Will businesses pull out of Cambodia over tax reforms?

Gerald Flynn

Left unaddressed, excise grievances could translate into real economic self-harm

Left unaddressed, excise grievances could translate into real economic self-harm

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Kong Vibol, director-general of the General Department of Taxation, took to the stage at The Great Duke Hotel in Phnom Penh to address the crowd assembled for the European Chamber of Commerce’s Tax Forum.

“Reform never ends and that applies to developed countries as well,” proclaimed Kong at last week’s event, hinting at the elephant in the room. While reform under Kong’s leadership may never end, the patience of the business community appears to be reaching its end.

Grumblings among the business community have been growing louder of late, following the 2016 reforms that the General Department of Taxation (GDT) used in a bid to bring the Kingdom’s tax regime in line with international standards.

The abolition of the Estimated Regimes on Taxation was widely praised, in the face of wide corruption it tackled.

In fact, the World Audit 2015 Corruption Rankings depicted Cambodia as the most corrupt nation in Southeast Asia.

Globally, the Kingdom was ranked 133rd out of 150. Similarly, in 2016 – before the self-assessment tax regime was introduced – TRACE International research found Cambodia was the fifth country most at risk of business bribery in the world.

TRACE International’s 2019 Bribery Risk Matrix saw Cambodia jump up just one place in business bribery risk measurements, although the Kingdom’s overall score went from 92/100 in 2016 – with 100 being the most susceptible to bribery – to 79/100 in 2019.

While EuroCham led the charge in raising issues that many businesses – in particular foreign-owned businesses – have found challenging, the discussion was as ever diplomatic and perhaps masked some of the more grievous discontent that is reportedly simmering quietly away among business owners.

Grievances take many forms

These grievances arise in many forms, but there is a very real fear on behalf of businesses about speaking out. One foreign business owner who wanted to see a light shone on these issues would only discuss them with Capital Cambodia on condition of anonymity. He explained why business owners were reluctant to speak out.

“The GDT has, in the past, been known to be quite vindictive,” he says, adding that many of his fellow entrepreneurs feel the same, but are uncomfortable raising their heads above the perceived parapets.

“The punitive tax audits are the big issue. Many companies that are audited are then fined – they’re given two options: either shut down under the cost of the fine or go underground,” he explains, noting that many of the companies he sees as affected have been compliant with Cambodia’s tax regime for years but now feel cheated by harsh penalties that are seemingly being conjured up by tax auditors for profit.

Many of them, he says, are international businesses and nongovernmental organisations (NGOs) that have operated in Cambodia for years but are now considering abandoning the Kingdom.

New leadership, new direction

Kong Vibol has widely been seen as a man of vision, leading Cambodia’s tax department into the 21st century and stamping out a lot of the under-the-table payments that had characterised the nature of doing business in the Kingdom. His professionalisation of the GDT was praised and revenue generated through tax has shot up in recent years, having already reached $2.4 billion in the first 10 months of this year.

This is an increase of 28.31 percent from the same period last year and is typical of the annual growth in tax revenue that the Kingdom has recently enjoyed. From collecting just $1.06 billion in 2014, this jumped to $1.3 billion in 2015, $1.5 billion in 2017 and $2.19 billion in 2018. Clearly a nation doubling its tax revenue in under five years is doing something right, but it comes at a cost.

“The GDT tripled the number of auditors on staff. They’ve made the auditing process more rigorous – mandatory annual audits are part of the problem, but the real issue is the incentivised nature of the audits,” claims a source familiar with the matter, before explaining that auditors now receive 10 percent of the fines brought against non-compliant companies.

He states that since last year the GDT has become less flexible, less willing to negotiate over the fines from audits – and it is killing businesses – especially small and medium enterprises (SMEs) that are less able to foot a hefty tax bill.

Taxed to death

Disputing the outcome of audits, he says, is almost impossible – given the one-month time frame in which a business can challenge the outcome of an audit. He claims the GDT rely on bureaucracy to ensure that disputes are never addressed before that window of opportunity closes. To this day there is no third party arbitrator who can review this and so the GDT, he argues, has control over the entire process.

“The GDT is pushing employers away from Cambodia and shutting down businesses – you know 40 percent of their revenue comes from audit penalties? Combine this with Thailand losing its GSP [Generalised System of Preferences] status on a range of products going to the US, so more Cambodian migrant workers will return home, the potential loss of the Everything but Arms status here – this will have grave implications for the Kingdom’s economy,” he says, adding that this will affect everyone from SMEs, to NGOs – all the way up to larger international companies, the majority of which he claims have been compliant for years.

While the GDT’s communications officer Emily Than repeatedly refuses to answer questions put to the department, Kong Vibol hinted at an understanding of these grievances while addressing the business community at EuroCham’s Tax Forum last week.

“There have been concerns that foreign companies in the Kingdom have been targeted through audits but these aren’t true – every company in Cambodia is treated as a Cambodian entity.

The GDT does take into account every concern and improvements have been made for a better tax payer service.

Transparency has been a focus of the department and we will continue to improve on it,” he said, noting that a call centre had been established to deal with complaints and that next year the Kingdom can expect to see an online tax submission system, which he hopes will improve transparency and cut through the red tape that currently binds the department.

