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227 Cambodia@dfdlmekong.com|www.dfdlmekong.com

4 February 2008

BY EMAIL
Asian Development Bank Mr. Joao Farinha Re: Diagnostic Analysis of Cambodian Tax System and Tax Reform of Leasing TA-4786 (Cam) Contract S13548 (revised and updated) Dear Mr. Farinha, We refer to our engagement TA-4786 (Cam) and contract S13548. Please find here our observations with respect to the necessary changes in tax regulations, and our views on how to bring about these reforms, both for your comments. This advice was prepared in exclusive cooperation with Mekong Law Group. Legislative reference We have based ourselves for our review on the Law on Taxation (as amended in 2003) (LOT), the Sub-Decree on Value Added Tax No. 114 (1999) (VAT Sub-Decree), the Prakas on Tax on Profit No.1059 PK/MEF/DT (2003) (Prakas TOP), Prakas on VAT No. 1031 PK.SHV.PD (1998) (Prakas VAT) and associated tax regulations, plus our understanding of the interpretation and implementation of this legislation by the Cambodian Tax Department (TD). PART A. Diagnostic Analysis of Cambodian Tax System In this part of our assignment, we render our considered appraisal of the Cambodian tax system from the perspective of enterprises, particularly small and medium sized enterprises. We formulate suggestions for reform and to discuss the feasibility of implementing these suggestions. 1. Introduction: salient features of the Cambodian tax system The taxation system in Cambodia is relatively new and is characterized by numerous taxes and frequently changing legislation, which is often unclear, contradictory, and subject to interpretation. Often, differing interpretations exist among different divisions of the Tax Department (TD). Taxes are subject to review and investigation by a number of different divisions of the TD. These facts may create tax risks in Cambodia substantially more significant than in other countries.

A M B O D I A

A O S

Y A N M A R

H A I L A N D

I E T N A M

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The LoT, promulgated in 1997, provides principle guidelines on the various types of taxes to be implemented. Subsequent regulations need to be passed to support the Law. The LALoT was promulgated on 31 March 2003 and introduced sweeping changes to the taxation of QIPs, and widened the tax net on payments to non-residents of Cambodia. The LALoT became effective from 1 January 2004. With the Financial Act 2007, Cambodia has revised the LoT again (notably art. 7), this time to introduce a taxation on capital gains on immovable property, investment property and financial property realized outside of the scope of business transactions, including gains realized by physical persons. The Prakas on Tax on Profits (PTP) passed in August 2000 was not comprehensive. The regulations were revised in December 2003 in an attempt to clarify ambiguities in the original document and to be in accordance with the LALoT. Notwithstanding, the regulations in place are often vague, inconclusive and subject to inconsistent interpretation and application. Furthermore, due to the limited complexity of the domestic commercial environment, these regulations are often insufficient to deal with complex agreements and transactions. In the past 24 months there has been a large increase in the number of tax audits being conducted, and the TD has been increasingly aggressive in issuing reassessments for taxpayers that have not been complying with the LoT. The TD has also increased its efforts in pursuing and collecting outstanding tax debts. Due to the shortcomings in the law, and the lack of experience of the tax officials in dealing with international tax issues, tax reassessments dealing with issues that are outside the local operating environment (such as sophisticated operating and management agreements or offshore arrangements) are often arbitrary and have little relevance to the actual issue under consideration. It is not possible to obtain rulings on tax issues from the tax authorities; in fact the TD is reluctant to respond, in writing, to any issue that the taxpayer may raise with the TD. We also advise that Cambodia does not have any Double Taxation Agreements with any country, but treaty negotiations are soon to start based on a Model DTA prepared by the Tax Department in cooperation with a foreign expert. The LoT provides for three types of tax regime (i) the real regime tax system (RRTS); (ii) the estimated regime; and (iii) the simplified regime. These three systems impose different tax obligations on taxpayers. All enterprises, other than sole proprietorships, are taxable under the real regime. Accordingly, our comments below are based upon the tax provisions for the RRTS.

Basis of taxation
Taxpayers in Cambodia are classified as either resident taxpayers, or non-resident taxpayers. A resident taxpayer is primarily an enterprise that has a place of management and carries on business in Cambodia. A non-resident taxpayer is an enterprise that is a not a resident taxpayer, but derives Cambodian source income. A non-resident taxpayer will be deemed to be Cambodian resident for tax purposes if it is found to have a Permanent Establishment (PE) in Cambodia. In such instances, the nonresident will be subject to tax in Cambodia in respect of its Cambodian source income. Cambodian source income for this purpose includes income from services performed in Cambodia and income from business activities carried on by the non-resident through the PE.

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Under the LoT and its implementing texts, a PE is established by having a fixed place of

business or a resident agent in the Kingdom of Cambodia through which a non-resident person carries out business, wholly or partially, in the Kingdom of Cambodia. A permanent establishment includes also any other association or connection or mean through which a non-resident person engages in economic activity in the Kingdom of Cambodia1.

The term economic activity is explained as the regular or continuous or from time to time activity of a person, whether or not for profit, in the supply of, or the intent to supply, of goods and services to other persons for the purpose of obtaining any benefit2. The LoT further states that a permanent establishment includes the following forms of business activity in Cambodia: A place of management; A branch of a foreign enterprise; An office of a foreign enterprise; A warehouse; A factory; A workshop; A mine, or any other place of extraction, of natural resources; A building site, a construction project or an assembly project, or supervisory activities connected to such site or project where such site or project or activities continue for a period of more than six months; and The furnishing of services including consultancy services by the employees or other personnel of a foreign enterprise where such activities continue within Cambodia for periods aggregating more than six months in any 12-month period.

Notwithstanding all the aforementioned criteria for establishing a PE, the TD will ultimately decide on a case-by-case basis whether an enterprises activities constitute a PE. However, we advise that there is the established precedent of the TD not applying the PE rules to foreign companies that, although they have technically established a PE in Cambodia, do not maintain a physical presence in Cambodia. As a matter of fact, we advise that the TD requires that the concerned entity should have been duly registered with the MoC to enable a tax registration to be effected.

Taxation of resident enterprises

Resident taxpayers are subject to the following tax imposts: TAX ON PROFIT The LoT provides for a 20% tax on profit rate for profit realized by a legal person and is applicable to world-wide income. A PE (which is deemed to be a resident taxpayer) is taxed at the rate of 20% of profits derived from Cambodian source income only. Taxable profit is calculated by adjusting accounting profit for various expenses that are not allowable, or subject to limitation, for tax purposes. Expenses subject to non-deductibility or limitation include:
1 2

Depreciation over allowable rates Interest (thin capitalization rules)

Section 1.2 (paragraph 5) of the PTP. Section 1.3 of the PTP.

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Increase in provisions Amusement, recreation or entertainment expenses Penalties and fines imposed by the TD, Customs Department, or other government bodies (including the courts) Donations, grants and subsidies Taxes reassessed by the TD Extravagant and / or unrelated business expenses.

PREPAYMENT OF PROFIT TAX Taxpayers are subject to a prepayment of tax on profit calculated at 1% of monthly turnover. This payment is made monthly and is offset against the tax on profit due at the annual tax liquidation. MINIMUM TAX The Minimum Tax is a separate tax to the Tax on Profit, and similarly to the Prepayment of Tax on Profit, is calculated at 1% of turnover. The Minimum Tax is only payable if the Minimum Tax is greater than the Tax on Profit. The Minimum Tax is calculated at year-end, however it should be totally liquidated by the monthly Prepayment of Tax on Profit. WITHHOLDING TAXES Withholding taxes imposed in Cambodia comprise resident withholding tax and non-resident withholding tax.

Resident withholding tax

Payments of certain Cambodian source income, by a resident taxpayer carrying on a business in Cambodia, to a Cambodian resident are subject to the following withholding taxes: Services provided by a resident person 15% Applicable for payments for services including management and consultancy services, to a Cambodian resident enterprise that is not registered for the RRTS. Royalties 15% Applicable for all payments for the use of intangible assets, including know-how, the granting of rights, and interests in minerals, oil or natural gas, regardless of whether the recipient of the payment is registered for the RRTS or not. Interest payments 15% Applicable for all interest payments to a physical person or enterprise, other than interest paid to a domestic bank or savings institution Rental payments 10% Applicable to all rental payments for the use of movable and immovable assets, including motor vehicles, plant and equipment, office space, residential accommodation etc, regardless of whether the recipient of the payment is registered for the RRTS or not.

Non-resident withholding tax

Non-resident withholding tax at the rate of 14% is to be deducted from the following payments to non-residents:

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Royalties, rent and other income related to property; Interest; Management and technical services (these fees are currently undefined in the LoT and tax regulations, however the TD will in practice adopt a very broad definition of management fees and technical services); and Dividends

Cambodia does not have double tax agreements with any country. Accordingly, the 14% WHT impost will apply to all payments of interest, rent, management and technical service fees and dividends to non-residents, regardless of the non-residents country of residence. WHT tax is a final tax for the recipients of the payments that are subject to WHT. Consequently WHT is the only Cambodian tax that will apply to non-resident entities receiving income from Cambodian taxpayers that have not established a PE in Cambodia. WHT is applicable for payments made by all resident taxpayers regardless of the taxpayers legal form. Accordingly, the WHT liability in respect of the abovementioned payments will apply to payments made by PEs (deemed residents), corporate entities and branch operations registered in Cambodia. It should furthermore be noted that in our experience, the TD may take the position that WHT on market interest rates is also due in case of interest-free loans or loans with interest rates that are below market rates. The liability for WHT rests with the remitter. The TD has no recourse to recover WHT from the recipient of the payment. VALUE ADDED TAX Value added tax is applicable to the taxable supply of goods and services. An enterprise is required to charge VAT at the rate of 10% on all sales of taxable supplies in Cambodia, and at the rate of 0% on the sale of taxable supplies exported from Cambodia. An enterprise registered under the VAT provisions can offset input VAT charged on purchases against the output VAT. In theory, refunds are available subject to certain general conditions, but in fact refunds are subject to prohibitive delays for most taxpayers (see below). The prescribed thresholds to qualify as a VAT-taxpayer are as follows3: taxable turnover in any period of 3 consecutive months exceeds 125 M KHR (goods) (approximately 30,000 US$) or 60 M KHR (services) (approximately 15,000 US$); or expectation to exceed taxable turnover in the coming period of 3 consecutive months of 125 M KHR (goods) or 60 M KHR (services); or having government contracts exceeding 30 M KHR.

In addition, there is an annual threshold, which is 500 M KHR in the case of the supply of goods of 250 M KHR for services. Taxable supplies are defined as all supplies other than exempt supplies. Exempt supplies are not subject to VAT and include:
3

Art. 2 Sub-Decree on VAT No. 114 ANKR.BK

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Public postal service; Hospital, clinic, medical, and dental services and the sale of medical and dental goods incidental to the performance of such services; The service of transportation of passengers by a wholly state owned public transportation system; Insurance services; Primary financial services; The importation of articles for personal use that are exempt from customs duties; and Non-profit activities for public interest that have been recognized by the Ministry of Economy and Finance.

