Indonesia’s New Negative Investment List.

 

18 June, 2016

 

 

Presidential Regulation No. 44 of 2016 regarding the List of Business Fields That Are Closed and Business Fields That Are Conditionally Open for Investment (May 18, 2016) (the “2016 Negative Investment List” or the “2016 DNI”) replaces the 2014 Negative Investment List or “2014 DNI,” and was made public on May 24, 2016. The 2016 Negative Investment List refers to business lines and code numbers set forth in the Indonesian Standard Industrial Classification of 2015 (the “KBLI”).

 

The 2016 Negative Investment List liberalizes some areas of foreign investment in Indonesia, including foreign investment from ASEAN countries. However, it is also true that the 2016 DNI does not contain the dramatic changes that had been anticipated by some members of the foreign investment community.

 

In this Legal Alert, we provide an overview of the 2016 Negative Investment List and a comparison of some of its provisions against the 2014 DNI. We also discuss some of the policy decisions of the Indonesian Capital Investment Coordinating Board (“BKPM”) under the prior Negative Investment List that may still be applied by the BKPM under the 2016 DNI.

 

I. Fundamental Principle of the DNI:

 

Pursuant to Article 3 and Article 1(2) of the 2016 Negative Investment List, business lines that are not listed in the attachments to the 2016 DNI are deemed 100 percent open for foreign investment. There is no change in this basic concept.

 

The 2016 Investment Negative List sets out that if a KBLI code number includes more than one business line, then a capital investment limitation stated in the 2016 Negative Investment List is applicable only to the business line that is expressly mentioned. For example, KBLI Code No. 70209 covers “other management consultancy businesses.” The 2016 DNI specifically refers to this KBLI code number and horticulture development consulting, which is limited to a maximum 30 percent foreign investment. That foreign capital investment limitation applies only to horticulture development consulting and not to other types of consulting businesses.

 

II. Grandfather Provisions

 

A. Basic Concept – Prior Investments Are Protected Against Future Changes: Similar to the 2014 Negative Investment List, the 2016 DNI provides grandfather protection for businesses whose capital investments were approved prior to the enactment of the 2016 Negative Investment List on May 18, 2016. The 2016 DNI is silent on what is meant by an approved capital investment. Thus, if an application has been filed and received a principle approval but no permanent license has been issued, which DNI will apply? The BKPM’s approach to this issue in the past was to apply a prior DNI to any application for which a principle approval had been given, which will also then be applicable to the later application for a permanent business license. If no principle approval had been issued, however, then the new DNI would be applied to a pending application. However, this approach does not necessarily mean that an investor that received a principle approval under the 2014 DNI cannot apply for more liberal treatment under the 2016 DNI. These and other issues are not explicitly addressed in the 2016 DNI and a different policy could be adopted by the BKPM.

 

B. Unwritten BKPM Policies on Grandfather Protection: There are also other situations governed by the unwritten policies of the BKPM, in which grandfather protection does not apply or conditionally applies. The situations below are based on our experience with the 2014 DNI and its predecessors. It is likely but not certain that the BKPM will continue such policies under the 2016 Negative Investment List.

 

1. Business Expansion by Adding New KBLI Code Number: If investors wish to add a new investment activity (i.e., one covered by a new KLBI code number) to an existing company, there are two consequences. First, the investors must increase their investment level by a minimum investment of Rp 10 billion for each new KBLI code number.1 Second, the maximum level of foreign investment could be affected. For example, under the 2016 Negative Investment List, the distribution business is open for foreign investment up to 67 percent. If PT X obtained a business license in 2008 for a distribution business with an approved foreign investment of 90 percent, then its approved foreign capital investment is protected under the grandfather clause. PT X will not be required to adjust its capital structure in accordance with the new DNI. However, if PT X were to expand its business by adding another business line, e.g., electronic trading transaction with an investment value less than Rp 100 billion, which has a maximum foreign investment level of 49 percent, then PT X would be required to reduce its foreign investment level to no more than 49 percent.

 

As another example, under the 2016 DNI, the foreign investment level is a maximum of 33 percent for the production of class A health equipment. If PT Z obtained a business license in early 2000 with an approved foreign investment of 90 percent, it will not be required to lower its foreign capital investment because it is grandfathered. However, if PT Z plans to also engage in the distribution business, which is open for foreign investment up to 67 percent, the BKPM will require PT Z to decrease its foreign capital investment to 67 percent to comply with the 2016 Negative Investment List.

