transition from EOR to legal entity in Indonesia poses a pertinent question for businesses: How can this transition be effectively carried out?

Key reasons for the transition from EOR to legal entity in Indonesia

Businesses decide to transition from EOR to legal entity in Indonesia in the form of Foreign Investment Company (PT PMA) for various reasons. The most prevalent motives include:

Increase in the number of employees!

Foreign businesses must pay monthly fee to the Employer-of-Record (EOR) to carry out the payroll and tax compliance. However, as the number of employees increase in Indonesia, it renders the use of EOR more costly compared to incorporating and hiring the employees through own legal entity in Indonesia.

Time constraints on EOR arrangements

In certain countries, there are regulations in place that indirectly put a limit on the total period employees can be hired through EOR for. For instance, in Indonesia, there are two different types of employment agreements: Fixed-term (PKWT) and Indefinite (PKWTT). Foreigners can only be hired on the fixed-term (PKWT) contracts and the maximum total time allowed for fixed-term (PKWT) contracts is 5 years. This means foreign businesses cannot hire expats through EOR for more than 5 years. After 5 years, businesses in Indonesia must decide to either terminate the expats or transition from EOR to legal entity in Indonesia and continue with direct hiring.

Key reasons for transition to legal entity

Mitigating permanent establishment risk

Utilizing an Employer-of-Record (EOR) in Indonesia doesn’t shield foreign businesses from tax liabilities and legal repercussions associated with permanent establishment. To prevent tax liabilities affecting the foreign entity’s total corporate income, foreign businesses must at some point in time decide to transition from EOR to legal entity in Indonesia where revenue is generated.

Access to greater business opportunities in Indonesia

In many cases, local Indonesian customers prefer to do business with companies that have legal presence and local bank accounts in Indonesia. Establishing a business in Indonesia not only fosters increased trust among local customers but also shields the customers and businesses from foreign exchange risks. Furthermore, this incorporation opens the avenue for the businesses to actively participate in tender bids, unlocking valuable opportunities for growth and development.

Key considerations before transition from EOR to legal entity in Indonesia

  1. Gain a comprehensive understanding of corporate tax requirements and proceed to register with the relevant local corporate tax authorities.
    • Note that, in certain instances, registration may entail the submission of a financial report.
    • Ensure that all filings adhere to local Generally Accepted Accounting Principles (GAAP) and consider utilizing a designated accounting platform for the process.
    • Familiarize yourself with and leverage local tax incentives, such as those pertaining to research and development credits.
  2. Thoroughly document intra-group financing activities to mitigate risks associated with non-compliance with related rules.
    • Failure to adhere to intra-group financing regulations can result in consequences like interest-deduction denials, tax leakage, and potential reviews by tax authorities.
  3. Conduct a meticulous transfer pricing assessment.
    • Define transfer pricing arrangements and benchmarked pricing to guarantee the integrity of arm’s-length transactions and undertakings.
    • Prepare comprehensive transfer pricing documentation, incorporating necessary intercompany agreements.
  4. Develop an understanding of local indirect tax (VAT/GST) requirements and proceed with registration with the respective local indirect tax authorities.
    • Be mindful that requirements may vary depending on factors such as country, business activities (e.g., business-to-business or business-to-consumer), service location, and others.
    • In specific cases, such as within the EU, an existing registration in another state may be deemed sufficient.
    • Consider engaging a third-party tax agent to fulfil VAT (PPN) obligations, maximizing the potential for indirect tax recovery.

Before transition from EOR to legal entity in Indonesia

Assess the cost of compliance

  1. Tax Compliance: Assessing the cost of tax compliance is crucial, covering aspects like income tax, value-added tax (VAT), and other relevant taxes in Indonesia. Indonesia operates a system of various withholding taxes such as Article 21, Article 23 and Article 4(2). Understanding these tax articles and requirements is crucial to ensure businesses allocate resources appropriately.
  2. Payroll Compliance: Evaluating the costs associated with adhering to payroll regulations, including tax on salaries of employees (Article 21) and mandatory social security contributions such as BPJS Health and BPJS Manpower (BPJS Kesehatan and BPJS Ketenagakerjaan) is essential for financial planning and regulatory adherence.
  3. Corporate Tax Filings: Determining the expenses linked to annual corporate tax filings, which may involve preparation of annual reports, financial statements, and other documentation, is fundamental in budgeting for compliance activities.
  4. Investment Report (LKPM) Filings: In Indonesia, all foreign investment companies must submit an Investment Report (LKPM) to the Indonesian Investment Board (BKPM). Understanding the costs associated with investment report filings helps businesses gauge the financial implications of regulatory reporting requirement.

Physical office requirement

Virtual Office vs. Physical Office: In Indonesia, majority of the business activities are allowed to use Virtual Office however there are certain business activities that must use an actual physical office space. Understanding the regulations around the use of virtual offices and the necessity of a physical office space is vital. Compliance with these requirements can impact the choice between a virtual office, Virtual office is often chosen for cost-effectiveness however it may be mandatory in certain business sectors to use a physical office.