Basic features and problem posed

The Cambodian VAT system has the same basic features of any VAT or GST system: taxpayers must apply VAT on their sales and may deduct VAT on supplies made to them to carry out VAT business. Taxpayers pay the excess output VAT or get a refund for excess input VAT. Under Cambodian tax law, offsetting input VAT with output VAT is effectuated in the VAT return of the taxpayer, subject to verification by the TD. The VAT returns are specific per taxpayer. Each taxpayer has a unique Taxpayer Identification Number (TIN) which features on the VAT return. VAT taxpayers are, for the most part, companies that are subject to the real regime of taxation. Each company must register at the TD and is issued a TIN, often with the VAT number. It is possible for a company not to have a VAT number if it will not perform any VATtaxable supplies such as selling land. Renting out immovable property is however considered a taxable service for VAT purposes. In Cambodia, the synchronicity of this system is hindered by the procedures and delays associated with VAT refunds. As a matter of law, refunds are only allowed after an audit has been conducted to verify the legitimacy of the VAT refund claim of the taxpayer4. This audit may be a lengthy procedure and disputes may drag out over months or even years. Even when a refund may be approved by the Tax Department (TD), in practice important delays exist for the actual remittance of the refund. As a consequence, your situation is not VAT effective from a consolidated perspective. CM I will have to charge VAT on its sales (rent) while CM II will have no effective way to recoup the input VAT that was charged to CM II on the supply of construction work.

Value Added Tax rules on deductibility of input VAT

The general rule on deducting input VAT is found in the LOT, which reads as follows: The input tax credit and the non taxable supplies shall be determined as follows: 1.The tax paid by a taxable person on goods and services for use in the business which are supplied by another taxable person or the tax paid by the taxable person as an importer on imported goods or services for use in his own
4

Art. 41 par. 4 Sub Decree on VAT

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business shall become an input tax credit deductible against the output tax. Input means any goods or services purchased and output means any goods or services sold. 2.In the case where goods and services purchased are used partly for taxable supplies and partly for non taxable supplies, the tax credit shall be allowed only for that portion used for taxable supplies5. The Prakas on VAT adds on this point, among other things, that an input credit on goods supplied to the taxpayer is allowed if the goods are purchased to make taxable sales or to use in the production of taxable supplies by the registrant6. The input tax credit is calculated based on all supplies made to the taxable person during the month and on all imports made by that person that month7. The moment that the credit may be effectuated is at the time goods or services are supplied or imported by the taxable person. If supply or import takes place in another month than in the one the taxable person claims the credit, the credit may not be deducted. This refers to the rules on time of supply as they apply to output VAT. A supplier must pay VAT when he issues the invoice, regardless of the time of the completion of the service or the delivery of the goods. Thus, whenever the supplier issues the invoice, the time of supply of VAT is established. But when a supplier does not issue an invoice, VAT is also established. In such a case the time of supply is when the supplier should issue the invoice. That time is defined in Cambodian VAT law as at the earliest of seven days after goods are shipped, services are rendered or when the payment is received from the customer. To obtain the credit in practice, the taxpayer must provide a value added tax invoice, drawn up in accordance with article 77 of the LOT, or a customs Bill of Entry for Import, certified by customs authorities, which must state the name of the taxable person as consignee or importer and the amount of tax paid at the time of import. Based on the legal provision cited above, the following constituting elements can be noted for applying the deduction and constituting the VAT credit: 1. The input VAT must be paid. This should be interpreted as meaning that in order to claim the deduction, the VAT must have been charged to the taxpayer; It should be noted that under certain circumstances, VAT charged by an agent may also be deducted by the principal8; The input VAT is charged on the supply of goods and services which the taxpayer uses for his VAT-taxable business. This means that the supplies should have been incurred to make VAT taxable sales or production of goods or services that will constitute taxable supplies; The input VAT is evidenced by a VAT invoice with all the required features as defined by law and regulations; Input VAT can only be deducted in the period that the supply was made to the taxpayer;

2.

3. 4.

5 6 7 8

Article 65 Input Tax Credit and Non Taxable Supplies Art. 27 par. 2 Prakas on VAT Art. 28 Prakas on VAT Art. 52 Sub Decree on VAT

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Tax Incentives

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On February 03, 2003, the National Assembly of the Royal Kingdom of Cambodia has adopted the Law on Amendment to the 1994 Law on Investment and the Law on Taxation of 1997. Under the amended LOI, only Qualified Investment Projects (QIPs) are entitled to the benefits of the incentives provided for under this law. An investment project must be granted a Final Registration Certificate (an FRC) in order to become a QIP. To obtain an FRC, the potential investors must submit an Investment Proposal to the Council for the Development of Cambodia (the CDC) in the required form. Within three business days of receipt of the Investment Proposal, the CDC will issue to the applicant a Conditional Registration Certificate (CRC) or a Letter of Non-compliance. If the CDC fails to issue a CRC or a Letter of Non-Compliance within these three days, the CRC will be considered to have been approved. The CRC will state the approvals, authorizations, clearances, licenses, permits or other registrations required for the QIP to operate, as well as the government entities responsible for issuing such approvals. The CRC will also confirm the incentives to which the QIP is entitled. A Final Registration Certificate ("FRC") must be issued within 28 business days of the date of issue of the CRC. The QIP will commence on the date of issue of the FRC. We noted that approvals required under the CRC will still need to be obtained by the QIP, even after the QIP commencement date. Tax exemptions and incentives available to QIP under the amended LOI are as follows: 1. Profit Tax exemption An exemption on profit tax imposed under the Law on Taxation (normally 20% on the net profit) for a profit tax exemption period. The tax exemption period is composed of a Trigger Period + 3 years + a Priority Period. The Trigger Period is the earlier of the first year of profit or three years after the QIP earns its first revenue. Therefore, the constructing and financing phase will be covered by the Trigger Period. The Priority Period will be determined in accordance with the Financial Management Law. You will need to get confirmation from the Royal Government on this issue, notably in the QIP Final Registration Certificate. 2. The profit tax exemption entitlement will be subject to the QIP obtaining an annual certificate of compliance. 3. QIP will be subject to profit tax (20%) after their tax exemption has expired. During and after the tax holiday, transfer of dividends off-shore is subject to a 14% withholding tax and an additional 20% withholding tax if such dividends benefited from a tax holiday. 4. QIP will not be entitled to claim any special depreciation if they use an entitlement to a profit tax exemption.

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5. Domestically-oriented QIP will be entitled to import production equipment and production input construction materials exempt of customs duty. 6. A QIP is entitled to obtain visas and work permits for the employment in Cambodia of foreign citizens as managers, technicians and skilled workers, and residency visas for the spouses and dependants of those foreign nationals as authorized by the CDC and in compliance with the Immigration and Labor Laws. In addition to these amendments, we note that QIP are no longer required to pay Minimum Tax in accordance with Article 24 of the Taxation Law (normally 1% on the turnover), nor are they subject to the Prepayment on Tax on Profit (normally monthly payment of 1% on turnover). TAX ON SALARY, WAGES AND FRINGE BENEFITS A detailed explanation of the tax on salary is included at Appendix A. In summary, resident employees (effectively any employee that spends more than 182 days in any 12 month period in Cambodia) are subject to salary tax on worldwide salary income, with tax rates operating on an incremental scale, with the highest marginal rate of 20%. Non-resident employees are taxed on Cambodian source salary only, at a flat rate of 20%. Benefits in cash or kind provided to an employee are subject to Fringe Benefits Tax, which is payable monthly by the employer. The rate of Fringe Benefits Tax is 20% of the gross value of the benefit provided. SPECIFIC TAX ON CERTAIN MERCHANDISE AND SERVICES Specific tax is imposed on certain merchandise and services at varying rates. PENALTIES Penalties for non-compliance with the tax regulations, or breaches of the tax regulations range from 10% to 40% of the unpaid tax. In addition, interest is levied at the rate of 2% per month on the unpaid tax. Officers of the taxpayer may be subject to criminal charges in cases of tax evasion. OTHER TAXES

Patent tax
All business enterprises are subject to an annual Patent Tax. This is the equivalent of a business registration tax. The amount is currently fixed at KHR1,140,000 (approx. USD285).

Customs duties
Imported goods are subject to import duty at varying rates. A limited number of goods are subject to export duties.

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EFFECTIVE TAX RATE

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Resident taxpayers are subject to tax on profit at the rate of 20%, and dividends distributed to non-residents from fully taxed profits are subject to 14% withholding tax. Accordingly, the effective tax rate on profits in the hands of a non-resident shareholder is 31.2%. As noted above at Section 7.2.1.4, WHT applies to all dividend payments made by resident taxpayers to non-resident entities regardless of the taxpayers legal form. Accordingly, the 31.2% effective tax rate will apply equally to profits repatriated offshore by a corporate entity, branch operation or a PE registered for the RRTS in Cambodia. Estimated Regime Under Cambodian tax law, taxpayers that are not and must not register for the RRTS, are subject to tax under the estimated regime. In that case, the taxable profit as turnover tax will be determined in common accord with the local tax official. 2. The international legal framework: global standards and principles on the tax treatment of business and investment In this part of our advice, we recall international principles and experiences relating to the tax treatment of investment. We have approached this problem from the perspective of the internationally respected rules on investment protection as included in investment protection agreements and requirements or transparency under GATT and GATS, which may also apply to tax matters.

Tax and foreign investment

The tax treatment by the host state of an investment (the state in which the investment is made) and of the profits generated by an investment are an important factor for every international business enterprise. Obviously, a foreign investor will want to get a clear picture of all taxes that will apply and that may weigh on the net return of his investment in another country. Usually states have many different taxes that will concern the investor. Import duties or tariff will for example increase the cost of raw materials and equipment that are used in the manufacture of products, or will increase the cost price of goods that are meant to be resold in the host state. Value added taxes will have to be passed on to the customers of the investor and thus increase the sales price of products, or in case the investor is not entitled to offset input VAT with output VAT may present a real cost for the operation9. Corporate income tax will typically be levied on the net profit of the company and a withholding tax on dividend distributions will further reduce the actual profit repatriation to the foreign investor. Attracting loans, intellectual property or services from abroad will also trigger withholding taxes that will normally be considered by the investor as economical costs. Depending on the type of the investment other taxes may also play an important role such as transfer tax on immovable property, excise duty, and so-called mineral royalties.

9 Under the tax laws of many countries that have a VAT system, certain types of business operation are not treated as VAT-taxpayers but as end-consumers, such as real estate development, banks and insurance, hospitals and universities.

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On the other hand the host state may offer tax holidays or special tax reductions that may have an impact on investment decisions. In that case, the investor will seek advice on the conditions, the reductions and the period he is expected to benefit from this tax incentive. The investment decision will normally take into account all important elements of the taxes of the host state, mainly their taxable basis, rates and exemptions or reductions. It is of no use just to compare tax rates when countries can have important differences in the calculation of the amount subject to tax. From the economical perspective taxes and duties are costs and as such they weigh on the net return of the investment.