 

2. Product Diversification: The addition of a new KBLI code number does not always trigger the termination of grandfather protection. The BKPM is of the view that an additional KBLI code number within the same general business field may be permitted and will not require a foreign investor to reduce its capital to a lower level required by the 2016 DNI. This may occur in the case of product diversification. To illustrate, PT Z is a company engaging in the business of perfume distribution, which is classified under KBLI Code No. 46494. PT Z obtained its business license from the BKPM in 2000 when distribution companies were permitted to have 100 percent foreign capital investment. PT Z plans to expand its distribution business by adding liquid shower soap, which is classified under the same five-digit KBLI code number as perfume distribution. As one would expect, the BKPM will not require PT Z to reduce its foreign capital investment to 67 percent. 

 

Product diversification without a change in the foreign investment level may also be achieved by adding a new KBLI code number. For example, PT A is a company engaging in distribution of batik cloth and falls under KBLI Code No. 46411. PT A obtained its business license in 2004 and was permitted to have foreign capital investment of 90 percent. To develop its business, PT A now plans to also distribute shoes and sandals for children. Distribution of clothing and footwear is classified respectively under KBLI Code No. 46411 and 46413. Since both KBLI code numbers are classified under the business group of the wholesale business of textiles, clothes and footwear and share common KBLI code numbers for the first three digits, the BKPM may not require PT A to comply with the current DNI limitation on foreign capital investment in distribution of 67 percent, since these code numbers are related and involve the same general business lines.

 

Product diversification raises a question about how related KBLI code numbers must be to avoid a reduction in foreign investment. For example, if a company distributes footwear, can it also distribute computer chips? The 2016 DNI does not address this issue and there is no absolute standard. The BKPM may have a different treatment for each product and business line. However, the greater the disparity in the products, and thus the KBLI numbers, the more likely the BKPM will apply the restrictions in the 2016 DNI.

 

3. Business Expansion by Increasing Production Capacity: In this situation, an existing company wishes to expand its production capacity. It is not adding a new line of business. While prior approval from the BKPM is required for an existing company to increase its production capacity beyond 30 percent, such a production capacity increase is unaffected by the DNI and no adjustment in foreign equity level is required.

 

For example, PT Y is a company engaging in the geothermal power plant business with a capacity of less than 10MW and has an approved foreign investment level of 90 percent. Under the 2016 DNI, such a geothermal power plant would only be approved if the foreign capital investment level was no more than 49 percent. PT Y would like to expand its business by increasing its production capacity by more than 30 percent. BKPM approval is required but PT Y will not be required to reduce its foreign capital investment to 49 percent. 

 

4. Total Change of Business: Where an existing company intends to change its business line entirely, then it will be required to comply with the 2016 Negative Investment List. For example, if PT X obtained its business license in 2008 for management consultancy with an approved foreign investment of 100 percent and now plans to engage only in the inland freight transportation business, it must comply with the 2016 Negative Investment List, which limits foreign capital investment in the new business line to a maximum of 49 percent.

 

5. Voluntary Decrease of Foreign Capital Investment: A foreign investor may reduce its capital investment in an Indonesian company by selling shares to a domestic investor. In that case, it cannot thereafter increase its capital investment, whether

the increase is to the original approved level before the enactment of the 2016 Negative Investment List or to a lower level allowed by the 2016 DNI if that level is higher than the foreign investor’s current investment level.

 

For example, PT X holds a business license for the construction and installation of high- voltage electrical utilization with an approved foreign investment of 90 percent. ABC Pte. Ltd., a Singaporean legal entity, owns 90 percent of the shares. The 2016 Negative Investment List sets forth a new maximum foreign capital limitation of 49 percent for the construction and installation of high-voltage electrical utilization business. If ABC Pte. Ltd. transfers some of its shares to an Indonesian shareholder, so that it holds less than 90 percent, it cannot later increase its foreign capital investment to its previously approved level or any other level greater than its then current level. However, we believe if ABC Pte. Ltd. reduces its capital investment in PT X by transferring its shares to a foreign entity or individual or to another Indonesian foreign capital investment company or a “PMA” company2, so that PT X’s total foreign shareholding composition is still 90 percent, ABC Pte. Ltd. can thereafter reacquire shares from the foreign transferees up to its original 90 percent. However, BKPM policy on this latter point is not clear. 

 

We emphasize that most of the above rules are unwritten and have been developed informally by the BKPM to address specific issues that have arisen over time. There is no assurance that the BKPM will continue such unwritten policies or change them. We have discussed these matters with BKPM officials. However, due to the fact the 2016 DNI was recently issued, the BKPM has yet to determine its policies. We understand the BKPM will be meeting internally over the next several weeks to determine these and other policies.

