The taxman cometh – Cambodia’s capital gains tax casts the net on individual taxpayers

Content image - Phnom Penh Post
Property prices have soared in Phnom Penh in the last five to 10 years. Hong Menea

In a country where only limited personal income tax existed, the new taxation law beginning January 1, 2021, will make taxpayers out of Cambodians, whether they are ready for it or not

About two years ago, a little known amendment was made to Article 7 of the Law on Taxation to include physical persons (individuals) to the original text which until then only featured legal persons, meaning registered businesses.

Uncannily, nothing much was discussed publicly, apart from intellectual literature and discourses, wheresome found its way to the internet.

According to Article 7, taxable income is the result of the adjustment of deductible expense on the total income in a tax year, which shall be determined by sub-decree.

Essentially, what it means is that a majority of individuals or Cambodians, in this case, would be subjected to personal income tax on an annual basis.

Currently, individuals are not taxed for most forms of income unless they are employees of a registered entity. The tax on salary follows a tiered structure based on income brackets.

Although a large fraction of the population is aware of the government’s plan to tax individuals at some point, this legal section inadvertently sets the wheels into motion.

With the inclusion of individuals in the law, the authorities can now be seen to make a clear push to expand the tax base.

Of course, direct income tax deductions via annual tax filings would still take a few years to materialise with guidance provided by a sub-decree.

For now, one of the intentions of the amendment has been met and it is to give effect to the enactment of prakas 346, otherwise known as the 20 per cent capital gains tax which will be enforced on January 1, 2021.

The scope of the prakas (declaration) is broad. A quick look shows that it is geared towards immovable properties while exempting residential property transactions.

Content image - Phnom Penh Post

It also covers capital gains from the transfer of investment assets such as company shares, bonds and securities, foreign exchange gains (excluding riel), leases and intellectual property.

But a lack of guidance and explanation over the implementation, as well as expert input from industry players, has resulted in speculative talk among the business community and individuals alike.

The tax was supposed to come into effect on July 1, this year, after it was signed two months earlier but was deferred to next year.

Apparently, the deferment was decided in order to iron out details including the calculation and further exemptions, said Ministry of Economy and Finance spokesman Meas Soksensan.

So, why rush to implement it?

According to observers, the capital gains tax has sat on the backburner for 10 to 15 years, possibly due to contemplations over backlash and timeliness.

No reason was accorded for the introduction of the tax in the current economic landscape, suffice to say that it is part of the tax reform regime.

But with the partial loss of the EU’s Everything but Arms (EBA) scheme and severe impact on key economic sectors, particularly manufacturing and tourism, the timing of the tax is suspect.

In the past, the government had announced plans to expand the tax base and has done so when it put in place the transfer pricing rule and raised the registration of small- and medium-sized enterprises.

But these have focussed mostly on legal entities, not so much individuals. Looking at the present tax perspective, the capital gains tax will subject them to personal taxation in future.

Clint O’Connell, partner and deputy managing director of legal, tax and investment advisory firm DFDL Mekong (Cambodia) Co Ltd, said the Article 7 amendment should have been a warning to anyone that the government is taking the first step towards implementing personal income tax.

Following that, the authorities are likely to take step two, three and four to provide some guidance as to implementing the law. In fact, the closest the authorities have come to is this prakas.

Although the methods of implementation are unclear, it is likely that the General Department of Tax (GDT) would start by rolling out the taxation of immovable property, which many see as low lying fruits before the tax on intangible assets is clarified.

Why shouldn’t the government earn returns?

In September 2019, the International Monetary Fund (IMF) in a working paper titled Advancing Inclusive Growth in Cambodia noted that the Kingdom relied relatively little on progressive income sources such as personal income tax, income and capital gains or property taxation.

Content image - Phnom Penh Post

It said revenue from these components only made up 4.2 per cent of the gross domestic product (GDP) in 2017, which was the lowest among its peers in the region. Similarly, revenue from property taxation accounted for only 0.1 per cent of GDP, which was also very low compared to Malaysia, Indonesia and Philippines.

“[At that time] Cambodia’s revenue sources [were] skewed towards value-added tax and import taxes,” IMF wrote.

Having said that, the implementation of a more comprehensive tax regime is inevitable in the long run, a notion that is supported in the revenue mobilisation strategy.

In an earlier part of the strategy’s second phase publication (2019-2023), which was released on May 2019, the government was said to have yet to levy taxes on other sources of income such as capital gains, which it found to be inequitable, unjust and caused losses over potential revenues.

It outlined the means to implement personal income tax which would involve the adoption of short-term and medium-term measures.

The short-term measures feature the development of a policy framework for personal income tax and the introduction of taxes on capital gains whereas medium-term measures would see the formation of a competent and specialised tax administration.