Changes to the tax laws of the host state

Although taxation (or tax incentives) will rarely be the decisive factor for the investment decision, it is certain that consequent changes in tax policy or practice may have an important impact on the value of or the return on an investment. Careful investors will allow for a certain flexibility in their calculations. After all, everybody knows that tax laws and tax rates will evolve over time. So, usually changes in host state tax regimes will not result in catastrophic consequences for (a particular) foreign investor. Moreover, states will normally be careful not to deter foreign investors with their tax policies. But on occasion a new tax regime may have a severe impact on foreign investment anyway, intended or not. The canceling of a duty free zone in a host state, for example, may make the business of a chemical processing company prohibitively expensive because import tariff will now be levied on the materials that customers send to be processed. The raising of excise duty on cigarettes may make the products to expensive for a producers existing foreign markets if a rebate for export is not provided. The sudden increase of corporate income tax rates may present severe difficulties for enterprises that have fully reinvested their profits and now cannot raise the cash to pay the additional taxes. Some new taxes may weigh relatively higher on foreign owned companies thus reducing their capacity to compete with nationally owned companies.

Measures of tax administration

New taxes or tax increases are a major concern to every business, but surprising administrative measures and decisions of the tax authorities concerning the existing ones may also present severe difficulties for foreign investors. Tax audits and investigations may lead to a re-assessment by authorities of (1) the taxable basis (amount) or (2) the characterization (nature) of the transaction or event. An example of the first kind would be when the taxable profit of the foreign investor is re-assessed either by disallowing costs or increasing revenue for the purposes of corporate income tax. In most of these cases, high penalties and interests apply. Also when the value of imported goods is increased by customs for the purpose of calculating tariff, or when the tax authorities increase the basis for excise duty calculation foreign investors may be subject to higher taxes and penalties. Examples of the second kind are re-classification of imported goods for tariff purposes or re-characterization of the type of income for the purpose of withholding taxes. Furthermore, authorities may decide to revoke tax privileges attached to an investment incentive program, cancel or delay the refund of taxes, refuse to apply tax exemptions, etc. The manner in which the administrative measures and decisions which lead to increased tax costs for the foreign investor are carried out, are particularly of note here. The investors may feel justified or not- that the process was arbitrary or not transparent, discriminatory or unfair.

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Administrative collection measures applied by tax authorities may also severely affect the operation of foreign owned businesses. Bank accounts may be seized or frozen, goods impounded or property foreclosed.

Fair and Equitable Treatment in Tax Matters

Fair and equitable tax treatment is a fundamental principle of business and investment. Almost every investment treaty, for example, provides that the host state must accord to foreign investment by investors from the other state fair and equitable treatment. Often the provision reads: Each Contracting State shall in its territory in any case accord investments by investors of the other Contracting State fair and equitable treatment as well as full protection under the Treaty10 Based on an analysis of the international case law on the subject, the OECD Working Paper includes the following elements that are encompassed in the fair and equitable treatment standard11: Vigilance and protection (due diligence) Due process and prohibition of arbitrariness; Prohibition of denial of justice Transparency Good faith and legitimate expectations

Due diligence in tax matters

Usually referred to as vigilance and protection, this obligation is an element of fair and equitable treatment. It often applies to physical security, seizures and the acts of the states police and security forces but in fact is extended to all powers of persons acting under the authority of the state. The obligation is for the state to control its functions, the measures taken by officials so that illegal treatment does not occur. The state is not liable to prevent all violations, but it must take reasonable measures to prevent and remedy violations. When agents of a state enterprise illegally seized two hotels in Egypt, for example, in the context of a dispute between that enterprise and the foreign investor who owned the hotels, the Tribunal found that Egypt had violated its duty to extend fair and equitable treatment, namely due diligence and vigilance. The government knew that the agents of the state enterprise were about to illegally seize the hotels and did nothing to prevent it. And once the seizure was a fact, Egypt did nothing to remedy the situation, the Tribunal considered12. In tax matters seizures and other measures of pressure or collection are often applied when taxpayers do not (timely) pay the tax debt. The question is thus raised to which extent the duty of due diligence applies in these cases. As long as the host states tax collection measures are legal under the law of the host state and do not violate international law (including fair and equitable treatment, national treatment under investment treaties, etc.) it seems that they cannot lead to a violation of the duty to due diligence on the host state. But if
10 11

Germany Model BIT art 2 par. 2. OECD Working Papers on International Investment, Fair and Equitable Treatment Standard in International Investment Law, Paris, September 2004, p. 26 12 Wena Hotels Ltd. (U.K.) v. Arab Republic of Egypt, ICSID Case No ARB/98/4 (Award) (Dec. 8, 2000), [annulment denied] reprinted in 41 I.L.M. 896 (2002).

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the seizure measures applied are illegal under the host states domestic law, or when the measures violate international law, then the host state has the duty to take reasonable measures to prevent them or, if they already were taken, to remedy the situation. It seems that this is not an absolute duty, so it must for example be shown that the host state knew about the measures and could have prevented them. A more fundamental question is exactly when the host states collection measures may be deemed to violate international investment law. Is it possible to deduce practical rules from the various sources of international law in this respect? For the moment, this is an open question. The issue of collection or recovery measures will be revisited below with respect to expropriation.

Denial of justice in tax matters

The principle of denial of justice is deemed a part of customary international law and is thus binding upon all nations13. In its narrow sense, which is used here, denial of justice refers to access to courts and to wrongdoing by courts both in terms of procedure and in terms of substantive justice. Foreigners and thus also foreign investors must be given a fair judicial treatment. A fair and independent court can squash unlawful governmental measures and thus remedy a state measure that would otherwise be a violation of international law. That is why tax assessments which are unlawful under domestic law are not (yet) violations of international law. The host states judicial infrastructure must be allowed to perform its normal function, which does by the way not necessarily mean that a foreign investor is barred from the arbitration procedure under the investment treaty until domestic legal proceedings are finalized. The problem becomes one of denial of justice if the correcting function of a fair domestic legal proceeding does not occur. However, international arbitration tribunals are not appellate courts for domestic judicial decisions that foreigners do not agree with. Even an error by a domestic court supposing one would later establish that the decision was indeed erroneousdoes not necessarily constitute a denial of justice under international law14. The error must be of such a significance, or the procedures applied so unusual and unfair that it puts into question the legitimacy of the whole proceeding. In the words of the Arbitral Tribunal of the Azzinian v Mexico15, denial of justice in the strict sense would occur when: the relevant courts refuse to entertain a suit; or they subject it to undue delay; or they administer justice in a seriously inadequate way; or there was a clear and malicious misapplication of the law.

In another relevant investment case, Mondev v USA, denial of justice was seen as follows: The test is not whether a particular result is surprising, but whether the shock or surprise occasioned to an impartial tribunal leads, on reflection, to justified concerns as to the judicial propriety of the outcome, bearing in mind on the one hand that international tribunals are not courts of appeal, and on the other hand that Chapter 11 of NAFTA (like other treaties for the protection of investments) is intended to provide a real measure of protection. In the end the question is whether, at an international level and having regard to generally accepted standards of the administration of justice, a tribunal
13 14

F.V. Garca-Amador et Al., Recent Codification of the Law of State Responsibility for Injuries to Aliens (180) 1974 Encana v Ecuador, par. 194-196 15 Azzinian v Mexico, ICSID ARB(AF) 97/2, par 102-103 (available at www.investmentclaims.com/decisions/AzinianMexico-Award-1Nov1999-Eng.pdf) (hereafter Azinian v. Mexico)

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can conclude in the light of all the available facts that the impugned decision was clearly improper and discreditable, with the result that the investment has been subjected to unfair and inequitable treatment. This is admittedly a somewhat open-ended standard, but it may be that in practice no more precise formula can be offered to cover the range of possibilities16 The implications of denial of justice as an element of the fair and equitable treatment standard are important for matters involving tax disputes. The following examples can illustrate this:

Review by courts in tax matters

The absence of an administrative appeal or independent judicial review is clearly very problematic in terms of denial of justice. Even if nationals of the host state also have no access to appeal or judicial review, it seems likely that a Tribunal will find that international law is breached. In the absence of independent review, the taxpayer is always at the mercy of the authorities. In international law, the notions of a denial of justice and of a fair trial are relatively developed. The appeal or independent judicial review must be of such a nature that it can deliver justice to the investor. More precisely, the proceedings must be in accordance with the requirements of the international minimum standard in all respects. This means that fundamental rights as fairness, right to a defense, rule of law, good faith and proper rules of procedure must be respected. A rubber-stamp review that agrees with the authorities regardless of the merits of the case can certainly not fulfill that requirement. The appeal or review must be timely so that the process does not become meaningless. It is difficult to prescribe exact time limits in this regard as much will have to depend on the facts and the circumstances of each case. With respect to tax matters, various issues are raised when it comes to the international obligation to provide the taxpayer with a fair trial. Most states have administrative phases of dispute settlement, where the taxpayers protest is decided by a government official and not by an independent judge. Sometimes, there is only the administrative procedure for certain types of taxes. The question can be raised if that in itself constitutes a denial of justice. The same can be asked for stringent conditions and restrictions to have access to independent legal proceedings in tax cases, such as short time periods for filing a request or high expenses. Although many states provide that an appeal or a review does not suspend the obligation to pay the tax that is in dispute, such a measure may easily lead to situations where the taxpayer has no real chance to defend himself, so that there could be a denial of justice. This could be the case with an arbitrary and extremely high tax assessment that is vigorously disputed by the taxpayer. But, since the tax in dispute must be paid even in case of appeal or review, for a high tax claim the taxpayer may go bankrupt even before winning the appeal or the review. Practical and economical circumstances can also raise questions of denial of justice in tax cases. When disputing import duties, for example, in case an investor does not have the right to import goods and pay duties while reserving his right to protest the assessment after customs clearance, one could argue that the investor does not really has access to a fair and
16

Mondev International LTD v. United States of America, ICSID Case No. ARB(AF)/99/2, par 64 65.

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independent legal proceeding. Commercial and financial considerations will prevent most investors from leaving the goods in the customs depot to await the outcome of a lengthy court battle.

Grossly unjust decisions by tax courts

When tax courts find in favor of the tax authorities in domestic tax disputes, there may be a denial of justice under international law if the decision was shocking to the sense of legal property or clearly improper against the backdrop of the administration of justice. As was said above, it does not suffice that the domestic tax court came to the wrong conclusion. That is not a claim which can be entertained before an international tribunal, which does not sit in the capacity of appellate court to the host states tax courts. In other words, the tax courts in the host state may come to the wrong decision without this in itself being a denial of justice under international law17. For international law to be breached in this respect, the host state tax court must have willfully ignored the law, applied rules of procedure which are clearly dishonest to the investor or administer justice so slow that the process becomes meaningless to the investor. Dishonest rules of procedure could include review by a judge that is not impartial and independent and unequal rules on evidence. An undue influence by the government on the decision by the court would probably also amount to a denial of justice.

