Accountability, Effectiveness, and Independence — Striking the Proper Balance

Tax Incentives and Transparency of NGOs in Indonesia

The International Journal
of Not-for-Profit Law

Volume 8, Issue 4, August 2006

By Pahala Nainggolan1

The Indonesian government’s draft tax law, now pending before parliament, includes a provision long sought by Indonesian nonprofit organizations: a tax incentive for donors. If the provision is approved, the impact on the Indonesian non-profit sector could be enormous – or it could be minimal. Which proves to be the case depends on whether nonprofit organizations adopt high standards of transparency and accountability.

This article provides a snapshot of the Indonesian Third Sector and some of the problems that bedevil it, examines current rules requiring transparency and accountability, summarizes the potential tax deduction, and finally explains what nonprofit organizations must do – and who must help them – if they are to enjoy the fruits of the possible change in law.

The Third Sector in Indonesia

At present, corporations cannot treat donations as expenses in calculating their tax. Under the Income Tax Law number 17/2000, the only expenditures treated as deductible are those directly related to the company’s efforts to gain, collect, and maintain its taxable revenue (article 9). Consequently, a company’s donations result in a taxable income that exceeds accounting income. Some companies, however, have gotten around this limitation by treating their grants as marketing expenses – specifically, investments to improve their images in the communities they serve. (For recipients, donations are nontaxable under article 4:3 so long as no business relationship or common ownership exists between donor and donee.)

Citizens make few donations in Indonesia, mostly for religious purposes or to alleviate the suffering caused by natural disasters.2 Why are individual donations so rare? For one thing, people in developing countries with more income feel obliged, first and foremost, to assist their relatives. For another thing, people are uncertain about the future, so they tend to save any surplus. In addition, individuals are allowed to deduct very few donations from their taxable income. Many observers believe that the potential of individual donations in Indonesia is huge; it is a matter of changing the behavior.

To date, most nonprofit funding has come from donor agencies, mostly international ones In Indonesia, as in some other countries, many nonprofit development and advocacy organizations have sprung into being based on the availability of funding rather than on the needs of the community. Existing organizations have similarly adjusted their missions to suit donors and, in some instances, undertaken operations without the needed skills or community support. One must question the sustainability and impact of such work.

Against this backdrop, financial sustainability remains a major problem. Legal Aid Offices (YLBHI) provide a case in point. In 2001, after decades of successfully helping marginalized people gain access to justice, the organization faced a major shortfall. Their longtime donors decided to discontinue funding, and YLBHI could not continue operating its 23 offices across Indonesia.

Thousands of NGOs may find themselves in the same situation. Programmatic sustainability depends on financial sustainability.

Transparency and Accountability Requirements

Indonesian law requires significant transparency and accountability. Foundation Law No. 16/2001, and its amendment, Law No. 28/2004, state that a foundation must make its annual report available for public access. The report should disclose what the organization does and how it manages its resources as reflected in its finance report. The finance report must meet what is known as Standard of Financial Accounting No. 45, the Indonesian Accounting Standard Reporting for Non-Profit Organizations. Those organizations whose annual income, from government or any other sources, exceeds Rp. 500,000,000 (five hundred million rupiah) must publish their audited financial reports in local newspapers. Finally, Article 78 requires foundations that receive public funds to provide public access to their annual reports covering the past ten years.

In practice, unfortunately, few nonprofit organizations heed these rules, and enforcement is exceedingly weak. Results from the ongoing TANGO3 (Transparency and Accountability of NGO) program confirm the situation. It finds the three major problems confronting Indonesian nonprofit organizations to be financial, programmatic, and legitimacy. The financial element consists of generating, auditing, and publishing a financial report that meets the applicable accounting standard, as well as measuring the effectiveness of fundraising efforts. Programmatic elements include applying a logical, impact-focused approach to designing, managing, and evaluating programs. Legitimacy, finally, concerns the organization’s stakeholders, their access to its programs, and their assessment of them.

All of these problems are interrelated. What they have in common is transparency and accountability. The TANGO program’s tentative conclusion is that many organizations are willing to be more transparent and accountable but lack the technical knowledge to do so.