 

III. Policies Established by the 2016 DNI

 

A. Expansion to a New Area: Article 7(3) allows a PMA company located in one area to expand to another area without establishing a new business entity, provided it continues to comply with the Government’s spatial layout and environmental requirements. However, there was no legal requirement to establish a new company if the investors wanted to create an additional location for their existing business. BKPM approval is required to add an additional location and this does not appear to be changed by Article 7(3).

 

B. Investments Conducted Through the Capital Market or Indirectly: Article 8 of the 2016 DNI provides that business lines that are open with requirements under Article 2(2)(b) and Attachment III (i.e., among others, foreign investment limits) are considered open without such conditions if an investment is made indirectly or by portfolio trading on the Indonesian stock exchange. We believe the BKPM in effect treats such shares traded as domestic capital.

 

Article 8 presents some interesting issues that have not yet been resolved. Clearly, portfolio trading is freely permitted by Article 8, but it is not clear what is meant by investments that are “carried out indirectly.” The use of the word “or” suggests that indirect investments are to be distinguished from portfolio investments. However, it is possible that indirectly was meant to refer to portfolio trading as indirect, which the language “or by portfolio trading” was intended to clarify, and that the investment is considered indirect in the sense BKPM approval is not required. Future regulations or policy directives of the BKPM may make this clearer. 

 

Article 8 is also unclear in another respect given the BKPM’s prior policies. When PMA companies have gone public in the past and their articles of association still refer to the original foreign investor and the PMA companies continue to hold a BKPM approval, it has been the BKPM’s unwritten policy that such companies are still required to comply with all reporting, approval and licensing obligations under BKPM regulations. Thus, even though the PMA public company’s shares are treated as domestic capital, this is not true for the original foreign investor. Its shares continue to be subject to BKPM regulatory jurisdiction as foreign capital, even though they are also traded publicly and even though Article 8 clearly provides that the business line of such a public company is treated as an “Open Business Field,” meaning there are no restrictions to foreign investment. If that is the case, then why does the BKPM continue to assert regulatory jurisdiction over the public company?

 

This policy has several ramifications other than the obvious different treatment of foreign shareholders. First, if the publicly held PMA company wants to change its capital ownership which was last approved by the BKPM, the company must seek BKPM approval (it may also be subject to any new foreign capital investment limitations in the 2016 DNI, if other changes such as an additional line of business are requested). This is true even though that foreign investor could increase its shareholding by purchasing additional shares on the public market. The conclusion appears to be that, if the original foreign shareholder wanted to increase its ownership beyond the limitation in the 2016 DNI, it could not do so, even if a new foreign shareholder could. If the public company still has a PMA license, and the total foreign investment of both the original foreign shareholder and new foreign shareholder exceeds the DNI limit on foreign investment, is there a violation of the DNI? We do not believe this should be the result because the new foreign shareholders’ shares are treated as domestic capital. However, is that still true if the original foreign shareholder increases its shareholding over the 2016 DNI limit by purchasing public shares? If so, then those shares are not, in that case, treated as domestic capital. If such shares are treated as foreign capital in the hands of the original foreign shareholder, and therefore violate the DNI limit, is the same true if an affiliate of the original foreign shareholder purchases such shares? If a new foreign shareholder wants to purchase the shares of the original foreign shareholder, BKPM approval would apparently be required since there would be a change in the shareholder composition affecting the original foreign shareholder’s share ownership. Finally, if a new foreign shareholder purchases the new shares acquired by an original foreign shareholder, BKPM approval would apparently not be required.

 

As seen, the BKPM’s policy raises several difficult issues that hopefully will be clarified by further regulations.

 

One reason the BKPM may wish to retain regulatory jurisdiction over such a company is because the original foreign investor with a BKPM approval could assert it is entitled to foreign exchange repatriation guarantees in the event foreign exchange controls were adopted or the company were nationalized, benefits that are not available to other shareholders of public companies. The BKPM may need to know these possible claims on the country’s forex reserves. Perhaps this legitimate concern could be addressed by simply requiring the original foreign shareholder to report changes in its original shareholding to the BKPM. However, this is speculation on our part and this issue can best be clarified by BKPM regulations.

 

C. Special Economic Zones: Article 8(2) dispenses with DNI limitations for a company that is open for foreign investment but with requirements if the company is located in a special economic zone, as long as the business field is not reserved for micro, small and medium enterprises and cooperatives (koperasi).

