Foreign Investment in Indonesia: Legal Framework and Challenges

Indonesia, as Southeast Asia's largest economy, continues to attract significant foreign direct investment (FDI) thanks to its strategic location, vast resources, and growing consumer market. However, establishing foreign investment companies in Indonesia can be challenging, primarily due to the country’s complex legal framework, bureaucratic hurdles, and evolving regulations. While the government has made efforts to streamline the investment process, foreign investors still face significant legal and operational obstacles.

The Legal Framework for Foreign Investment in Indonesia

Foreign investment in Indonesia is regulated by a combination of laws, regulations, and decrees that govern everything from business structures to ownership rights. The primary laws regulating foreign investment are the Investment Law (Law No. 25/2007) and List of Business Fields with Certain Requirements as regulated in Presidential Regulation Number 49 of 2021 concerning Amendments to Presidential Regulation Number 10 of 2021 concerning Investment Business Sectors. Other regulations regarding investment that need attention are Government Regulation Number 5 of 2021 concerning the Implementation of Risk-Based Business Licensing, and Investment Coordinating Board Regulation No. 4 of 2021 concerning Guidelines and Procedures for Risk-based Business Licensing Services and Investment Facilities.

The Investment Law serves as the cornerstone of Indonesia’s investment framework, aiming to attract foreign capital by offering various incentives such as tax holidays, reduced import duties, and other benefits for priority sectors. However, it’s important to note that the List of Business Sectors with Certain Requirements imposes restrictions on foreign ownership in certain sectors, such as Domestic Sea Transportation 49% (forty-nine percent) and Courier Activities at 49% (forty-nine percent), for further details can be found in Appendix III of Presidential Decree No. 49/2021.

The government has periodically updated these laws, reflecting Indonesia’s attempts to balance the need for foreign capital with protecting local industries. In 2020, the Job Creation Law as stipulated in Law Number 6 of 2023 concerning the Determination of Government Regulations in Lieu of Law Number 2 of 2022 concerning Job Creation into Law was enacted to simplify business regulations, reduce bureaucracy, and make the investment climate more competitive. This law aims to create a more business-friendly environment by eliminating some of the more burdensome regulations that previously stymied foreign investment, such as strict labor laws and licensing procedures. However, despite these improvements, the implementation of these changes has been slow and uneven across regions, creating a degree of uncertainty for foreign investors.

Establishing a Foreign Investment Company in Indonesia

To establish a foreign investment company in Indonesia, investors typically opt for a PT PMA (Penanaman Modal Asing), a limited liability company specifically designed for foreign investment. A PT PMA allows foreign investors to operate fully within Indonesia, and it can engage in a wide range of business activities, provided they comply with the ownership and sector-specific restrictions set out by the government.

The process of establishing a PT PMA is relatively straightforward in theory but can be time-consuming and complex in practice. It involves several steps, including:

1. Setting up a legal entity: Investors must register their company with the Ministry of Law and Human Rights, obtain a tax identification number (NPWP), and secure the necessary business licenses and permits from relevant local authorities.
2. Complying with local content regulations: Investors must ensure that their business complies with local content requirements, which are increasingly enforced in sectors such as manufacturing, construction, and technology.
3. Hiring local staff: For many businesses, hiring local employees is a necessity to meet local labor regulations, and in some cases, investors may be required to prioritize local workers over expatriates.

Challenges in Establishing Foreign Investment Companies

While the legal framework in Indonesia has evolved to encourage foreign investment, numerous challenges persist in the process of establishing and operating a foreign investment company.

1. Bureaucratic Red Tape and Delays

One of the most significant challenges for foreign investors in Indonesia is navigating the bureaucratic maze. The application process for permits, licenses, and approvals often involves multiple government agencies and can take months. Despite efforts to streamline processes under the Job Creation Law, local authorities and ministries still operate with different standards, leading to delays, inconsistent implementation, and a lack of transparency.

2. Ownership Restrictions

The List of Business Sectors with Specific Requirements fields imposes restrictions on foreign ownership in many sectors, which makes it difficult for investors to fully control their business. In some industries, foreign ownership is limited to just 49%, which means investors should look for local partners who may not have the same expertise or commitment. This cooperation often creates conflicts of interest, mismatch of business objectives, and potential legal disputes.

3. Complex Taxation and Labor Laws

Indonesia's tax system is another hurdle for foreign investors. The country has relatively high tax rates compared to other ASEAN nations, and foreign investors often find themselves subject to taxes on both profits and dividends. Additionally, labor laws are complicated and rigid, with extensive regulations on wages, benefits, and terminations. For example, Indonesia’s labor laws require severance payments even for workers who are dismissed for legitimate reasons, which can be a financial burden for businesses.

4. Legal Protections and Dispute Resolution

Legal protections for foreign investors in Indonesia are not always as robust as in more developed markets. Dispute resolution mechanisms can be slow and costly, and the judicial system is often criticized for inefficiency and inconsistency. Foreign investors can face challenges when enforcing contracts or resolving disputes with local partners or government authorities, particularly in areas where the rule of law is weaker.

5. Corruption and Governance Issues

Corruption remains a concern in Indonesia, with reports of bribery and improper practices affecting businesses in various sectors. While the government has made strides to combat corruption, it remains an issue that can complicate the process of starting and operating a business, particularly in dealing with local authorities or securing permits.

Conclusion

Establishing and operating a foreign investment company in Indonesia presents both significant opportunities and challenges. While the legal framework has become more investor-friendly in recent years, navigating the complexities of the investment landscape requires careful planning and local expertise. Understanding the regulatory environment, addressing ownership restrictions, and managing bureaucratic hurdles are essential to successfully doing business in Indonesia. Foreign investors who approach the market with patience, diligence, and the right local partnerships can unlock the potential of one of Southeast Asia's most dynamic economies.

How Suria Nataadmadja & Associates Can Assist

At Suria Nataadmadja & Associates, we specialize in guiding foreign investors through the complexities of Indonesia’s legal framework. With our deep understanding of Indonesian corporate law, we provide comprehensive legal services to help foreign companies establish and operate successfully in the country. Our services include:

1. Business Entity Formation: We assist foreign investors in establishing PT PMA companies, ensuring compliance with Indonesia’s foreign investment laws. Our team will guide you through the entire process, from establishment of your company and obtaining the necessary permits and licenses.
2. Navigating Ownership Restrictions: We help foreign investors understand and navigate the List of Business Sectors with Specific Requirement fields and provide advice on how to structure joint ventures and partnerships with local businesses. By carefully drafting contracts and agreements, we aim to reduce potential conflicts and protect your interests.
3. Regulatory Compliance: We provide expert advice on navigating Indonesia’s tax, investment laws and labor laws, ensuring that your business stays compliant with local regulations. Our team can also assist with addressing labor issues, and handling dispute resolution.
4. Legal Representation and Dispute Resolution: In the event of legal disputes or issues with local partners, we provide representation and assist in resolving conflicts through negotiation, mediation, or litigation. We work to protect your rights and ensure that your business interests are safeguarded.
5. Ongoing Legal Support: As your business grows in Indonesia, we offer continuous legal support to help you stay compliant with evolving laws and regulations. Our team provides updates on changes to the legal landscape and advises on any new compliance requirements.