The Law on Financial Management for 2016 (“the Law”) has been slated to come into effect late this month and, based on its current content, will include a number of significant tax implications which we highlight below.
The Law on Financial Management for 2016 (“the Law”) will come into effect late this month. Based on its current content, the Law will include a number of significant tax implications which we highlight below.
Estimated Tax Regime
As it currently reads the Law will amend Article 4 of the Law on Taxation (Royal Kram No. NS/RKM/0297/03 1997) and in doing so mark the end of the so-called Estimated Tax Regime (“ETR”). Under the ETR, taxpayers were able to negotiate their annual tax liabilities upfront with the General Department of Taxation (“GDT”). With the scheduled elimination of the ETR by 2016 there will remain one tax regime – the Real Regime of Taxation (“RRT”).
The Law divides taxpayers in the new RRT as follows:
- Small taxpayers: Enterprises that have annual turnover from Khmer Riel (“KHR”) 250 million (USD62.5k) to KHR700 million (USD175k);
- Medium taxpayers: Enterprises that have annual turnover from KHR700 million (USD175k) to KHR2,000 million (USD500k) or that have been registered as a legal person;
- Large taxpayers: Enterprises that have annual turnover over KH2,000 million (USD500k) or that have registered as a Qualified Investment Project (“QIP”) as approved by the Council for the Development of Cambodia..
Further details about the three types of RRT as outlined above will be determined by a separate regulation to be issued by the Ministry of Economy and Finance (“MoEF”).
The Law also introduces additional guidelines for taxpayers in the revised RRT as follows:
- Income and expenses to be recognized on an accrual basis for medium and large RRT taxpayers.
- Tax deductions for related party transactions to be allowed only when the applicable expenses have been settled/paid.
- Banks and licensed financial institutions will be permitted to make doubtful debt provisions with respect to the determination of taxable profit. (The rules and procedures for the provisions to be decided by a separate Prakas).
- Small RRT’s, as defined above, will be able to follow a simplified accounting basis, (to be determined by a separate Prakas), meanwhile Medium and Large RRT’s will need to follow Cambodian International Financial Reporting Standards (noting that Cambodia has fully adopted IFRS).
The Law also proposes changes to the annual fees currently paid by enterprises with respect to Patent Tax (payable on each business activity that a taxpayer carries out). Currently the official government fee for Patent Tax is USD285. Under the Law, Patent Tax will be aligned in accordance with the new classes of RRT as follows:
- Small taxpayers: annual Patent Tax of KHR400,000 (USD100).
- Medium taxpayers: annual Patent Tax of KHR1,200,000 (USD300).
- Large taxpayers: a minimum of annual Patent Tax of KHR3,000,000 (USD750) and a maximum of KHR5,000,000 (USD1,250).
It is anticipated that these changes in the Patent Tax fees may be in place by 2016 i.e. payable by 31 March 2016, and that the MoEF will shortly issue further guidance as to how they will apply – in particular to Large RRT’s.
A number of contributing factors have led to the move by the MoEF to eliminate the ETR in Cambodia. Cambodia’s developing economy, its inclusion in the widely publicized Asian Economic Community coupled with a desire to increase tax revenues and promote a favorable climate for FDI have all led to this predictable point.
Anecdotal evidence suggests that taxpayers in the ETR make up the vast majority of all businesses in Cambodia but contribute only a very small percentage of the total tax revenue collected.
Tax registration regulations in Cambodia have been in place since the inception of the current tax regime but up until now most locally owned businesses and SME’s have simply not complied. Currently a taxpayer is required to register in the RRT based on its legal form i.e. all limited liability companies must register, level of turnover or the type of business activities undertaken.
Based on the current registration requirements only sole proprietors who don’t import or export and who have annual revenue of less than USD125,000 (if selling goods) or annual revenue of less than USD62,500 (if providing services) should be in the estimated regime.
The incentive for a business to move into the RRT is of course not particularly high when the amount of tax required to be paid would in some cases increase dramatically (no more upfront negotiated tax payments), tax compliance and advisor costs would increase (monthly and annual tax returns), and the tax equivalent of the Sword of Damocles in the form of tax audits is ever present.
