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Cambodian Tax Factsheet Circular No.1707
by Dary So
What is Circular #1707?
Circular 1707 is one of the latest and most significant pieces of tax legislation ever issued by the General Department of Taxation in the Kingdom of Cambodia. It deals with the interest charges on lending and the documentation required to be established for loans by real regime tax payers.
What does this Circular cover?
Given the rapid recent growth in international investment in Cambodia Circular 1707 is a particularly critical piece of legislation given its wide ranging scope and focus on interest charges and lending arrangements.
Circular #1707 covers the application of 0% interest loans, low interest loans and market rate interest loans in the Kingdom of Cambodia. It also specifies certain required documentations to enable loans to be recognised by tax authorities.
When doe this become effective?
Circular #1707 becomes effective from the 2nd of October 2013.
Who does this circular affect?
Circular #1707 affects any real regime tax payer who engages in lending arrangements as either a borrower or a lender.
How does this circular affect us?
Circular #1707 impacts business in a number of key areas
- Reduction of Tax risk
Historically a major source of tax risk for international investors has been the application of deemed interest charges by regulatory tax officials during the tax audit process and the subsequent application of Withholding Taxes on unpaid “deemed interest”. #1707 significantly restricts regulatory officials’ powers to deem transactions in relation to financing arrangements and thereby limiting the application of deemed interest.
- Increased flexibility when structuring group debt arrangements
#1707 allows the provision of interest free loans, loans at below market rate interest, and of course loans at market rate. These new provisions override the historic market based approach to determining the tax base of transactions and accordingly presents major opportunities for businesses to realise significant tax savings in relation to withholding tax on interest.
- Certain required criterion to enable recognition of loans.
The impact of circular #1707 is not all positive for tax payers’; this circular requires tax payers to take certain additional steps to ensure that loan arrangements are recognised by tax authorities. Real regime tax payers are required to ensure they have undertaken the following compliance items for loan arrangements:
- Established suitable loan arrangements, between the lender and the borrower. These loan agreements are required to be certified by recognised lawyers on behalf of both the borrower and the lender.
- Appropriate accounting records to be maintained with respect to the loan transactions.
- Evidence of cash transactions is required to be documented which support the balance of the loan account having been received by the borrower.
What happens if we fail to comply with the above?
The failure of the real regime tax payer to document the loan arrangements in accordance with the requirements set out above, creates a potential tax liability in accordance with Section 2.2.3 f of the Prakas on Tax on Profit.
I.e. The funds received under the loan agreement will be taxed as income and form part of the real regime tax payers’ taxable profit.
Therefore as a minimum the tax payer is exposed to an instant 1% tax on the loan balance, and potentially a profit tax liability of up to 20% of the loan balance, plus penalties of 10%-40% plus interest of 2% per month.
What opportunities does Circular #1707 provide?
Given the radical changes that Circular #1707 provides for the calculation of the tax base of interest charges, a number of opportunities are created for business with related party loans or cross border financing arrangements.
#1707 provides specific guidance on the General Department of Taxation interpretation of maximum level of interest rates, these are as follows;
Locally sourced funds – Average interest rate specified by the National Bank of Cambodia
Internationally sourced funds – SIBOR + 6%
These clearly defined thresholds provide opportunities for more aggressive tax planning and repatriation of profits for international investors leveraging intra group financing arrangements.
The introduction of a formally defined market rate of interest allows for a major reduction in overall tax risk and potentially for savings in Withholding Tax on Interest, even on locally sourced funds.
How does #1707 affect Lenders?
The application of #1707 is to both related and independent entities. Accordingly the maximum allowable interest for borrowers on locally sourced funds is restricted to the average interest rate as determined by the National Bank of Cambodia.
Any interest which exceeds these thresholds is a non-deductible expense for real regime borrowers and accordingly may result in borrowing becoming more expensive for SME borrowers through the loss of the tax shield on interest.
How can I be sure I am #1707 compliant?
We would be happy to assist in ensuring your business is #1707 compliant, we can assist with everything from reviewing and certifying loan agreements through to ensuring appropriate documentation and accounting records are in place.
To download this Factsheet along with the Prakas on circular #1707 click here
For more information please contact Ms. Dary So at: email@example.com
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