Due process and arbitrariness in tax matters General remarks

The fair and equitable treatment standard is often interpreted to include respect for due process and to prohibit arbitrariness. Moreover, many investment treaties include an obligation on the host state forbidding certain unreasonable, discriminatory of arbitrary measures18. In its wider sense, denial of justice applies to actions by all the branches of the state and the executive, including the tax authorities and customs19. It has often been applied by international courts and tribunals, sometimes in relation to arbitrariness which is mentioned in provisions of many investment treaties20. The decision of the International Court of Justice in the ELSI case is in this regard of particular note. In that decision, the Chamber offered a definition of what is arbitrary: Arbitrariness is not so much something opposed to a rule of law, as something opposed to the rule of lawIt is a willful disregard of due process of law, an act which shocks, or at least surprises, a sense of judicial propriety21. The Waste Management v. Mexico case also offers an interesting analysis of the content of fair and equitable treatment with respect to due process: Taken together, the S.D. Myers, Mondev, ADF and Loewen cases suggest that the minimum standard of treatment of fair and equitable treatment is infringed by conduct
17 18 19 20 21

Encana v Ecuador, par. 194-196

same view in The International Responsibility of States for Denial of Justice (1938) 25 June 2001

H. Accioly in Recueil des Cours (1959) p. 379; Hackworth, Digest of International Law ; A. Freeman shares the Alex Genin, Eastern Credit Limited, Inc. and A.S. Baltoil Genin v. Republic of Estonia, ICSID Case no ARB/99/2 , Elettronica Sicula S.p.A. (ELSI) (United States of America v. Italy), ICJ Reports, 1989, p. 15, par. 128

See for example Netherlands Model BIT art. 3.1

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attributable to the State and harmful to the claimant if the conduct is arbitrary, grossly unfair, unjust or indiosyncratic, is discriminatory and exposes the claimant to sectional or racial prejudice, or involves a lack of due process leading to an outcome which offends judicial propriety as might be the case with a manifest failure of natural justice in judicial proceedings or a complete lack of transparency and candour in an administrative process. In applying the standard it is relevant that the treatment is in breach of representations made by the host State which were reasonably relied on by the claimant22 The Tribunal in the Occidental v. Ecuador case also offers interesting considerations in this regard23: Although fair and equitable treatment is not defined in the treaty, the Preamble clearly records the agreement of the Parties that such treatment is desirable in order to maintain a stable framework for investment and maximum effective utilization of economic resources. The stability of the legal and business framework is thus an essential element of fair and equitable treatment. The Tribunal must note in this context that the framework under which the investment was made and operates has been changed in an important manner by the actions adopted by the [tax authorities]. The tax law was changed without providing any clarity about its meaning and extent and the practice and regulations were also inconsistent with such changes. Various Arbitral Tribunals have recently insisted on the need for this stability. The Tribunal in Metalclad held that the Respondent failed to ensure a transparent and predictable framework for Metalclads planning an investment. The totality of these circumstances demonstrate a lack of orderly process and timely disposition in relation to an investor of a Party acting that it would be treated fairly and justly. A denial of justice, arbitrariness and infraction on due process are not the same as unlawfulness under domestic law. A regulation that is unlawful under the domestic law of the host state of an investment is not necessarily arbitrary or a denial of justice24.

Due process in tax administration

The domestic legal systems of many states have developed notions of due process or principes de bonne administration which have been applied to tax matters. Those domestic laws or doctrines may in some ways actually have the same operational contents as the international concept of due process. In tax matters, the issue of due process and arbitrariness will mostly be raised in cases where the tax authorities have an explicit or implicit discretion under the tax laws and regulations. This discretion can relate to the granting (or refusing) of privileges such as tax holidays, reductions and credit and delay of payment. It can also relate to investigation and enforcement such as audits, tax recovery measures and measures to obtain information. As opposed to the domestic laws and doctrines, due process of tax administration matters has not been much examined in international law. Some further study of international25 and national sources may result in a clearer understanding of the obligations of states on tax proceedings.

22 23 25 27

Waste Management, Inc. v. The United Mexican States, ICSID Case No. ARB(AF)/00/3 Occidental v. Ecuador par. 184 et seq. 24 ELSI USA v Italy, loc cit, par. 128

For example the International Covenant on Civil and Political Rights, art. 14 (due process). Transfer Pricing Guidelines for Tax Administrations and Multinational Enterprises, OECD Paris

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Due process of a tax re-assessment

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How does the requirement of due process affect the tax reassessment process? Errors may happen and in every state and a tax re-assessment always involves some degree of discretion for the tax officials that carry out the audit. The question can be raised if the requirement of due process means that a re-assessment measure must be justified with objective arguments in law and in fact. Given that a taxpayer must be able to defend his case, a re-assessment that is completely unmotivated will be difficult to maintain in view of the requirement of due process and the prohibition of arbitrariness. When tax authorities carry out re-assessments based on factual data such as prices, values or margins, ideally the relevance (the reasonable relationship with the taxpayers case) of that data should be clearly demonstrated. In many states, the data should also be made available to the taxpayer for review. The question remains how this would be regarded from the perspective of international law. Tax re-assessments based on secret comparables in transfer pricing cases, for example, is troublesome from the perspective of the standard of fair and equitable treatment27, because it is for the taxpayer simply impossible to argue against evidence he is not aware of. Also, it seems likely that the taxpayer must be given proper notice in writing of the reassessment procedure and of the points of view of the tax authorities so he can offer alternative explanations or arguments to the contrary. A re-assessment that is completed without hearing some way or another the taxpayer may easily be seen as contrary to due process. The finality of the process is also an issue. Once an audit is completed and the re-assessment is issued, are tax authorities prevented from revisiting the same tax years of the same taxpayer to find new issues or grounds for re-assessments, unless newly acquired information (for example from cross-checking with other taxpayers) has come up? Or may audits be done and redone without limitation from the perspective of international law? None of these failures in terms of due process or arbitrariness necessarily leads to a violation by the host state of the fair and equitable treatment provision in an investment treaty. The host state may have domestic measures in place to remedy the situation, such as an administrative appeal or a judicial review. Unless those appeals or reviews are carried out in a way that denies justice, the host state is not internationally liable under an investment treaty.

Answers by tax authorities on questions about the interpretation or application of the tax law
Many countries provide in the possibility for rulings on the interpretation of the tax law, and in advance pricing agreements on transfer pricing cases. In some national legal systems, there are some uncertainties as to the legal status and binding effect of such rulings and arrangements. It would be interesting to explore this question from the perspective of international investment law. It seems likely that the principle of due process and the prohibition of arbitrariness implies that when tax authorities answer a request from a foreign investor about the tax treatment of their investment, the given answer should bind the tax authorities. This should be the case even when it turns out that the answer was in fact incorrect. In the Occidental v. Ecuador case, the Tribunal emphasized that the ruling the foreign investor had requested from the tax authorities was answered wholly unsatisfactory and thoroughly

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vague and this was one of the elements the Tribunal based itself on to find in favor of the foreign investor28.

Refusal or undue delay by tax authorities to register a taxpayer

Tax systems usually operate by means of identifying and registering those who are subject to its operation. Often, registration does not only create liabilities but also benefits for taxpayers such as entitlement to refunds of tax that was paid or withheld at source in excess of what will be finally due by the taxpayer. In such a case, tax authorities may delay the refund of excess taxes by refusing or delaying the registration of taxpayers. This may constitute a violation of the fair and equitable treatment standard which requires due process and good faith on the part of entities of the host state, or the national treatment standard in case national investors are in fact being registered less cumbersome29.

Transparency in tax matters

There is reference to transparency in instruments of international trade law30 and many investment treaties impose an obligation upon the host state to publish or make otherwise available the laws and regulations that relate to foreign investment31. The US Model BIT provides for example that: Each Party shall ensure that its: (a) laws, regulations, procedures, and administrative rulings of general application; and (b) adjudicatory decisions respecting any matter covered by this Treaty are promptly published or otherwise made publicly available32. There are a few recent international decisions that associate fair and equitable treatment with transparency of the host states legislation and regulation. In other words, the host state is held to be in violation of the requirement of fair and equitable treatment in case the regulations or procedures that cause injury to the foreign investor were not transparent. In Metalclad Corporation v. United Mexican States (see paragraphs 66-69), the Tribunal found that the absence of a clear rule concerning construction permits requirements in Mexico, had failed to ensure a transparent and predictable framework for Metalclads planning an investment33. It decided that this failure of the part of Mexico to ensure the transparency required by NAFTA in its Article 1802 on transparencywas a breach of fair and equitable treatment under Article 1105. A similar mention is reported by the OECD Working Paper outside of the scope of NAFTA. In the Maffezini case, the Tribunal held that:
28 29

company, apparently in part because this action was filed, and in part as a result of the ongoing audit of the rebates for exports during 1996 and 1997, even though, as Mr. Diaz Guzman indicated, three other cigarette export trading companies had been granted registration 30 See for example art 63 of TRIPS and art. III of GATS 31 NAFTA art. 1802; See for an overview UNCTAD IIA Series Transparency 32 US Model BIT, art. 10 par. 1 33 Metalclad Corporation v. United Mexican States, par 101

Occidental v Ecuador, par. 184 Feldman v Mexico par. 175 The evidence also shows that CEMSA was denied registration as an export trading

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.because the acts of SODIGA (public company) relating to the loan cannot be considered commercial in nature and involve its public functions, responsibility for them should be attributed to the Kingdom of Spain. In particular, these acts amounted to a breach by Spain of its obligation to protect the investment as provided for in Article 3(1) of the Argentine- Spain Bilateral Investment Treaty. Moreover, the lack of transparency with which this loan transaction was conducted is incompatible with Spains commitment to ensure the investor a fair and equitable treatment in accordance with Article 4(1) of the same treaty. Accordingly, the Tribunal finds that, with regard to this contention, the Claimant has substantiated his claim and is entitled to compensation. It is however difficult to deduce hard and fast rules from these decisions with respect to all investment disputes, especially with respect to tax matters, which are often seen as inherently complicated and difficult to understand. Many uncertainties remain. What is the consequence when a state failed to meet its general obligation to publish laws and regulations? Is this (always) a violation of the fair and equitable treatment standard? Or (only) a violation of the provision on the publication of laws and regulations itself? In the latter case, how is the state liable towards investors? What if the state a least developed country for example- lacks the resources to fulfill its obligations? Although strictly speaking the dispute settlement mechanism of the investment treaty may very well apply to each and every obligation in the treaty, including the one on transparency, it is difficult to imagine a violation of such obligation on transparency that is not also a violation of fair and equitable treatment as well. How can foreign investors defend themselves in disputes with the host state if relevant regulations are not made known? So, perhaps an explicit requirement on transparency will mostly serve to emphasize that it is the duty of the host state to provide clarity (publicly and on a case by case basis) on the interpretation and application of tax laws, regulations and procedures. An obligation to publish investment-related laws, regulations etc. will most likely apply to taxation as well as pure investment laws and regulations if one takes the position that taxation is included in the treatment of investment. Taxation may certainly affect the investments of investors in the sense of that provision and thus tax laws, regulations, procedures as well as rulings and decisions must be made known.

