One of the more material developments in the Cambodian tax landscape in recent times has been the introduction of domestic transfer pricing (“TP”) guidelines. Prakas 986 was issued by the Ministry of Economy and Finance on 10 October 2017 and became effective for all taxpayers in Cambodia from 1 January 2018.
Prakas 986 introduced new TP compliance requirements, of which the most significant was the preparation of annual Transfer Pricing Documentation for taxpayers, demonstrating that their related party transactions were being undertaken at “Arm’s Length”.
With 2023 marking the fifth-year anniversary of the introduction of the TP regime in Cambodia, Cambodia Investment Review spoke with Kieron Gaffney, a leading transfer pricing subject matter expert in the Cambodian market, and head of DFDL’s Cambodian Transfer Pricing Practice.
For readers who may not understand what transfer pricing is and why it matters from a taxation perspective, could you please summarize?
KG: “Transfer pricing refers to the price of goods and services that are exchanged between companies under common control. For example, if a subsidiary sells goods or renders services to its parent company the price charged is referred to as the transfer price.
From a taxation perspective, governments, and by extension tax authorities, want to ensure that the transfer price is transacted at fair market value (known as “Arm’s Length”), which effectively means a price comparable to what independent parties would transact with one another on the open market. This is to ensure that a fair amount of tax is collected in their jurisdiction.”
Was there a particular catalyst for the introduction of transfer pricing guidelines in Cambodia?
KG: “Globally we have seen an increasing number of countries introduce transfer pricing guidelines in recent years, which has predominantly been in response to European Union and G20 initiatives. Many countries like Cambodia rightfully want to ensure that they also protect their tax base, and as such have taken measures including the introduction of domestic transfer pricing regimes.”
How would you assess the initial implementation period of transfer pricing in Cambodia and how has it developed since?
KG: “It sounds relatively simple, but the step taken by GDT Auditors to increase scrutiny on related party transactions and to request transfer pricing documentation during tax audits was incredibly significant. This is far more difficult to achieve than it may seem. There are numerous examples of transfer pricing guidelines being introduced in countries but not being enforced by the tax authority to any meaningful level.
The GDT demonstrating their determination to enforce Prakas 986 so soon after its introduction inevitably led to an initial period of inconsistency in its application by auditors which taxpayers found frustrating. However, the GDT has done a good job with increasing the knowledge and consistency of application by their auditors. The Transfer Pricing Bureau at the GDT, which falls under the umbrella of the Enterprise Audit Department, has a wealth of knowledge and experience now.
To what extent has the TP compliance requirements been adhered to by the business community in Cambodia?
KG: With respect to complying with the documentation requirement itself, I would say the level of compliance is far higher after five years than analysts expected back in late 2017/early 2018, which is testament to the consistent and high level of enforcement by the GDT. There are however areas where taxpayers have made limited progress with respect to enhancing their compliance and audit defense from a substance perspective.
Which substantive issues do you regularly see still occurring in Cambodia?
KG: In general, the issues relate to making the wrong assumptions, inadequate supporting documentation and using outdated methods to determine the cost base of transactions. The main issues we see on a regular basis include:
- Not Maintaining Annual TP reports: Some Cambodian taxpayers will complete a TP report for the first year of a related party transaction and then neglect to produce a separate TP report for the following years if the related party transaction runs for more than 12 months. The need for separate TP reports for each tax year is clearly stated in Cambodia’s TP regulations. The need for a separate annual TP report may simply involve reviewing and rolling over the report details from the previous year noting that certain economic benchmark analysis will typically need to be updated every 3 years.
- Lack of fundamental or contradicting supporting documentation: Far too many taxpayers do not retain contractual agreements, timesheets, invoices, purchases orders etc. to demonstrate a legitimate transaction took place. Furthermore, some taxpayers supporting documentation will contradict itself with a contractual agreement being for a certain type of service whereby the invoice matched to the contract details a totally different type of service. A slightly more complex version of this relates to allocation of cost for services, for which many Cambodian taxpayers still use an outdated value calculation method such as a percentage of revenue. This unfortunately can result in the whole service cost being disallowed, due to the taxpayer not being able to substantiate the cost base.
- Not updating supporting documentation. This admittedly is starting to happen less, but we still receive service agreements which were originally executed many years ago and have not been reviewed and updated since. This is a huge red flag to the GDT, as support services a Cambodian taxpayer required 15 years ago will not be the same as they require today, particularly if they now have fully functioning departments in areas such as finance, human resources, corporate law, information technology, marketing etc.
What updates do you believe we will see with respect to transfer pricing in Cambodia over the next five years and is there anything you would like to see?
- Advanced Pricing Agreement (“APA”) process: An APA is an agreement which is usually for multiple years, between a taxpayer and at least one tax authority, which details the pricing method and rate to be applied to a specific transaction or transaction type, Once an APA is agreed between taxpayer and tax authority, it effectively means the method and rate outlined in the APA is acceptable and shall not be subject to adjustment by the tax authority during the agreed period, as long as there are no changes which may change the value of the transaction.
- Dedicated process to request a review by the Transfer Pricing Bureau of the GDT: The GDT have embarked on several large recruitment drives in recent years. With increased capacity throughout the GDT, there will inevitably be increased resources within the Transfer Pricing Bureau. Currently taxpayers may request a review by the Transfer Pricing Bureau on a related party transaction reassessment.I believe this will become a defined process with specific perimeters/thresholdsoutlining when a taxpayer may make such a request.
- Safe harbors: Safe harbors are effectively a range of rates or a threshold, which if a particular related party transaction type is either between the range or does not exceed the threshold, then that related party transaction is excluded from scrutiny by the tax authority, if adequate supporting documents are available. Safe harbors are often put in place to reduce disproportionately high costs for taxpayers and excessive administrative burdens for tax authorities. The GDT recently introduced their first safe harbor rule with respect to loans made to Cambodian taxpayers, in the form of Instruction 10979. Cambodia could benefit on safe harbors for SMEs and “low value adding services”. I believe well thought out safe harbors in these instances would benefit both Cambodian taxpayers and the GDT. “