“An ounce of prevention is worth a pound of cure.” Benjamin Franklin
For tax advisors, CFOs, and finance personnel throughout Cambodia, the last few weeks of March are typically extra stressful due to the 31 March deadline for filing annual Tax on Income (TOI) declarations with the General Department of Taxation (GDT).
Cambodia’s tax system operates on the principle of self-assessment, meaning taxpayers declare and pay taxes based on their reading of tax regulations. Consequently, annual TOI declarations become very important documents: they play a major role in the tax audits that are undertaken by the GDT. To use an analogy, think of a taxpayer as a student who is handing in an exam paper (the TOI declaration) to a professor (the GDT). In a worst-case scenario, the student receives a bad grade. For a taxpayer, however, the worse-case scenario can potentially lead to an assessment of underpaid tax, penalties, interest – or even jail-time!
We have provided below some of the common issues that we see arising in tax audits, issues that can be directly attributed to the information contained in an annual TOI declaration and some tips to mitigate associated tax audit pain.
(1) Reconciliation Issues
To some extent, there should be a degree of continuity between the information that a taxpayer provides during the year in their monthly tax declarations and what is presented in the annual TOI declaration. For example, the annual TOI declaration requires a taxpayer to provide information on their annual operating revenue (Box B20) and annual salary expenses (Box B23).
There may often be legitimate discrepancies between the submitted annual revenue and expenses figures in an annual TOI declaration, and what has been declared in the monthly Value-Added Tax (VAT), Pre-payment of Tax on Income (PTOI), and Tax on Salary (TOS) returns during the year.
These discrepancies need to be identified when preparing the annual TOI declaration and clear supporting documentation must be maintained to show the reasons behind those discrepancies – this is so evidence can be provided to a tax auditor in a future audit.
(2) Permanent and Temporary Differences
The starting point of any TOI declaration is an assessment of the accounting financial statements that have been prepared for the year. The concept that all tax advisors are taught from the beginning of their careers is that income and expenditure are recorded in a certain way following certain accounting standards, whereas for tax there are separate rules regarding how income and expenditure is recorded.
A “permanent difference” is the difference between financial accounting and tax accounting that can never be eliminated or reversed. An example of a permanent difference is a fine, penalty or entertainment expense.
“Temporary differences” are transactions that create temporary differences recognized by both financial accounting and accounting for tax purposes, but at different times. An example of a temporary difference is depreciation when the depreciation rates and method, may differ between accounting and tax.
The key point to note here is that if these adjustments are not correctly picked up in the annual TOI declaration, this can lead to an over or under disclosure of income and or expense for tax purposes. Common mistakes that are often discovered in tax audits include the 180-day rule concerning unpaid salaries and expenses from related parties, taxes borne by a taxpayer, such as withholding tax, and entertainment expenses.
An issue that we are increasingly starting to see in tax audits concerns depreciation expenditure, which is being adjusted by the GDT. Cambodia’s tax regime allows for different depreciation methods and rates to be used based on the classification of an asset. From a rate of 50% for computers and software, down to a rate of 5% for buildings, the deprecation class that you choose can have a significant bearing on the amount of taxable income that is declared to the GDT.
The GDT understands this and has intensified its scrutiny on asset classification and associated depreciation classes that have been declared by taxpayers. This means care is needed when deciding which depreciation class to apply to an asset. While it can be tempting to increase expenditure by being liberal when choosing a certain asset class, this can come back to bite in a subsequent tax audit. Conversely, it may be tempting for a taxpayer in tax losses to choose a depreciation class that may provide a lower depreciation rate – this should be avoided also if the asset does not fall clearly under the asset class description.
(4) Transfer Pricing
Cambodia’s transfer pricing provisions have been in place since the 2018 tax year. A Cambodian enterprise that enters a related-party transaction is obliged to maintain a local transfer pricing file for each year that it has related-party transactions.
The annual TOI declaration requires taxpayers to list, in Annex 1 of the declaration, all the related-party transactions entered during the year relating to sales and expenses. There is also a requirement for taxpayers to indicate whether they have maintained transfer pricing documentation.
It should be noted that local transfer pricing documentation does not refer to a management agreement or loan document. It refers to a local transfer pricing file in which an analysis is carried out using one of the approved transfer pricing methodologies to determine if a related-party transaction is within an arm’s length range. Ideally, local transfer pricing documentation will be in place at the time a taxpayer files their annual TOI declaration, allowing them to tick “yes” in Annex 1 of the TOI declaration. Ticking “no” in Annex 1 of the TOI declaration may increase the tax audit risk of a taxpayer.
(5) Minimum Tax
Most taxpayers in Cambodia will have to pay either Tax on Income or Minimum Tax when filing their annual TOI declaration. The former is typically applied at the rate of 20% on taxable income and the latter is applied at the rate of 1% on the annual turnover of a taxpayer. The taxpayer will pay whichever is higher, for example if a taxpayer who is in a tax loss position may still be required to pay Minimum Tax to the GDT.