Good faith and legitimate expectations of investors

The fair and equitable treatment standard is taken to include the obligation of good faith on the host state34. One can scarcely find a principle more fundamental to the law of treaties than the requirement of observing treaty obligations in good faith. Not only is good faith mentioned five times in the Vienna Convention on the Law of Treaties35, and enshrined in the UN Charter36, it has repeatedly been invoked and acknowledged by international courts37 to

34 OECD Working Papers on International Investment, Fair and Equitable Treatment Standard in International Investment Law, Paris, September 2004, p. 26 35 Preamble, art. 26 (pacta sunt servanda), art. 31 (general rules of interpretation), art. 41 (provisions of internal law) and art. 69 (consequences of invalidity). 36 Art. 2 par 2 Charter of the United Nations 37 Including in Treatment of Polish Nationals case, PCIJ 1932 A/B, n. 44, p. 28.; Minority Schools in Albania case, PCIJ, 1935 A/B, n. 64, p. 19-20.; Rights of Foreign Nationals in Morocco case, ICJ Reports 1952, p. 212.; North Sea Continental Shelf cases, 1969 ICJ Reports 3 p. 47 par. 85.; Nuclear Tests cases, 1974 ICJ Reports 253, p. 268 par. 46.; WHO/Egypt Agreement Advisory Opinion, 1980 ICJ Reports 73, p. 95-8 (par. 48-51).; Military and Paramilitary Activities in and against Nicaragua case (jurisdiction and admissibility) 1984 ICJ Reports 392, p. 418 par. 60.; Border and Transborder Armed Actions Nicaragua-Honduras (jurisdiction and admissibility) 1988 ICJ Reports 396, p. 69 par. 105

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say nothing of the international literature dedicated to this topic38. The principle of good faith has been associated with the respect for legitimate expectations of treaty partners39. This means in essence that there may be circumstances where one party may reasonably expect the other party will conduct itself in a certain manner. In some investment law cases, international tribunals have referred to the legitimate expectations of foreign investors with respect to the policy of the host state40. Tribunals accept that investment decisions are made on certain basic expectations and assumptions. As a principle states remain free and sovereign to issue regulations which are not what investors may have hoped for. But there may be circumstances where it would be unreasonable for the host state not to respect the legitimate expectations of foreign investors. This issue may play an important part when it comes to drastic changes in the tax policy of the host state, but it remains largely unexplored. Although the general rule remains that states are free to change the tax regime of foreign investors, it is clear that the principle of good faith protects the legitimate expectations of investors in specific circumstances. When a tax exemption for investments in a certain sector is installed by the government of the host state only to be cancelled just after a major investment has been completed, for example, the principle of legitimate expectations may come into play. More study is however needed on this issue.

Conclusions with respect to tax reform in Cambodia

Based on the review above of the prevailing principles in international law on the tax treatment of business and investment, the following conclusions are in order: 1. International investment treaties, trade agreements and other economic treaties incorporate fundamental principles that apply to the tax treatment of business and investment; 2. Cambodia has concluded many of these treaties, which are currently in force, including investment protection agreements, WTO agreements such as GATT and GATS and ASEAN-related treaties; 3. These treaties provide a legal basis/obligation for the Cambodia tax system for inter alia the following: a. Transparency of the tax audit and re-assessment process;

Kolb R., La Bonne Foi en Droit International Public, PU France, 2000.; OConnor Good Faith in International Law, Darmouth, 1991.; Rosenne, S., Developments in the Law of Treaties 1945-1986 (Chapter 3- Good faith in the codified law of treaties), Cambridge UP, p. 135-179.; Mani V.S. Basic Principles of Modern International Law, Lancers Books, 1993, p. 200-220.; Stuyt A.M., Good faith and bad faith, N.I.L.J., vol. 28, 1981.; Zoller, E., La Bonne Foi en Droit International Public, ed. A. Pedone, Paris, 1977.; Virally M., Review Essay: Good faith in public international law, AJIL, 1983, p. 130-134 39 Tammes (Netherlands), GAOR, 20th session, 6th Cmtee, 974th mtg, p. 199 (referring to good faith and the expectations that parties make while drafting an instrument, as noted by Mani, V.S. Basic Principles of Modern International Law, Lancers Books, 1993, p. 205; Fisheries Jurisdiction, Judgment, ICJ Reports, 1973, p. 57-58, par. 22-23 40 See for example TECMED v Mexico ICSID case No ARB(AF)/00/2 (Award) (May 29, 2003) par. 102; Azurix v Argentina, ICSID No. ARB/01/12, par 316

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b. Independent settlement of disputes and judicial settlement; c. Clarification and predictability of tax treatment; d. Non-discrimination; e. Due diligent tax treatment; and f. Respect for legitimate expectations of taxpayers.

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3. Suggestions for tax reform in Cambodia a) Encouraging businesses to operate as registered taxpayers

Problem posed
As was noted above, the basic distinguishing criterion in Cambodian tax law is the duty to register for tax purposes. All companies are required to register for tax purposes. Other businesses must register if and when certain thresholds are reached or are expected to be reached. As was already noted above, these thresholds are as follows41: taxable turnover in any period of 3 consecutive months exceeds 125 M KHR (goods) (approximately 30,000 US$) or 60 M KHR (services) (approximately 15,000 US$); or expectation to exceed taxable turnover in the coming period of 3 consecutive months of 125 M KHR (goods) or 60 M KHR (services); or having government contracts exceeding 30 M KHR.

In addition, there is an annual threshold, which is 500 M KHR in the case of the supply of goods of 250 M KHR for services. In fact, compliance with this rule is difficult to monitor. To assess whether the businesses that do not volunteer registration meet the threshold, the tax officials must have access to financial information that is usually not available. Furthermore it should be noted that the difference in tax implications and other compliance costs between a non-registered business and a duly registered taxpayer is substantial. The following are the main concerns in this regard: VAT: a taxpayer must on almost all supplies apply 10% VAT except for export. An unregistered business obviously does not have VAT charged on its goods and services; Withholding tax: a taxpayer must apply a 14% withholding tax on most remittances to foreign lenders, service suppliers, lessors and other recipients of most types of income except for the buying of goods. Resident withholding tax: a taxpayer must assume a 15% withholding tax when paying resident service suppliers, while unregistered taxpayers are not subject to this. Salary Tax: Taxpayers are subject to withhold salary tax for their employees which adds to the cost of labor, while unregistered taxpayers do not have to account for this.

41

Art. 2 Sub-Decree on VAT No. 114 ANKR.BK and .Prakas TOP

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Minimum Tax and Tax on Profit: unregistered taxpayers evade the 1% Minimum Tax calculated on turnover and the 20% TOP on the net profit. Compliance: taxpayers must on a monthly basis file at least 4 tax returns: the prepayment of TOP return, the VAT return, the withholding tax return and the salary tax return. As most taxpayers do not have sufficiently trained human resources, often tax officials are approached to do this, with obvious consequences in terms of transparency. The cost of the monthly returns may be estimated at US$150 to US$300 on average per month, which is too high for SMEs.

The combination of a relatively easy to avoid registration requirement with a high incremental tax- and compliance cost of operating as a registered taxpayer, results in high non-compliance by all those that do not need to have a corporate legal entity, or can afford to dispose regularly of corporate shell.

Options for reform

The Government is very much aware that the lack of proper taxpayer registration and the existence of the estimated regime is the most important obstacle to proper revenue collection and tax administration. It feels however that in the current situation, whatever the measures the Government may take, businesses are unlikely to respond. A part of the solution may be found in reducing the divide in terms of tax and compliance costs between registered and unregistered taxpayers. This could be done by (1) reducing the tax and compliance costs for registered taxpayers, or (2) increasing the tax and compliance costs for unregistered taxpayers or (3) both. As to reducing the tax and compliance costs for registered taxpayers, this may face opposition if such measures would result in a loss of revenue for the Government. Not all measures need to actually do that, however. It could be considered to: Provide in a concessionary TOP rate for certain newly registered SMEs; Provide in a temporary nominal TOP without compliance requirements for qualifying taxpayers; It should be noted that the TD has ahead adopted a model for bookkeeping for small tax payers; Provide in a temporary exemption or grace period for qualifying taxpayers; Change TOP and VAT compliance into quarterly returns; and Improve procedure and time for refunds of VAT.

As to increasing the tax cost of doing business as an unregistered taxpayer, the following measures could be considered: Provide in a withholding tax of 15% on buying goods from an unregistered taxpayer, not only on services; Improve administrative registration capabilities; Disallow receipts from unregistered taxpayers for TOP-deduction;

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Create a central register of taxpayers capable of identifying facilitators of repetitive non-compliance with corporations; and Create legal impediments to businesses that operate as unregistered taxpayers, such as inability to conclude certain types of contracts.

b) Clarification and simplification of tax laws and regulations

Problem posed
As was noted above, the Cambodian tax system is quite young. It was superimposed from modern jurisdictions without having the benefit of being based on existing legal concepts or a tax order. As a result, the meaning and workings of the tax laws are quite unfamiliar to most persons that must use them. The tax laws are complemented by few administrative regulations. There are no procedures for asking tax authorities for clarification of laws and regulations. The TD currently receives questions to and directs them to the Tax Policy office, but the resources to address these questions in an organized and timely manner are not available, so the questions are few in numbers. Most business transactions, leasing being a case in point (see below) currently raise questions in Cambodia as to the tax treatment. This can be said for TOP, VAT and basically all other taxes.

Options for reform

The following measures could be considered to improve the clarity and predictability of tax laws and regulations: Intensified program of issuing Prakas and Notifications by the MEF on a range of issues; Program to issue Prakas and Notifications from the framework of the Subcommittee; Create the possibility and administrative resources for a system of advance rulings; Program to issue Prakas and Notifications in the context of a large scale conference for tax reform; Create an independent dispute settlement system and publish the decisions (see below); and Create and publish an official commentary on the tax laws and regulations to be issued by TD.

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c) Improvement of taxpayer service with respect to tax registration

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Problem posed
A frequent complaint in the business practice of SMEs in Cambodia relates to the tax registration process. Normally this involves instances of payment of tax: Payment of the Registration Tax and Stamp Duty (first registration) The payment of the registration tax and Stamp Duty for the Commercial Registration Certificate can only take place within one week after the Ministry of Commerce (MOC) issues the Commercial Registration Certificate. The mount of Registration Tax payable is 100,000 in Khmer Riels and in the US Dollar equivalence of approximately $25; Patent Tax payment on Office Lease Agreement This tax payment is due by the Lessor/Landlord on an annual basis at the progressive rates determined by the TD; and Value Added Tax Registration;

This process is costly and time consuming. It is sensitive to abuse as well, as companies manage to register at times without a VAT registration number, or when the same operators are able to register company after company without ever complying with the tax obligations.

Options for reform

A major obstacle to reforming the tax registration process is the fact that various governmental departments are involved. Coordination between these departments is difficult. The following measures could be considered: One-stop registration at the Ministry of Commerce (MOC): The process could be reformed so that all payments of tax and submission of documents takes place at the MOC. The MOC would then have to remit the documentation to the other governmental departments. This process is to a certain extent similar to what is at present customary for companies that are registered at the Council for the Development of Cambodia. Simplification of the process: The process could be simplified by the TD no longer requiring stamps confirming the payment of tax on office leases at the Municipal tax office.

Recently, the MEF has indicated that it is in favor of these reforms. In fact the Tax Department has announced in the Government-Private Sector Tax Subcommittee on 3 December 07 that it will make a proposal to the MEF to introduce a one stop registration system with the Ministry of Commerce. The main features of this planned reform are: The TD will daily recuperate information on new registrations; Issue a letter with a taxpayer ID number that is to validated by payment of the appropriate tax;

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Registrants may pay the tax at the National Bank if they are clear about which tax indeed to pay; Registrants may consult the Tax Department offices in case of doubt.