Kong went on to state that he seeks further dialogue with EuroCham in the development and refinement of the Kingdom’s tax regime, but was quick to point the finger at the Ministry of Commerce regarding errors in tax calculations.

Striking the balance

Reflecting on EuroCham’s stance, trade and investment research analyst Ayden Darmenia disagrees with the notion that foreign businesses have been the victims of Cambodia’s evolving tax systems.

“I can say that we would not support the position that the GDT is specifically targeting foreigners,” he says.

“Rather, the perceived focus of the enhanced enforcement has been towards companies that are pursuing their compliance with the complexities of Cambodia’s formal tax system, which is comprised of both Cambodian and foreign companies. This is creating a larger divide between compliant companies and those that continue non-compliance, resulting in an uneven playing field,” explains Darmenia, stating that he hopes to see the Kingdom move in the direction of a system that rewards and encourages compliance.

Other experts were quick to assert that the loss of business would not be so harmful to the Cambodian economy as some businesses may like to believe.

“It would be frivolous to categorise any recent tax reforms as damaging. Rather it is more practical to suggest some may have been challenging and problematic for taxpayers to implement,” argues Anthony Galliano, group chief executive officer of Cambodian Investment Management.

“In particular the Ministry of Economy and Finance Prakas (directive) 986 on transfer pricing, which was totally appropriate and well overdue, initially caused chaos for unprepared taxpayers and is still troublesome for many.

Small and medium-sized taxpayers were behind the curve on transfer pricing and many found it onerous to comply with the regulations. This was severely compounded by disallowing zero interest shareholder loans, dramatically increasing tax for those with significant shareholder debt, or compelling an increase in capital at a cost to avoid the additional tax burden,” explains Galliano, adding that the 2016 abolition of the Estimated Regimes on Taxation saw a spurt of Khmer businesses registering with the Ministry of Commerce in order to become compliant.

“My observation and experience is that Khmer businesses are equally targeted in audits. With the real estate boom and consistently robust growth of the economy, it is no secret that a great deal of Khmer businesses have strong and healthy financials. The GDT certainly would have realised that there is money to be made in auditing the Khmer businesses, especially conglomerates and those benefiting from the explosion in real estate development and prices,” he says.

He goes on to say that the enhanced audits have coincided with other changes to tax and labour regulations, adding further costs to businesses in Cambodia – particularly enforcement of the National Social Security Fund payments, seniority payments and pension savings.

Real impact of taxation

“We are registering slightly more businesses than we are closing, but certainly the number of businesses closing this year is much higher than in the past, many citing the increased cost of doing business, devastating tax audit outcomes and more competition entering the market,” admits Galliano.

Despite this seemingly corroborating evidence from anonymous sources, Galliano contends that the success of Kong’s taxation gambit can be seen in the mathematics, citing the GDT’s predicted record revenue collection growth of 30 percent for 2019.

“The dismantling of the Estimated Regime and increased registration of non-compliant businesses spurred tax collection growth in 2017 and 2018, but the massive increase in the number of audits and compliance because of the fear of audits, are materially contributing to tax collection growth – those in the former Estimated Regime are paying five to 10 times more tax and we are seeing much greater compliance from existing taxpayers, resulting in a significant increase in their annual tax outlay,” notes Galliano.

While businesses maintain that they’re being financially decimated by the new audit processes, their threats to pull out of Cambodia seem reminiscent of the ongoing tax disputes between the European Union and US-based tech giants, Apple, Google and Amazon. Although there are obvious flaws between the comparisons, the notion that businesses can effectively hold an economy to ransom over tax disputes is one that Cambodia would do well to avoid.

Exploring other avenues

“The corporate tax rate for the Kingdom is slightly below the global and Asean average, so it is neither a high nor low tax jurisdiction and is at a viable level to support government expenditure without being punitive,” says Galliano, who praises Kong’s reform of the GDT, but sees a plethora of avenues for further reform.

“The Kingdom’s ‘sin’ taxes are too low, particularly on cigarettes and alcohol. Governments regard high sin taxes as deterrents, however they are major contributors to tax collection,” he notes. Cambodia is tied with Sierra Leone for the fourth most affordable country in the world to buy tobacco, with only Rwanda, Guinea and Paraguay being cheaper, according to a 2019 report from the United Nations Development Programme and the World Health Organization.

“The announced intention to implement personal income taxes should be swiftly executed, especially on capital gains and particularly on real estate transactions. The GDT has significant room to increase property taxes, which have remained marginal despite the increase in property prices,” argues Galliano, echoing the findings of an International Monetary Fund working paper that pointed to a need for greater effort on reforming progressive taxes that would disproportionately affect the Kingdom’s wealthiest rather than the poorest.

“Finally, VAT [value-added tax] collection at a consumer level remains weak, a large percentage of businesses remain unregistered and it appears the GDT has lost traction on enforcement in this area,” states Galliano.

Earlier this year, Director of the SMEs department at the Ministry of Industry and Handicraft (MOIH) Chhea Layhy said that SMEs made up 99.8 percent of businesses nationally and that 95 percent of them weren’t properly registered.

Layhy went on to say that the MOIH is seeking to register 70 to 75 percent of SMEs by 2025 as part of the Kingdom’s national push towards a more formalised economy, noting that the constraints on the growth of this sector typically revolve around access to finance, information and international markets.

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