A taxpayer can be exempted from Minimum Tax by virtue of being a Qualified Investment Project (QIP) that maintains annual external audited financial statements or by maintaining proper accounting records. With respect to the letter, a submission must be made to the GDT, where an evaluation committee will learn whether the taxpayer has maintained proper accounting records considering the criteria outlined in Prakas 638 that was issued in 2017.
(6) Free Goods/Services
If a taxpayer provides free goods or services during the year, the taxpayer would need to account for VAT and other monthly taxes such as Pre-payment of Tax on Income, Specific Tax, and Public Lighting Tax based on the “market value” of those goods or services. The market value is typically the value that a good or service is sold to a third party under normal trading circumstances.
Similarly, the annual TOI declaration requires taxpayers to include the total amount of free goods and services made during the year (Box E19 of the TOI returns). A common mistake made by taxpayers when completing Box E19 of the annual TOI declaration is to include the cost associated with the free good and/or service but not the market value. A misrepresentation of the market value of free goods and services made during the year will result in a tax re-assessment in a subsequent tax audit.
We also note that this issue can apply equally to discounted goods or services if the taxpayer has failed to maintain sufficient supporting documentation or has failed to obtain upfront approval from the GDT.
(7) Unearned Revenue
Based on tax regulations for the annual TOI computation, income must be reported at the time of supply, which is the earlier time of when the supplier is contractually obliged to invoice or the time the supplier issues the invoice. Based on its accounting records, if a taxpayer obtains an upfront payment or advance payment, but the goods/services are not supplied, it will be recognized as unearned revenue/unearned income, which is recorded as a liability in the Balance Sheet of the taxpayer.
From a tax perspective, unearned revenue is recognized as revenue in the year that it is incurred (Box E24 of the TOI declaration), i.e., when the payment is received. If an advance payment is received in year 1 before the goods/services are supplied, it will still be recognized as revenue for tax purposes.
From an accounting perspective, unearned revenue from year 1 will be recognized as accounting revenue in year 2, i.e., when the goods/services are supplied.
Consequently, an adjustment will need to be made from the accounting revenue in year 2 for tax when the accounting revenue for the supplied goods/services in year 2 will be classified as “non-taxable” income.
Often taxpayers do not correctly adjust unearned income in their TOI calculation, leading to unintended tax audit implications.
When preparing the annual TOI declaration, provisions made by taxpayers with respect to an expense or loss is not allowed as a deduction for tax purposes. A claim for a tax deduction can be made when the provision has been realized. Common examples of provisions include bad debt, seniority staff payments, and inventory impairment.
An increase in the provision must be added back in the TOI calculation, whereas a decrease in the provision must be deducted from the TOI calculation. During tax audits, it is critical that taxpayers maintain sufficient supporting documents to show the tax authority regarding adjustments to their provisions or there is a risk that the tax auditor may disallow the decreased provision adjustment in the TOI working, which will result in higher TOI payable or a reduction in tax losses carried forward.
We note that financial institutions in Cambodia have their own set of rules around provisions from a tax perspective.
(9) Voluntary Disclosure
After filing your annual TOI return, it is highly advisable to seek an independent review so that any unintended errors or mistakes can be identified before you are subject to a tax audit by the GDT. The introduction of Prakas 217 MEF.P (“Prakas 217”), which was issued by the Ministry of Economy and Finance on 14 March 2022, provides incentives to taxpayers who wish to make voluntary declarations with the GDT.
Under Prakas 217, taxpayers who choose to voluntarily amend lodged tax declarations and pay under-declared tax resulting from an unintended error may benefit from:
- A reduced penalty rate of 10% on the underpaid tax (which re-states the current practice).
- A 50% reduction in the monthly late interest rate of 1.5% if the amendment is made within six (6) months after the original filing date of the tax declaration.
- A 20% reduction in the monthly late interest rate of 1.5% if the amendment is made after six (6) months of the original filing date of the tax declaration.
To obtain the full benefit of the incentives, a voluntary disclosure should be made before the taxpayer receives a formal notice from the GDT of a tax audit investigation for the period in which the underpaid tax occurred.
“The hardest thing to understand in the world is the income tax.” – Albert Einstein
Keeping up to date with new tax regulations and practices can be difficult given the fast-paced environment that most of us find ourselves in these days. DFDL’s award-winning tax compliance team offers a full range of tax compliance services, from preparation of monthly and annual tax returns to tax reviews and tax health checks and submitting voluntary disclosures.
The objective of outsourcing tax compliance in recent times has changed from merely saving costs to achieving sustained performance improvement. At DFDL, we understand the industries that our clients work in from back to front. Our tax advisors work closely with our commercial advisors so that we get the big picture.
We also lead the way in advocacy and technical discussions with the Cambodian regulatory authorities via various public-private working groups on a direct basis. We welcome you to a free consultation to see for yourself the expertise that we can provide.
Tax services required to be undertaken by a licensed tax agent in Cambodia are provided by Mekong Tax Services Co., Ltd, a member of DFDL and licensed as a Cambodian tax agent under license number – TA201701018.
The information provided here is for information purposes only and is not intended to constitute legal advice. Legal advice should be obtained from qualified legal counsel for all specific situations.