Obviously this initiative is quite interesting and deserves to be followed closely. d) Improvement of transparency of the tax (re-)assessment process

Problem posed
Any body of rules needs independent dispute settlement to further develop and improve, and to ensure an effective practical operation. At present, the Cambodian tax law does not have a dispute settlement mechanism that is capable of playing that role. The LOT does provide in the procedure for appeal, arbitration and judicial settlement. The provisions read as follows:

Section 8 Settlement of the Taxpayers Protest Article 120: Rules for Administrative Protests

The rules for the settlement of the taxpayers protest on tax issues shall be as follows: 1. A taxpayer who is not satisfied with the tax re-assessment or other decision made by the tax administration can file a protest with the Director of the Tax Department. The protest must be limited to facts or other information contained in the tax re-assessment or the decision or the procedures of the tax re-assessment. 2. The administrative protest must be made in writing according to the form as stated in the article 121 of this law, and must be submitted to the tax administration within 30 days after the day the taxpayer receives the letter of notification for tax collection from the tax administration. 3. The administrative protest does not relieve the taxpayer of any obligation to pay various taxes, additional taxes, and interest as specified in the letter of notification for tax collection. Article 121: Contents of the Administrative Protest by the Taxpayer

An administrative protest can only be accepted if the letter of protest has the contents as below: 1. identification number of the taxpayer who makes the letter of protest, if available; 2. reference to the assessment, decision, or results which are the objects of the letter of protest; 3. 4. facts or acts which are objects of the letter of protest; reasons of the protest;

5. date and signature of the taxpayer and signature of the taxpayers authorized representative if necessary.

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Article 122: Decision by the Tax Administration

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The tax administration must issue a new decision within 60 days after the date the letter of protest is received to confirm the correctness or incorrectness, in whole or in part, of the tax assessment or other decision that the taxpayer disputes. The tax administration shall also state the basis of this decision. If the taxpayer does not accept this new decision of the tax administration he can file a letter of protest to the Committee of Tax Arbitration within a period of 30 days. Article 123: Committee of Tax Arbitration

The organization and functioning of the Committee of Tax Arbitration shall be determined by sub-decree upon proposition of the Minister of Economy and Finance. Article 124: Appeal to the Court

The taxpayer has the right to appeal to the competent court against the decision of the Committee of Tax Arbitration within a period of 30 days after receiving notification of that decision. The taxpayer must deposit in the national treasury an amount of money equal to the taxes, additional taxes, and interest under dispute and as assessed by the tax administration before filing the appeal to the court.
The following problems can be noted at this time with respect to the dispute settlement procedure: The TD may not have the necessary resources to take a decision on the administrative appeal by taxpayers within 60 days as required by law because in practice this rule is not respected; At present, the appeal process is not transparent in terms of motivation and evidence relied upon by the TD to decide on the appeal; There is no official procedure for the taxpayer to complain about the application or interpretation of the tax law by officials prior to the issuing of the reassessment notice; The Tax Arbitration Committee is not established. This means that no independent review is available at the administrative level; and Judicial review is only possible after rejection by the Tax Arbitration Committee, which does not exist, so in theory there is no judicial remedy open to the taxpayer either (unless Cambodian courts would judge themselves competent anyway).

An effective dispute settlement system would protect the taxpayer from unreasonable or illegal reassessments by the auditing tax officials, whereas now such protection is not readily available.

Options for reform

In due course, the following measures may be considered: Capacity building for TD officials engaged in dispute settlement;

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Implementation of the Tax Arbitration Committee;

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Creation of a consultative committee of experts that renders a non-binding recommendation on a dispute; Introduction of binding arbitration in tax matters; Capacity building for judiciary; and Ombudsman in tax procedures.

The MEF has indicated to be open to these reforms but is of the view that first some experience with the ruling-system should be developed. e) Increasing the predictability of the taxation of SME business activity

Problem posed
Against the background of unclear tax laws and lack of dispute settlement mechanisms, it is not surprising that businesses often will not be able to assess the tax consequences of their activity, and may resort to tax evasion rather than taking the risk that the official tax treatment of an income or transaction turns out highly unfavorable.

Options for reform

The following measures may be considered: Advance Pricing Agreements resulting in a fixed tax cost for typical business activities; Rulings on the tax treatment of income and expenses: an effective procedure with clear and timely outcome to determine in advance how an income or an expense will be treated for tax purposes. This requires the creation of small team of high level officials (ruling-committee) possibly supported by technical assistance; Create and publish an official commentary on the tax laws and regulations to be issued by TD. Creation of a consultative committee of experts that renders a non-binding recommendation on a dispute; Introduction of binding arbitration in tax matters; Ombudsman in tax procedures.

f) Modernization of certain older tax laws

Problem posed
Some of Cambodias tax laws which were not addressed by the Law on Taxation are difficult to apply in the context of the present economic and business situation. The Patent Tax law,

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for example, requires businesses to pay a registration tax per type of activity they perform. When companies want to carry out more than one activity, problems of interpretation arise. Another example would be the Transfer Tax. The law for this tax only comprises a handful of articles. Nevertheless, it covers important transactions such as sale of real estate and vehicles. For the purposes of Transfer Tax, it is not clear if a transfer of real estate by order of a court, inheritance or expropriation would be subject to tax since the limited language of the articles does not address these cases.

Options for reform

The following measures could be considered: Modernization of Stamp Duty, Patent Tax, Transfer Tax, Tax on House and Land Rent, Excise Tax, Turnover Tax; Replace Patent Tax, Transfer Tax, Tax on House and Land Rent and Stamp Duty by one modern Registration Tax Law;

g) Improve the distribution of information on tax compliance requirements among SMEs

Problem posed
In general, the knowledge on even the most basic tax obligations is poor among businesses. Businesses are not aware of the details of their tax obligations, base themselves at times on word-to-mouth incomplete information and do not know which liabilities they incur by not complying with tax laws. Our review has identified the following contributing factors to this problem: There exists no free or payable collection of tax laws and regulations available to the public. Even basic regulations are not readily available and not even the collection kept by expert firms seems to be complete; Only for VAT a simple, practical guideline exists. Tax on Profit, Transfer Tax, Withholding Tax , Specific Tax and Excise Tax do not have any information written in language that can be understood by SMEs; The TD does not seem to have the resources to organize a sufficient number of public and free seminars which are meant to inform taxpayers of the practical working of the tax laws; No organized question point exists for businesses to obtain clarification on the application of tax laws

Options for reform

The following measures could be considered to improve the distribution of information among SMEs: Compile a free and complete collection of tax laws and regulations for the public; Create and publish an official commentary on the tax laws and regulations to be issued by TD;

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Organize regular free seminars to explain tax compliance issues in a practical manner to a business audience; Create the possibility and administrative resources for a system of advance rulings on the interpretation and application of the tax laws (see above);

4. Conclusions Based on our experience and the observations noted above, we have the following conclusions for tax reform in Cambodia. 1. The gap in tax and compliance cost between registered and unregistered businesses remains a crucial obstacle to a systematic modern tax system. From the perspective of businesses the competitive disadvantages of adopting the VAT regime while the competitors do not, cannot be overcome lightly. At the same time, however, noncompliance clearly mortgages the future growth potential of the business as well as its transferability. Important liabilities are built up as long as the business continues to operate without complying with tax laws. Encouraging compliance (including by making compliance easier and less costly and by simplifying the process of registration itself) by businesses is in our view and important element in enabling enterprises to achieve some degree of financial, accounting and economic maturity. 2. Taxation must first and foremost be predictable and clear so as to not impede business and investment. In Cambodia, the transparency of the tax system would firstly greatly benefit from an intense program of tax regulations, clarifying or establishing the official administrative position on dozens of questions that affect the taxation of business. The TD however lacks the human resources to achieve this at present. Secondly, a procedure providing in rulings (for which there is an existing legal basis) would dramatically improve the predictability of the tax system. Thirdly, an independent and efficient tax dispute settlement system would contribute much to the clarity and predictability of the tax system. 3. In our view, in order for the Cambodian tax system to become fair and equitable in accordance with the prevailing international legal principles on the subject, and to empower businesses, an independent judicial or quasi-judicial procedure must be implemented to settle disputes. Against the background of the stalled implementation of the Tax Arbitration committee, alternative dispute settlement mechanisms may be considered, including arbitration (for which there is an exiting legal basis) or nonbinding decisions by expert bodies. This reform could take place as a logical consequence after implementing rulings (see above). The following synoptic table gives an overview of the objectives and possible measures.] Objective Possible Measures Encouraging businesses to Provide in a concessionary TOP rate for certain newly operate as registered incorporated SMEs; taxpayers Providing a temporary nominal TOP without compliance requirements for qualifying taxpayers;

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Provide in a temporary exemption or grace period for qualifying taxpayers; Change TOP and VAT compliance into quarterly returns; Improve procedure and time for refunds of VAT. Clarify and simplify tax laws Intensified program of issuing Prakas and Notifications by the MEF on a range of issues; Program to issue Prakas and Notifications from the framework of the Subcommittee; Create the possibility and administrative resources for a system of advance rulings; Program to issue Prakas and Notifications in the context of a large scale conference for tax reform; Create an independent dispute settlement system and publish the decisions (see below); Create and publish an official commentary on the tax laws and regulations to be issued by TD. Improvement of taxpayer service with respect to tax registration One-stop registration at the Ministry of Commerce (MOC) Simplification of the process Improvement of transparency of the tax (re)assessment process and settlement of disputes Capacity building for TD officials engaged in dispute settlement; Implementation of the Tax Arbitration Committee; Creation of a consultative committee of experts that renders a non-binding recommendation on a dispute; Introduction of binding arbitration in tax matters; Capacity building for judiciary; Ombudsman in tax procedures. Increasing the predictability Advance Pricing Agreements resulting in a fixed tax of the taxation of SME cost for typical business activities; business activity Rulings on the tax treatment of income and expenses; Create and publish an official commentary on the tax laws and regulations to be issued by TD;

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Creation of a consultative committee of experts that renders a non-binding recommendation on a dispute; Introduction of binding arbitration in tax matters; Ombudsman in tax procedures. Modernization older tax laws of certain Modernization of Stamp Duty, Patent Tax, Transfer Tax, Tax on House and Land Rent, Excise Tax, Turnover Tax; Replace Patent Tax, Transfer Tax, Tax on House and Land Rent and Stamp Duty by one modern Registration Tax Law; Improve the distribution of information on tax compliance requirements among SMEs Compile a free and complete collection of tax laws and regulations for the public; Create and publish an official commentary on the tax laws and regulations to be issued by TD; Organize regular free seminars to explain tax compliance issues in a practical manner to a business audience; Create the possibility and administrative resources for a system of advance rulings on the interpretation and application of the tax laws (see above);

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PART B. Tax Reform of Leasing As part of our assignment, we provide you with our advice on tax reform with respect to financial and operating leasing. Our methodology is as follows: 1. Identification of impediments to leasing in terms of treatment that is unfavorable compared to asset financing; 2. Withholding tax regime and options for reform; 3. Tax on profit depreciation regime and options for reform; 4. Tax point and recognition of income regime and options for reform; and 5. VAT regime and options for reform. For each impediment, we have considered the following elements for the option for reform and cited remarks where necessary: Level of difficulty to prompt reform from a procedural perspective; Impact of the reform on operators; Impact on government revenue; and Systematic nature of the law.