The Proposed Tax Deduction

The government recently presented the revised draft Tax Law to parliament. Parliament is expected to act on the proposal later in 2006, and the law will take effect in early 2007. In its current form, the bill would make corporate donations to nonprofit organizations for “social development” deductible. By treating the donations as deductible expenses, corporate taxpayers will no longer have to pay the current 30 percent income tax on those amounts. Although the law does not define “social development,” the phrase refers to development of the social infrastructure in the taxpayer’s community, complementary to the work of the government. If the law is adopted, regulations would clarify such details as mechanisms and procedures, the parameters of the beneficiary sector, and the category of eligible organizations.

An Opportunity and a Challenge

The tax proposal represents an important opportunity for Indonesian nonprofit organizations, but a significant challenge as well. The opportunity – new sources of funding that will help promote sustainability – hinges on the two factors noted earlier, transparency and accountability.

From the government’s point of view, tax-deductible donations are in part government funds. The deductibility provision would diminish overall tax revenues. If it is enacted, the government, reasonably, will want to ensure that the social benefit outweighs the cost.

If nonprofit organizations cannot responsibly and accountably handle tax-deductible donations, they will lose this source of funding – or, indeed, never enjoy it at all. The draft law leaves a great deal of room for interpretation through regulation. Authorities could create a government institution and make it the sole repository of deductible donations. The problems of today’s nonprofit organizations in Indonesia would remain unchanged.

What can be done to help foster accountability and transparency, in a gradual and realistic fashion – not only to receive the benefits of the tax deduction, but to expand nonprofit activities and increase their effectiveness overall? Three steps would help significantly.

First, nonprofit organizations need technical tools. One such tool is accounting software that is easy to use, low-priced, and complies with Standard of Financial Accounting No. 45. Most accounting software now available is designed for corporations and their needs, so it is ill-suited to nonprofit organizations.

Second, nonprofit organizations need to use accountability as a selling point. A 2002 study found that one reason that people do not donate to NGOs is uncertainty about what the organizations do with the money.4 To address this problem, an organization should generate a financial report (perhaps with the new software); get it audited, ideally by an accounting firm working pro bono; and then assure potential donors that it will use their funds capably and effectively. This will expand the Third Sector’s access both to individual donations and to public funds, including the proposed tax incentive.

Third, nonprofit organizations must address their programmatic shortcomings. They should learn the needs of the community and then target those needs. Doing so will require information as well as money. NGOs must master the issues, the experiences of other organizations in addressing similar problems, the best practices in the field, and the pertinent scholarship. Advocacy NGOs need to understand the rudiments of marketing management and persuasion as well.

Who should lead the way? As the major funders at present, donor agencies are the logical actors. Grants must foster capacity building on the part of nonprofit organizations, including purchasing software, hiring auditors if necessary, training managers and others, and acquiring deeper technical knowledge of the social problems they address.

Results will not come overnight. They will require donor agencies to adopt integrated, well-planned, long-term programs. But the results – an expanded, vibrant, sustainable Third Sector – will be well worth the wait.


1 Pahala Nainggolan is a Doctoral student of Management Science at the Graduate School of Economics-University of Indonesia, the former Finance Director of the grantmaking Tifa Foundation, still active in capacity-building programs for NGOs run by Tifa, and the author of several books and many articles. He gratefully acknowledges Ari and Basil at Tifa Foundation for sharing lessons learned, data, and ideas during the preparation of this article.

2 Leon, Patricia, Four Pillars of Financial Sustainability, The Nature Conservancy, 2001.

3 The TANGO program, run by the Tifa Foundation, aims to strengthen NGOs through capacity-building activities. At the beginning, participants undertake a self-assessment with the help of independent facilitators. The assessment measures six elements. The program then helps the organization strengthen the weakest of these elements through training, mentoring, and field visits. This has been applied to 190 NGOs in eight provinces, and the results show that financial, programmatic, and legitimacy problems tend to be the most serious. For details of the TANGO program, contact or

4 Saidi, Zaim, Sumbangan Sosial Perusahaan, Piramedia, 2003.