Cambodia Tax Alert: Transfer Pricing Regulations

On 10th October 2017, the Cambodian Ministry of Economy and Finance issued Prakas No. 986. MEF.P. (“Prakas 986”) in order to combat perceived transfer pricing abuses and loss of tax revenue in the country’s state budget.

Cambodia has been relatively slow in focusing on transfer pricing and is now seeking to bridge the gap with its Asian neighbors (including Thailand, China, Vietnam, Malaysia and Indonesia) in respect of transfer pricing documentation rules and a more structured audit process.

In a nutshell, Prakas 986 regulates that Cambodian enterprises that have transactions with related parties must comply with new compliance requirements consisting of:

1. An annual transfer pricing declaration, to be submitted together with the annual declaration on tax on income.
2. Annual transfer pricing documentation, to be submitted upon request by the General Department of Taxation (“GDT”).

This form and documentation will then be used the tax authorities to identify taxpayers with significant related party transactions for review, audit and potential adjustment if found not to be “arm’s length”. Put simply the arm’s length principle states that the amount charged by one related party to another for a given product/service must be the same as if the parties were not related.

What is a related party?

To be caught by Prakas 986, the transactions need to occur between two related parties. This is defined in Article 4 as one of the following:

• Member of the same immediate family
• One enterprise is directly or indirectly entitled to 20% of the dividend in the direct capital of the other enterprise or equivalent voting rights in the taxpayer’s Board of Directors
• A third-party enterprise or an individual possesses directly or indirectly at least 20% of the dividend in the direct capital of both enterprises or equivalent voting rights in Board of Directors of both enterprises.

Methodologies

The five methodologies endorsed by Prakas 986 to determine an arm’s length price in a related party transaction are as per those set out by the Organization for Economic Co-operation and Development (“OECD”).

Target transactions

Prakas 986 does not identify any specific target transactions within the scope of the guidelines or potential audit activity, however Articles 15-17 highlights intangible assets and services, which is an indication of one of the likely initial focus areas.

Article 15 introduces the term from the OECD BEPS Actions 8-10 of “DEMPE” functions (development, enhancement, maintenance, protection, exploitation) related to intangible assets. This reflects the application of a “substance over form” principle and the need to show that the party performing these key functions and incurring the associated costs is entitled to the reward. For example, if a Cambodian entity argues that its brand is owned by a related party in the Cayman Islands but the marketing team and associated marketing cost is in Cambodia, such a mismatch is likely to raise scrutiny under these measures.

In respect of intra-group services Prakas 986 requires the following criteria to be strictly applied to support a deduction:

• Services are delivered, necessary to taxpayer’s business and bring economic benefits/ commercial value to taxpayer

• The service charge must be at arm’s length.

Timeline and penalties

Prakas 986 is effective from the signing date of 10th October 2017, with no clear indication of the first fiscal year to be applied. However, considering many Cambodian enterprises have fiscal years ending 31 December and the annual corporate tax filing deadline is 3 months from fiscal year end, the assumption is that both the transfer pricing form and documentation should be completed by 31 March 2018.

Failure to comply with the above requirements would lead to:

• Transfer pricing adjustments, which would result in additional tax
• Tax penalties, which range from 10% to 40% of the additional tax for violations of the Law on Tax (LOT) according to Article 133 of the LOT, plus an interest charge of 2% on late payment
• A law suit filed by the local tax administration against enterprises for charges stipulated under the LOT.

It is possible that an extension may be granted to prepare documentation given this is the first year of implementation.

Our recommendations

Transfer pricing is not something that can be addressed at the time of lodging the tax return or preparation of the documentation. It needs to be considered at the time the transactions are entered into, to ensure the outcome is an arm’s length transfer pricing policy and defensible level of profitability.

It is recommended that taxpayers in Cambodia:

• Identify related parties under Prakas 986 and related party transactions in 2017
• Revisit significant related party transactions in 2017 (particularly royalties, service fees etc.) and consider potential exposures and the best way to manage them.  This step would be particularly relevant if the company is forecast to have a loss result or low profit in 2017.
• Kick-start the preparation of documentation following Prakas 986 as soon as possible. The actual preparation of the first year TP documentation may require significant information from the Group entities as well as more analysis, which take time to request, follow up and process.
• Revisit whether the company has any significant TP risks in years from the 2007-2016 period which could be challenged in an upcoming tax or TP audit. Although there is no retrospective provisions introduced in Prakas 986 practically speaking the tax authorities may seek to roll back the audit period if they identify exposures resulting in adjustments for 2017.

Upcoming Event: Transfer Pricing in Cambodia | 15 November 2017 | Phnom Penh

In collaboration with, 

Adriana Rominof

Chief of Legal Affairs

Bangladesh

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