 

D. Mergers, Acquisitions and Consolidations: Article 9 of the 2016 DNI lays out special requirements for mergers, acquisitions and consolidations:

 

(a)  in the case of a merger, the limitation on foreign ownership is that which is contained in the surviving company’s principle license or business license;

 

(b)  in the case of an acquisition, the relevant limit on foreign ownership is that in the principle license or business license of the acquired company; and 

 

(c) for a consolidation, the foreign capital limit is that which the 2016 DNI specifies for a new company.

 

The result of these rules is that the only company that needs to be concerned about 2016 DNI limits on foreign capital is the consolidated company, which is a new company. In the case of a merger or acquisition, the 2016 DNI will have no adverse effects on the foreign capital limits, but if the 2016 DNI is more advantageous than the limits contained in their business license, the foreign investor can apply for an increase (see Section F below).

 

This provision is identical to the 2014 DNI, except in the case of acquisitions. In the 2014 DNI, the foreign capital limit was that of the acquiring company. We believe such change was necessary to clarify that when an acquisition occurs, neither the acquiring company nor the acquired company needs to change their capital ownership.

 

By way of illustration, assuming PT X and PT A each hold business licenses for the distribution business from 2005. PT X has a permitted foreign capital investment of 90 percent while PT A has 80 percent. PT X acquires PT A and as a consequence PT A’s shareholders change. Pursuant to the 2016 Negative Investment List, the distribution business is open for foreign capital investment up to 67 percent. Under Article 9 of the 2016 DNI, PT A does not have to decrease its foreign capital investment to 67 percent or less and PT X may continue to hold 80 percent of PT A’s issued share capital.

 

E. Dilution: Article 10(1) of the 2016 DNI deals with the problem of a dilution of the local shareholder’s equity percentage. This occurs when additional capital is required and the domestic investor does not respond to the capital call. In that case the capital contribution made by the foreign shareholder could cause its shareholding percentage to exceed that permitted in the principle license or business license or the 2016 DNI.

 

In this situation the foreign investor is allowed to increase its percentage by subscribing to the newly issued shares, in accordance with its pre-emptive right under Law No. 40 of 2007 Regarding Limited Liability Companies (August 16, 2007) (the “Company Law”). The foreign shareholder’s ownership of such excess shares is limited to two years. At that time, the 

 

foreign shareholder must transfer the excess shares to a domestic shareholder. There are three methods to do so:

 

(i)  a transfer of shares directly to a domestic shareholder;

(ii)  a transfer of the excess shares through a public offering made on the Indonesian stock exchange; or

(iii)  the PMA company purchases the excess shares from the foreign shareholder and treats such excess shares as treasury stock, subject to Article 37 of the Company Law.

 

As an example of how Article 10 is applied, PT X engages in the geothermal power plant business with a capacity of less than 10MW. This is currently open for foreign investment up to 67 percent. PT X obtained its business license in 2015, which then allowed PT X to have an 80 percent foreign investment. A is the foreign shareholder holding 80 percent and B is the domestic shareholder holding 20 percent of the shares in PT X. PT X needs capital and wants to issue new shares. A wishes to subscribe to 80 percent of PT X’s new issued shares, but B does not want to subscribe to its preemptive right allotment.

 

PT X is required first to offer the new issued shares to A and B in proportion to their current capital ownership, i.e., 80 and 20 percent. Since B does not want to subscribe to the new issued shares, A, under Article 10 of the 2016 DNI, is permitted to subscribe to B’s allotment. This transaction is permitted, provided that A transfers its excess foreign capital to a domestic shareholder no later than two years after A subscribes to the new issued shares.

 

F. Advantageous Provisions: Article 13 provides that if the 2016 DNI has provisions that are more advantageous to the foreign investor than those it now has, it is entitled to the more advantageous provisions and can apply to the BKPM to obtain them.

 

G. Comparison Table: The table below is a comparison between the 2014 and 2016 Negative Investment Lists in relation to the foreign capital investment limitation on various business lines in Indonesia: 

 

 

 

 

 

 

 

 

 

1 With a three to one debt equity ratio, the equity portion of the investment can be Rp 2.5 billion. 

2 Article 1(3) of Law No. 25 of 2007 Regarding Capital Investment (April 27, 2007) defines foreign capital investment to include the subsidiaries of foreign capital investment companies. Thus, any Indonesian company owned in part or entirely by a PMA company is itself a PMA company and must register as such and is treated as a foreign company. This has long been consistent with BKPM regulations and policy. 

 

 

For further information, please contact:

 

Dyah Soewito, Partner, Soewito Suhardiman Eddymurthy Kardono

dyahsoewito@ssek.com

 

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