Before Transition to Legal Entity

Corporate tax filings and resident director requirement

  1. Role of Resident Director in Indonesia: Recognizing the significance of having a resident director with a local Indonesian tax ID (NPWP) for corporate tax filings is crucial. This entails understanding the regulations and ensuring compliance by appointing a director who will be physically present in Indonesia.
  2. Work Permit (KITAS) Requirements: Acknowledging the link between having a resident director and the work permit (KITAS) requirement for foreign directors is important. This includes understanding the application process and associated fees for obtaining the necessary work permit (KITAS).

Staffing considerations

Before establishing an entity, businesses should evaluate their ability to hire and manage tax and payroll staff. This is particularly relevant during the transition from Employer of Record (EOR) to a legal entity. Alternatively, outsourcing payroll services to a consulting firm can be a strategic option, ensuring compliance without the need for in-house staffing. Informing the current employees under the Employer of Record (EOR) about the impending shift from EOR to a different legal entity is of utmost importance. This will allow the employees ample time for consultations regarding the impending changes due to change in Employer.

These considerations collectively contribute to a comprehensive pre-establishment strategy for foreign businesses venturing into Indonesia, aligning with regulatory requirements, and optimizing operational efficiency.

Checklist for the transition from EOR to legal entity in Indonesia

Existing contracts & service agreements

  • Understand the terms of the existing Employer-of-Record (EOR) service agreement and the mandatory notice period required for the termination of this agreement.
  • Understand the existing employment agreement of the employees under EOR as well. It is crucial to understand the terms and conditions of these agreements to ensure smooth transition from EOR to legal entity without breaching any clause or deadline.

Draft and finalize new employment contracts

  • When transitioning employees from an EOR, it is imperative to ensure that new contract terms and entitlements align with or surpass the terms of the previous contract with the existing EOR provider. Businesses should also ensure that in the new employment agreements they recognize the previous working period of the employees to ensure their full experience counts towards there career growth.
  • In Indonesia, all the local contracts must be either be prepared in Local Indonesian Language (Bahasa Indonesia) or if preferred in dual language (English and Bahasa Indonesia). Businesses should ensure that they follow the local regulations related to new contracts.
  • Businesses should take services of a local legal and HR consultant to draft the new employment agreements for the employees to ensure comprehensive protection for the employer.

Understand and arrange for statutory benefits

In Indonesia, when employees are terminated, they are eligible for several statutory benefits depending on the type of employment contract and working period. These benefits include severance payments, long-service pay, compensation and any leave encashments. Providing these local benefits can be costly, and it’s essential to work with a third-party expert to comprehend options and budgeting considerations.

Checklist for transition to legal entity

Organize locally appropriate supplementary (non-statutory) benefits

  • Transferred employees should receive equivalent or enhanced supplementary benefits compared to those provided by the EOR provider.
  • Competitive local employment necessitates tailoring supplementary benefits based on country, region, industry, and job role, often requiring third-party assistance

Understand and adhere to local rules related to data protection and personal information

  • Many countries mandate employee consent before obtaining and retaining various types of personal information.
  • Background checks may need restrictions, excluding certain types of information.
  • Transferring personal data across borders may have additional restrictions and registration requirements

Develop and disseminate local HR policies

  • Tailor policies for each country to comply with local regulations and customs, ensuring alignment with organization-wide HR policies.
  • Local policies commonly cover remote work, expatriate employees, incentives for high-performing employees, promotion of organizational values, and more

Obtain work permit sponsorship (if applicable)

  • Organizations with a legal presence typically need to secure work permits and visas for non-local nationals.
  • In the rare case of transferring an expat from the EOR to the new legal entity, be aware that expats can only work in Indonesia if they have a valid work permit. Obtaining a new work permit sponsored by the new entity also has certain requirements such as minimum number of local employees and a local bank account.

Review existing salaries (optional)

  • Consider conducting a compensation benchmarking exercise to retain transitioning employees and attract new talent under the new entity.
  • Avoid planning compensation reductions, as this may be unacceptable under local regulations and is generally considered bad practice

How MAM Corporate Solutions can assist

Whether you’re seeking EOR services or considering a transition from EOR to a legal entity in Indonesia, MAM Corporate Solutions stands as your all-encompassing service partner. The distinctive advantage? There’s no need to navigate between different service providers. MAM Corporate Solutions ensures a seamless transition from EOR to a legal entity. Ready to streamline your business operations? Contact us here or fill out the form below to reach out to us.

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    Thanks to the efforts of the MAM Corporate Solutions team, we can now sell our products under the banner of the incorporated company. We appreciate how the MAM Corporate Solutions’ team is responsive and informative. The team’s best asset is their consistent communication.

    Damara Tiyas
    Chief Operating Officer, New Santara Global