Instruction 11946 issued by the General Department of Taxation (“GDT”) on the 21st of August 2018 (“Instruction 11946”) provides an important clarification regarding the determination of interest rates between related parties.
Since the introduction of Circular 151 in early 2014 Cambodian taxpayers were historically able to receive and extend interest free loans to domestic as well as overseas related parties. However since Prakas 986 brought in comprehensive transfer pricing guidelines in Cambodia in October last year there has been a large amount of speculation as to whether interest-free loans between related enterprises were still acceptable.
Instruction 11946 has now put the speculation to rest by clearly stating that when Cambodian taxpayers lend to, or borrow money from, related parties, the rate of interest to be applied to those loans must adhere to the “arm’s length principle” as set out in Prakas 986. In other words, the interest rate to be charged on related party loans should be determined based on the rate of interest that would have been charged between independent parties under similar circumstances.
Instruction 11946 raises some key queries which we have tried to address below.
My company currently has an interest free loan in place with its overseas shareholder – what should I do?
Based on our understanding – Instruction 11946 takes effect from its issue date – being 21 August 2018. We would suggest that all taxpayers in Cambodia that currently have interest free loans in place with related parties reconsider the need to maintain the loan versus early repayment or capitalization. If the answer to the earlier question is in the affirmative and the loan is to be maintained then an urgent review of the interest rate to be applied will need to take place.
This review may require an amendment to the existing loan agreement and may also have cash-flow and tax implications – the most obvious being withholding tax implications for the Cambodian Borrower when paying interest to a non-resident or resident related party Lender.
We strongly suggest discussing these changes as a matter of priority with your legal and tax advisors to ensure that you are fully aware of all the associated implications.
How do I ensure that the interest rate that is used for my related party loan is arm’s length?
Instruction 11946 notes that taxpayers are not required to submit related party loan documents to the GDT for approval but are required to record and keep all documents relating to the loans as outlined in Article 18 of Prakas 986. One of the key requirements under Article 18 of Prakas is that a taxpayer maintain transfer pricing documentation to support the interest rate that they intend to use.
To clarify, the transfer pricing documentation requirement under Prakas 986 will not be met by merely having a formal loan agreement in place. Of course a loan agreement is required but the transfer pricing documentation sits behind the loan agreement to support the interest rate that is used.
Typically a taxpayer would need to document the following steps when determining the most appropriate interest rate to use for a related party loan:
– A comparability analysis
This step typically involves taxpayers considering such facts and circumstances relating to the loan such as the credit standing of the borrower, the nature and purpose of the loan, the security offered if any and general market conditions at the time the loan is granted.
– Identification of the most appropriate transfer pricing method
Whilst Prakas 986 provides that taxpayers can use any transfer pricing method to price their related party loans it can be seen that in most circumstances the Comparable Uncontrolled Price (CUP) method is most suitable for loan transactions.
– Determination of the arm’s length results
Once the appropriate transfer pricing method has been chosen the method is applied using data of comparable independent transactions to arrive at the arm’s length result. The comparable rate can either be fixed or expressed as a spread on a base rate such as SIBOR or LIBOR.
Do I still need to notify the GDT within 30 days of any new related party loans that my enterprise enters into?
Based on our verbal enquiries with the GDT, taxpayers who from 21 August 2018 enter into related party loan transactions will no longer need to notify the GDT of those loan agreements within 30 days as per the requirements under Circular 151. Taxpayers who enter into related party loans will still need to complete the related party transactions annex which is attached to the Annual Tax on Income return and list all the existing and new related party loans that they have entered into during each tax year.
Taxpayers who enter into loan transactions with third parties are still required to notify the GDT within 30 days as per the requirements under Circular 151.
The DFDL tax team is always ready to answer any questions you may have on this and other tax issues.
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.
The information provided here is 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.