Prakas No. 518 “The Implementation of Withholding Tax on Dividend Distributions” (“Prakas 518”) was issued by the Ministry of Economy and Finance in Cambodia (“MEF”) on the 5th of this month and provides much needed clarity and guidance on the application of the withholding tax (“WHT”) regulations to dividend distributions from a resident taxpayer in Cambodia to their non-resident shareholders.
Prakas 518 makes reference to the amended definition of “dividend” in Article 26(1) and 33 of the Law on Taxation (“LOT”) as follows:
The term “dividend” means any distribution of money or property that a legal person distributes to a shareholder with respect to the shareholder’s equity interest in such legal person, with the exception of capital or corporation/equity distributions in the period of liquidation of the company. Whether or not a distribution is a dividend shall be determined under the preceding condition without regard to whether or not the legal person has net income in the current year or from the previous year.
As described in Articles 26 and 33 of the LOT, a dividend that is distributed from a resident taxpayer to a non-resident taxpayer will be subject to a 14% WHT on the amount paid.
Conversion of Retained Earnings to Equity
The salient point of Prakas 518 is the affirmation by the MEF (contained in Article 6 of Prakas 518) that a conversion (in whole or in part) of retained earnings into capital or equity will not be considered as a dividend distribution and therefore not subject to WHT.
Article 6 goes on to state that a conversion of retained earnings to capital or equity should be properly documented and approved by the regulatory bodies in Cambodia. This would typically involve documenting a shareholder resolution from the Board of Directors attesting to the conversion and obtaining of approval from the Ministry of Commerce to amend the Articles of Incorporation reflecting the increase in capital. The General Department of Taxation must also be notified of the conversion within 15 days from the date of the Ministry of Commerce’s approval.
Article 7 of Prakas 518 notably provides that if a company; transfer shares or distribute equity or capital back to its non-resident shareholders (either via a capital reduction or liquidation), when this capital originates from a conversion of retained earnings to capital, the 14% WHT will apply at this time.
The importance and timeliness of this Prakas cannot be overstated given the persistent uncertainty and concerns previously felt by certain sectors of the taxpaying community surrounding both the definition of ‘dividend’ under the LOT, and the timing of WHT.
As noted above, this uncertainty was not helped by the recent amendment to the definition of ‘dividend’ in the LOT (under the 2017 Law on Financial Management) which removed the reference to a stock dividend as one excluded for tax purposes. Stock dividends are permitted in general under Article 159 of the Law on Commercial Enterprises (“LCE”) which states: “A company may pay a dividend by issuing shares of the company…..”
Nonetheless, in the wake of Prakas 159, due care must be taken on how a company deals with a conversion of retained earnings to capital. While stock dividends can indeed be issued from other sources, they are usually issued from retained earnings. Consequently, a conversion of retained earnings to capital and the issuing of a stock dividend are substantively very similar. However, for the purpose of reducing WHT exposure at the time of conversion, careful use of terminology needs to be adhered to. The issuing of stock dividends, while very similar in substance to a conversion of retained earnings to capital, could be treated differently by the tax authorities depending on what source of funding is used to issue them.
The rationale as to why WHT should not apply to a conversion of retained earnings to capital is that, in practical terms, the conversion does not constitute a taxable distribution from a company to its non-resident shareholders. In theory, therefore, there has been no transfer of economic value. While the non-resident shareholder’s equity will increase due to the conversion, the underlying cash consideration and economic value remains within the business to be used for company expansion or other purposes.
The current LOT definition of a dividend expressly contemplates a “distribution of money or property” based on a shareholder’s equitable interest in the underlying company. Company shares represent a claim on the company’s assets and earnings by the shareholder. As noted above, a conversion of retained earnings to capital does not represent a distribution of money or property from the company. Instead it allows money and property to remain in the company, and simply increases the shareholders’ claim on the company’s assets and earnings by increasing their equity.
Under Article 7 of Prakas 518, in the event of a conversion of retained earnings to capital which increases the shares held by non-resident shareholders, the 14% WHT is merely suspended until the affected shares are transferred or paid back to the non-resident shareholder via a capital reduction or company liquidation. The company that issued the shares is responsible, as a withholding tax agent under the LOT, to pay the WHT to the tax authorities on the 20th of the month after such an event.
Worth noting further is that, under the revised definition of ‘dividend’ in the LOT, the tax authorities can now deem a distribution to shareholders as a dividend, even if they have no current or historical retained earnings.
If you need any assistance with a conversion of retained earnings to capital or dealing with your tax obligations please contact us.
The DFDL Banking and Finance and Tax teams are always on hand to assist you in answering any questions that you may have on this and other regulatory matters of concern.
DFDL Contact :
Cambodia Head of Tax
Head of Banking and Finance
Tax services required to be undertaken by a licensed tax agent in Cambodia are provided by Mekong Tax Services Co., Ltd, a member of DFDL and licensed as a Cambodian tax agent under license number – TA201701018