It would appear, as per the Law, that the historical benefits afforded to those businesses who sought sanctuary in the ETR will very shortly no longer exist. This fundamental change is far-reaching and would affect a very large number of businesses that currently operate in Cambodia. It is anticipated that more regulations will be passed to provide further clarity as to how these changes will be implemented.
Prakas on Tax Mechanism for Finance Lease Transactions
After a long period of consultation with the private sector and internal deliberation within the GDT the Prakas on Tax Mechanism for Finance Lease Transactions (Prakas No.1704 MEK.PrK dated 9 December 2015) (“Prakas 1704”) was finally passed this month.
To recap – a financial lease is a lease arrangement where a Lessor purchases a product (which must be a movable asset) selected by the Lessee from a third party as part of a lease agreement between the Lessor and lessee. For the term of the lease, the Lessor owns the product, and the Lessee has the rights specified in the lease agreement. In Cambodia, financial lease business may be conducted by banks – subject to approval from the National Bank of Cambodia (the “NBC”) and non-banks – subject to obtaining a license to do so from the NBC. In addition to the licensing requirements a financial lease business needs to be registered in the real regime of taxation.
The Law on Financial Leases (2009) offers parties the flexibility to structure the terms of their lease agreements to meet their needs. Parties to a lease agreement may incorporate a wide variety of terms and conditions into the agreement regarding, among other things, the use of the product, maintenance requirements, payment options, advance payments and security deposits (and interest thereon), and ownership transferal upon expiration of the lease term. The finance lease itself must be for a period of more than 12 months and must comply with the conditions that are set out in the Law on Financial Leases.
Prakas 1704 clarifies a number of issues that were previously unclear with respect to the taxation of financial leases in Cambodia:
- Valued Added Tax
Practically speaking VAT will not apply to the finance charge (interest) charged by the Lessor to the Lessee but will apply to everything else that is charged. If the Lessor purchases the product, that forms the basis of the finance lease, from a VAT registered taxpayer the Lessor can claim a VAT input credit with respect to the purchase.
The Lessor must charge VAT on the periodic invoices that are issued to the Lessee under the finance lease on everything but the finance charge i.e. the underlying principal amount, late payment penalty and administration fees if applicable.
If the Lessee is a RRT they can claim the VAT input on the VAT paid to the Lessor as per the standard time of supply rules that are contained in the VAT regulations.
- Prepayment of Tax on Profit (“PToP”)
The Lessor is required to pay the monthly 1% PToP on all charges and interest (exclusive of VAT) it receives under the finance lease excluding the principal amount. Effectively the principal amount is excluded from the definition of “turnover” for the purposes of PToP.
- Tax on Profit
The Lessor is required to recognize the revenue (finance charge, other charges etc) it receives from the finance lease at the earlier of when the payment to be received, is due or has been paid for Tax on Profit purposes.
- Tax Depreciation
The lessee, if they are a real regime taxpayer, is entitled to claim tax depreciation on the leased asset.
- Withholding Tax (“WHT”)
If the Lessee is a RRT they will not be required to withhold WHT with respect to the financial lease payments.
Prakas 1704 confirms what many tax experts in Cambodia already believed was the most pragmatic solution with respect to the taxation of financial leases. It would appear to be no coincidence that the introduction of Prakas 1704 comes at approximately the same time as the Estimated Tax Regime is about to be phased out in Cambodia under the 2016 Finance Management Law.
The commercial model under which financial leases operate is not sustainable in an environment where the sellers of products that form the basis of a finance lease are operating in a tax regime whereby they are not required to charge VAT i.e. the Estimated Tax Regime.
A consumer, in particular an individual, would not want to subject themselves not only to a finance charge, but also an additional 10% VAT if they would normally not have to pay VAT i.e. the finance company buys a product from an estimated tax regime enterprise (no VAT applies) and then has to charge 10% VAT on the principal amount in addition to applying a finance charge where invoicing the Lessee.
There appear to be no grandfathering rules contained in Prakas 1704 so it remains to be seen how the GDT will treat those finance companies who have adopted a contrary tax position in the past to that which is stated in Prakas 1704.
*The information contained in this legal update is provided for information purposes only, and is not intended to constitute legal advice. Legal advice should be obtained from qualified legal counsel for all specific situations.