1. Leasing under current Cambodian tax law as viewed by the report A Proposed Framework of Modern Leasing The report A Proposed Framework of Modern Leasing in Cambodia (the Report) identifies the following regulations as resulting in an unfavorable tax treatment of leasing as compared to finance of assets: 1) Domestic withholding tax of 10% for rental of movable property (Art. 25 LOT); 2) Depreciation for TOP purposes by lessee only (Art. 13 LOT); 3) Time of supply for TOP purposes requires full payment of VAT upfront at inception the lease in the case of finance lease (Sec. 4.1 Prakas TOP); and 4) Time of supply for VAT in the case of finance lease is the time of delivery of the goods (Art. 48 Sub-Decree VAT). In addition, the Report suggests that leasing should be zero-rated for VAT purposes to compensate for perceived competitive disadvantages leasing has as compared to finance of assets. We have taken the points that were identified by the Report as a basis for our review.

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2. Input from Private Sector interviews

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We have conducted interviews with the following private sector enterprises to assess their views on the Cambodian tax system with respect to leasing. Note that some interviews with other enterprises are still pending. RM Asia ANZ Royal Acleda bank Cambodia Public bank GE Capital

The following preliminary conclusions can be drawn from those interviews: 1. Many divergent views exist on the current tax system applicable to leasing transactions: some enterprises are thoroughly misinformed about the application of withholding tax and VAT liability in this regard; 2. For most lessors, the withholding tax obligation is a matter solely concerning the lessee and as such it is not much taken into account; 3. Every respondent felt that the uncertainties in the tax and regulatory field as much as any particular taxation poses a difficulty for their business; 4. Besides taxation, respondents frequently cited lack of enforcement of restitution of goods as a problem; 5. Some but not all of the banks felt no need to depreciate leased assets; 6. The larger operators felt that the current tax system renders leasing clearly less competitive compared to finance. 3. Withholding tax (residents) paid for rent of movable property

Tax regime: rent

Under Cambodian tax law, withholding taxes (WHT) apply differently depending in first instance on the residence of the recipient. When the recipient of the income is a resident of Cambodia, the general withholding tax or rather the resident withholding tax applies. This provision (Art. 25 LOT) reads as follows:

1. Any resident taxpayer carrying on business and who makes any payment in cash or in kind to a resident taxpayer shall withhold, and pay as tax, an amount according to the below mentioned rates which are applied to the amount paid before withholding the tax: a. The rate of 15 percent on: - income received by a physical person from the performance of services including management, consulting, and similar services; - royalties for intangibles and interests in minerals, and interest paid by a resident taxpayer carrying on business other than domestic banks and saving institutions to a resident taxpayer. b. The rate of 10 percent on the income from the rental of movable and immovable property.

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c. The rate of 6 percent on interest paid by a domestic bank or savings institution to a resident taxpayer having a fixed term deposit account. d. The rate of 4 percent on interest paid by a domestic bank or saving institution to a resident taxpayer having a non-fixed term saving account. 2. The withholding in this article shall not apply to interest paid to a domestic bank or savings institution and to the payment of tax exempt income as stated in article 9 of this Law.
The Prakas TOP provides further guidance as to the interpretation of the resident withholding tax in Sec. 8.2.1:

The rate of 10% on income from the rental of a movable or immovable property: for the purpose of the withholding tax, an income from the rental of a movable or immovable property refers to an amount in cash or in kind paid by the rentee in consideration for the use of a movable property such as an industrial, commercial, technical, scientific equipment ... or an immovable property such as land, house, other constructions, ... In this, an immovable property shall include all other properties accessory to it as well as the right to act in accordance with the law on land ownership, the right of usufruct, and any other right which can bring about a payment in cash or in kind in a specified or unspecified amount.
It should be noted that Cambodian tax regulations do not classify a lease payment in connection with a financial lease (a concept which is not defined in tax law) as interest. The notion of interest for withholding tax purposes is the same as for deductibility. It is defined in the Prakas TOP as follows (Sec. 5.9.1 Prakas TOP of 12 December 2003). The term interest refers to an amount paid by a debtor to a creditor in respect of money owing by the debtor to the creditor. Interest is a consideration for the loan of the money or for the forgiveness to sue for credit provided in the form of goods or services. Interest includes mainly: a1a2an amount paid or accrued under a debt obligation which is not a return of capital; any discount, premium, or similar payment.

Interest?
It could conceivably be argued that the obligation to pay the capital of the lease is also a debt obligation of some sort, but that is not quite in accordance with the definition that is used for tax purposes of debt obligation found in Sec. 5.9.b. Prakas TOP. (The term debt obligation refers to the obligation to pay an amount in cash or in kind to another person and includes the obligation of a bank or other financial institution with regard to a deposit, the obligation with regard to an account payable, a bill of exchange, a bond, ...). We have ascertained that it is currently the position of the Tax Department that lease payments fall under the scope of Sec. 8.2.1. (rent) rather than under Sec. 5.9.1. (interest) Prakas TOP.

Services?
It is also noteworthy that leasing and renting of properties are excluded from the scope of withholding tax for services (Sec. 8.2.1 a) Prakas TOP). It is recalled, incidentally, that the

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withholding tax for services by residents is exempt subject to the condition that the service fee is clearly identified on a proper VAT invoice from the service provider (Sec. 8.4.2 Prakas TOP).

Options for reform

Various options lay open to the MEF if one wanted to change the WHT treatment of leasing. We overview these options, together with their advantages and disadvantages. 1) Exemption of WHT for lease payments: The Report suggest as the sole remedy that lease payments could be exempted from withholding tax when paid to banks or savings institutions, as is now the case with interest. An amendment to the LOT in this sense would certainly be clear, but has the disadvantage of being a very long procedure that requires the adoption by the National Assembly and the Senate. Creating a different, special category of income for lease payments in terms of WHT is not customary in international tax law (see for example Art. 13 UN 2001 Model Tax Convention). The usual solution is to treat leasing income as rent with special rules applying to financial leasing. With respect to Cambodias upcoming negotiations on double taxation agreements (DTA), the reduction of WHT on lease in the LOT could be seen by the MEF as a measure that undercuts the bargaining position. In other words, because of the exemption of WHT for leasing in domestic relations, other countries will expect a reduction of WHT for cross border leasing as well. Advantages Highest legal basis Disadvantages Slow to implement Another classification of income Undercuts DTA-negotiations

2) Treat leasing as payment of interest: The LOT does not define the notion of interest or the notion of rent. Both are defined in the Prakas TOP. This means that it would be possible for the MEF to revise the definitions of each term in the Prakas TOP so as to treat payments in the context of a financial lease as interest or capital payment rather than rent. In other words, a distinction would be introduced in Cambodian tax law between rent and lease. The disadvantage of this approach is that the LOT does make it clear that there is a classification of income which is rent of movable goods and therefore there must be a distinction as to which is rent and which is not. That distinction will have to be in line with the leasing law but there is no reason why the tax treatment would have to wait for that law to come into force. Under this approach, the lessee would have to be able to show a schedule of payments to classify any periodical payment. In other words, only with a schedule could one determine what is interest and what is capital repayment. It is not likely that this change would affect the amount of non-resident WHT unless different rates would be introduced for each classification of income. That is likely to be the case at a later stage when DTAs are concluded, but such a problem could be

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addressed in the Protocol to a DTA should the need arise, or by including lease income under other income connected with the use of property (Art. 26 b LOT). There is an important disadvantage to this approach. The payment of lease income would fall under the exemption for interest paid to domestic banks and savings institutions. For other leasing institutions, however, qualifying lease income would be subject to 15% WHT rather than the current 10% (As you know, the current Draft Leasing Law provides that banks and financial institutions but also leasing institutions may be licensed for financial leasing Art. 34). This may be a factor if the MEF is set on giving non-banks access to the leasing market as well. If that is the case, this option is not feasible. In terms of procedure, a new Prakas would need to be issued that would be incorporated at a later stage in the Prakas TOP. Advantages Implementation by regulation possible Schedule needed No problem for DTA negotiations Disadvantages Only suits banks and financial institutions What remains rent?

3) Treating leasing as a service for WHT purposes It should be noted that under Cambodian tax law, payment of service fees to a Cambodian tax registrant is not subject to WHT. This is provided in the Prakas TOP, which reads as follows:

2Exemption of the withholding tax on the income of a legal person enterprise in real regime: aThe withholding tax shall not be applied on the income from the performance of services including management, consultancy, and similar services of a legal person enterprise which has been registered under the real regime system of taxation. bFor all cases as stated in sub-paragraphs a of this paragraph, an amount shall be exempted from the general withholding tax if that amount has been recorded in an invoice issued by the receiver of the money and which invoice must be made clearly and must contain all information as stated in the Prakas No 341-PK-MEF-TD, and the Prakas No 342-PK-MEF-TD, dated 30 May 1997 of the Ministry of Economy and Finance. cThe payor is responsible to the tax administration for any amount of the general withholding tax for which the payor has decided not to withhold by determining that the relevant income meets the conditions as stated in subparagraph a and b, of this paragraph, or for any other reason.
Along the same lines of the option discussed above, the MEF could consider to reform its regulations so that all or some types of leasing would qualify as a service rather than a rent of movable goods. Effectively, this would normally result in a WHT exemption for payments made to resident enterprises that are registered real regime taxpayers. In terms of procedure, a new Prakas could be issued that will be incorporated at a later stage in the Prakas TOP. As was mentioned above, the current Prakas TOP states that a service does not include rent or lease. Advantages Disadvantages

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Implementation by regulation possible Applies also to non-banks Not very systematic What remains rent?

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4) WHT credit more effective for the lessors: Under Cambodian tax law, any WHT withheld by the lessee would constitute a credit for the lessor. The effect of this credit is explained in Sec. 9.3. Prakas TOP as follows:

1- The determination of the tax on profit due or the tax credit for the tax year shall be as follows: a- If the result from the calculation in section 9.2 of this Prakas is greater than the sum of any withholding tax made on behalf of the taxpayer in accordance with the provisions in chapter 8 of this Prakas, and the prepayments for the tax on profit made by the taxpayer for the tax year under new article 28 of the Law on the Amendment of the LOT, the taxpayer shall pay the difference to the tax administration. b- If the result from the calculation in section 9.2 of this Prakas is smaller than the sum of any withholding tax made on behalf of the taxpayer in accordance with the provisions in chapter 8 of this Prakas, and the prepayments for the tax on profit made by the taxpayer for the tax year under new article 28 of the Law on the Amendment of the LOT, the taxpayer may apply for a refund of the difference, or carry forward the difference to be used as a prepayment in the following year.
In practice, however the refund of any excess WHT applied on behalf of the lessor is not remitted back to the lessor in a timely manner. In fact it is that which creates a tax cost for leasing in Cambodia, rather than the existence of a WHT in the law and regulations. In theory, any WHT applied by customers in the context of a leasing contract is fully creditable with the lessors TOP and Minimum Tax liability. The problem arises if the WHT exceeds the tax due by the lessor, because in that case a refund is in order. Delays in the refund would result in the transaction becoming economically unviable. In principle, in other words, the application of a domestic WHT does not present any cost of business for any type of leasing in excess of the CIT applicable in Cambodia to the lessor anyway. The practical application of this credit at present does present difficulties and costs to the lessor. This is because (1) there is no effective and timely refund in case the WHT credit would exceed TOP liability of the lessor and (2) there is no official documentary system in place to ensure the veracity of credit claims. Therefore, alternatively, the MEF could ensure that the application of a 10% WHT on lease and rent does not constitute a cost of business for the operation. This could in part be achieved by fully applying the current provisions of the LOT concerning the determination of the tax due of a tax year and the reimbursement of excess WHT applied on behalf of the taxpayer (Art. 38 LOT). The MEF could approach the issue from this angle, ensuring a full and effective tax credit for WHT on rent payments to banks. The MEF could even consider to create a refund procedure separate from the TOP returns. Advantages Guaranteed no loss of revenue for Treasury Implementation by regulation possible Disadvantages Need new compliance system Procedure for refund must be ensured

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Applies also to non-banks Current classification remains What if refunds fall behind?

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Note: Informally the TD has informed us that there may be considerable opposition to canceling the WHT for leasing any manner.
4. Tax on Profit depreciation of leased assets

Tax regime
Under Cambodian tax law, the party that is entitled to depreciations of assets is either the owner or the lessee. This is provided in Art. 13 LOT which reads in relevant part as follows: In determination of taxable profit, a deduction for depreciation shall be allowed to the owner of a tangible property, or to the lessee of that property in the case where the lessee bears the risk of loss or destruction of that property as determined by Prakas of the Ministry of Economy and Finance The Report has commented on this provision that the risk of loss is not relevant to the question of ownership. The Report suggests that assets should be depreciable for the lessor rather than the lessee, and that the lessee shall deduct the lease payments as expenses. However, the question could be raised if this issue really needs reform. If the objective of the reform is to grant depreciations to lessors, this will of course automatically result in lessees having none.

Option for reform

The comments in the Report criticizing the current depreciation treatment are difficult to understand. In fact, the law does not prevent in any way that the lessor would depreciate the assets as long as he has the risk of destruction. In our view, there does not seem to be any provision in the Draft Leasing law (see for example Art. 16 and 17) which prevents the parties from agreeing that the risk of loss shall be for the lessor. No change/implement by lease agreements As the text of Art. 13 LOT itself indicates, the matter of depreciation of leased assets depends on the allocation of the risk of loss. How strict or liberal that must be interpreted is very much a question of regulation by the Prakas that is to be issued under that provision. Advantages No regulation needed Disadvantages Excludes lessors that do not want to assume the risk of destruction Impact of insurance premiums

What is risk? Definition by Prakas The notion of risk is not defined by Art. 13 LOT, and may thus be regulated by Prakas or by other measures. In that sense, it is legally possible in our view to define this notion in such a

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way that normally in common lease transactions the lessor will be seen as the party that has the risk of destruction, not the lessee. Advantages Implementation by regulation Flexible Disadvantages Eliminates depreciations by lessee

5. Tax point and recognizing leasing income

Tax regime
It should be noted that the Draft Leasing Law provides in the possibility of advance lease payments (Art. 7). Cambodian tax regulations provide in special rules for income recognition in the case of hire purchase or finance lease and in the case of supply of goods under rental agreements or supply under periodic payments for successive parts. Sec. 4.1. of the Prakas reads in this respect as follows: d) For goods supplied under a hire purchase agreement or a finance lease, the time of supply is the time by which the goods are delivered, whether that delivery takes on the characteristic of a transfer of the right to use or to dispose. e) Where goods are supplied under a rental agreement, or goods or services are supplied under an agreement or law which provides for periodic payments, or where there is a continuous supply of services, such goods or services are treated as successively supplied for successive parts of the period of the agreement, and the time of supply of each successive supply is the earlier of the date on which the payment is due and the date on which the payment is received. It is noteworthy that for financial services, the same regulation provides that the income accrues to the taxpayer as stated in the contract or at the moment of payment of the interest, should that be earlier (Sec. 4.1.2. d Prakas TOP). The Report has deduced from Sec. 4.1 of the Prakas that in case of hire purchase or finance lease, the tax point would inevitably be the moment of delivery of the asset. For that interpretation to be correct, one would have to assume that paragraph d) of Sec. 4.1.2. has priority over paragraph e) of the same section when it comes to financial leasing, even if the lease price is not paid in advance. Although that is certainly not an unreasonable interpretation, it is not the only one. It is not a foregone conclusion that both paragraphs are to be read as mutually exclusive. Paragraph e) addresses the special case of supply with periodic payments while paragraph d) regulates the case of the undefined hire purchase and finance lease. One could argue that a finance lease which provides in periodic payments may be classified under both paragraphs. In that case, under generally acceptable principles of interpretation, the taxpayer does not violate one paragraph by complying with the other. As a result, the taxpayer is not required to recognize the income at the inception of the lease, but he is entitled to do so if he so wishes.

Options for reform

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1) Clarification of Prakas TOP: The MEF could, by a mere Notification, clarify that a financial lease of hire purchase that provides in periodic successive payments, resorts under paragraph e) of Section 4.1.2. Prakas TOP. No change in the LOT or the Prakas would be required. Advantages Implementation is simple Applies to all taxpayers Disadvantages Remains an interpretation by TD

2) Amendment of Prakas TOP: Alternatively, the MEF could amend the regulation on rent, financial lease and financial service. No change in the LOT is required. Advantages Implementation by regulation, not law Can be revoked Disadvantages

Note: Informally the TD has informed us that to agree with the interpretation above under 1) and that indeed such a Notification may be issued.
6. Leasing under VAT law and time of supply for VAT purposes

Tax regime
Under Cambodian VAT law it is clear that at present, financial leasing and hire purchase as well as rent are all considered VAT-taxable supplies. This can be derived from the provisions of the Sub-Decree and the Prakas on VAT which both contain references to the time of supply for VAT purposes for these types of transactions, although they are not defined. In other words, the exemption for primary financial services noted in Art. 57 paragraph 5 LOT does not seem to apply to leasing in general (or at least not to the concepts of leasing referred to in the Sub-Decree and the Prakas). As a matter of principle, the fact that the performer of the VAT-taxable service is a bank or financial institution licensed under the Law on Banks and Financial Institutions (with reference to Art. 2 of that Law) is not relevant for VAT law unless leasing would in that case be treated as a primary financial service. As discussed in our meeting, the MEF is currently considering to issue a Prakas to define the concept of primary financial services in this respect. Unfortunately, as tax law is autonomous public law, it is important to note that the mere mention of leasing as an allowed operation for licensed banks does not the status of that operation for the purposes of tax law. As was pointed out in the Report, Cambodian tax law now provides that the time of supply (which is the tax point for VAT purposes) for a hire purchase agreement or finance lease is at the moment of the delivery of the goods. The same provision points out, however, that where goods are supplied under a rental agreement; or goods or services are supplied under an agreement or law which provides in periodic payments; or there is a continuous supply of services, the goods or services are treated as successively supplied for successive parts of the period of the agreement, and the time of each successive supply occurs on the earlier of the date on which payment is due or received (Art. 48 Sub-Decree on value Added tax). The Report has, as in the case of TOP, deduced from Art. 48 of the Sub-Decree that in case of hire purchase or finance lease, the tax point would inevitably be the moment of delivery of the

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asset. As we noted above, although that is certainly not an unreasonable interpretation, it is not the only one possible in view of the entire text. It is not a foregone conclusion that paragraphs 2 and 3 are to be read as mutually exclusive. Paragraph 3 addresses the special case of supply with periodic payments while paragraph 2 regulates the case of the undefined hire purchase and finance lease. As is possible in the case of TOP, one could argue that a finance lease which provides in periodic payments may be classified under both paragraphs. In that case, under generally acceptable principles of interpretation, the taxpayer does not violate one paragraph by complying with the other. As a result, the time of supply for VAT purposes is in fact per successive payment rather than at the inception of the lease. The Report also recommends the MEF to exempt lease transactions of one year or more. The Report cites that after a leasing industry has been established this could be phased out. We consider this an issue of pure fiscal policy which may come up in the course of the consideration of the draft Prakas on primary financial services referred to above. One remaining and rather complicated issue is that of the application of the input credit ration to banks that engage in leasing transactions. Unless banks will be exempted from VAT when leasing assets to customers, they will have to be granted a VAT input deduction for the acquisition of the assets. The calculation of the input VAT ratio is however quite complicated in the case of banks. For all VAT taxpayers a ratio can be calculated in two ways to determine which portion of the input VAT may be deducted from output VAT in case the taxpayer has VAT-taxable and VAT-non taxable transactions. To carry out these calculations, the turnover of the taxpayer must be determined and there is little guidance as to what constitutes turnover for a bank at this time.

Options for reform

1) Definition by Prakas of primary financial service As was pointed out above, the MEF is currently reconsidering the VAT aspects of financial services. It is not clear whether leasing will be included in the final version of the Prakas that is currently being drafted. In that context, the MEF could issue a Prakas to define primary financial service and include (certain types of) leasing as exempted from VAT. This would in any event also necessitate the revision of the Sub-Decree and the Prakas on VAT, which still refer to leasing as a VAT-taxable transaction. No change in the LOT is however necessary. From a policy perspective, VAT on leasing is by the TD viewed against the background of what they see as massive non-compliance by taxpayers on VAT and the doubtful true VAT status of many banks. In other words, the TD views that many more financial services should be subject to VAT than in the present practice by most banks. At present, no bank is registered as a VAT-taxpayer. This means that most banks must maintain a wide interpretation of primary financial services in the absence of a more limited regulation by the TD. The problem of VAT on leasing has different considerations from the TD perspective. The most important ones are as follows: Will lessors be able to lease assets on which no VAT or customs duty was paid? Will lessors be able to offset input VAT on assets with output VAT on non-leasing operations?

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Will lessees be able to deduct more input VAT in the course of a lease than in the course of finance of assets?

By defining primary financial services by Prakas, leasing itself will be included in the scope of VAT supplies or will be excluded from being a taxable supply. Advantages Implementation by regulation, not law Revenue effect likely low Disadvantages The issue of non-banks If lease is subject to VAT, define ratio?

2) Clarification of Sub-Decree on VAT: The MEF could, by a mere Notification, clarify that a financial lease of hire purchase that provides in periodic successive payments, resorts also under paragraph 3 of Art. 48 Sub-Decree VAT. No change in the LOT or the SubDecree would then be required. Advantages Implementation by regulation, not law Flexible to provide conditions Disadvantages

3) Amendment of Sub-Decree on VAT: Alternatively, the MEF could amend the SubDecree on rent, financial lease and financial service. No change in the LOT (Art. 62 LOT) would be required. Advantages Disadvantages Needs amendment in Sub-Decree

Note: Informally the TD has informed us that there is agreement to exempt leasing for banks and financial institutions in accordance with 1) above, subject to final approval by the MEF.
***** We hope these observations are helpful to you. Please do not hesitate to contact us in case you have any query. ***** Qualification Our tax advice is based on our understanding of publicly known Cambodian laws, regulations and official practice. Any tax calculation in this advice is for illustration purposes only and does not engage our responsibility. There may however be instances where the unofficial practices applied by tax authorities are not in accordance or even contradictory to the Cambodian law. More importantly, as judicial interpretation of tax laws is at present not available, it can never be excluded that the tax authorities or the courts adopt an interpretation or application of tax laws which is not in accordance with our advice. We may furthermore not be aware of all laws

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and regulations that apply to your situation as not all are published. Also, the tax authorities or courts may translate laws, regulations and corporate documents differently from the ones adopted for this advice. **** Very truly yours DFDL MEKONG

Senior Tax Advisor Head of the Indochina Tax Practice

Edwin A. Vanderbruggen