This is possibly due with the original forecast for the rollout of personal income tax at the end of 2022 or 2023.

That aside, the enactment of the capital gains tax itself is arguably a brave move by Cambodia as opposed to other tax jurisdictions which simply skirted around the issue while deciding that it remain subject to regular corporate income tax, due to its non-populist ideology.

But in Cambodia, observers say capital gains should be taxed as it is long overdue. The tax department has seen the property value go up with land owners making millions of dollars, which begs the question as to why the government should not get some returns from that.

“I mean, this is a key distinction. Capital gains tax is more a speculation tax, not really one you consider to be based on sweat and toil. It is based on investing, a passive income [where you] buy and sell assets,” said O’Connell.

The overall view is that a lot of the land was inherited or bought for a small amount and sold to investors for a huge return.

Under the prakas, 20 per cent tax would apply to the residual amount of the sale, which means that the seller automatically pockets 80 per cent of the difference without having to provide documentation to the authorities.

But the absence of paperwork could lead to fraudulent acts involving price manipulations to reveal significantly lower transactions to avoid being taxed.

This is just so they can avoid paying a fraction of what they would receive anyway, a land valuer, who spoke on conditions on anonymity, said.

“It is hard to tell the mentality of some people,” said the source.

Financial services firm Cambodian Investment Management Co Ltd CEO Anthony Galliano finds that the entry of the tax is timely.

He said given the scale of recent property speculation and the money that has already been made, it is not soon enough as the government has lost out on substantial tax revenues in the absence of the tax.

“Registered businesses have been liable for capital gains under the Law of Taxation. Removing the loophole for individuals is timely, appropriate and fair,” he said.

Ideally though, there should be a differentiation between long- and short-term capital gains with lower rates for long-term holdings which is the case in several jurisdictions.

“I expect this to be refined over time,” Galliano said.

A lucrative lure

The call makes sense as land prices in several districts in Phnom Penh and Sihanoukville have soared no less than 10 per cent, with some parts hitting 100 per cent over five years, on price speculations and scheduled development.

Reports have cited that prime areas in Phnom Penh such as Chamkarmon, Daun Penh and 7 Makara have seen commercial land prices rise between $4,000 and $6,000 per square metre in recent years.

Although prices in the suburbs are stable, it has seen a slight uptick of less than five per cent such as Prek Pnov district in the north and Dangkao district in the south where prices range from $100 to $400psm, says realestate.com.

In the first eight months of 2018, stamp duty or property transfer tax surged 60 per cent year-on-year, making it the highest increase among taxable components.

And within October of that year alone, nearly $277 million was raised through property taxes including stamp duty.

Content image - Phnom Penh Post

In 2019, the GDT recorded over 111 per cent growth in revenue from stamp duty and rental tax, which pushed total tax collection to $2.8 billion.

These overall property tax figures are a lucid indication of how much earnings the state can make, backed by the real estate and construction sector in the last five years, particularly with the entry of Chinese investment.

Such is the lucrative lure in property gains that even Prime Minister Hun Sen made repeated calls to raise the four per cent stamp duty, asserting that it was “too low”.

Instead, the capital gains tax was introduced.

Chrek Soknim, president of Cambodian Valuers and Estate Agents Association, is none too pleased with the tax, saying that it is not a good move to implement it.

He claimed that landowners would inflate prices to make up for the so-called losses in the form of tax.

“It will cause pressure on the market which is already impacted by the economy. The government should be injecting funds into the real estate sector, not implementing the tax.

“There are other ways to raise government revenue. They are already earning from stamp duty but the capital gains tax would push up the price of land because owners would want to make up for the tax payment,” he said.

Setting up offshore companies

These quirks need to be fixed as most of the underlying angst is related to the uncertainty of the tax, and not just those relating to immovable property.

Historically, some of the largest deals or transactions have revolved around the transfer of shares in Cambodian companies which have never been taxed. a lot of them comprise multimillion-dollar deals.

However, the tax imposition on local businesses might instead force them to consider restructuring their companies, said an investment analyst, who declined being quoted due to his close relationship with the government.

“[This could involve] setting up an offshore company [in addition to the Cambodian company]. In future, when [shareholders] want to sell their shares, they would sell at the offshore level so they won’t be subject to the tax in Cambodia,” the analyst said.

Similarly, the business community is in the dark whether the government would tax both direct and indirect share transfers.

“Is it simply the amount you receive minus the par value of the share or do you look at the net asset value of the company?

“What about the difference between a person who trades shares of a listed company versus an owner of a company who has held shares in that company for 20 years and then exits?

“Is there a distinction between trading in shares and actual ownership [equity ownership]?” the analyst asked.

Painful audits to continue?

While these questions pile on, the big issue is whether the tax department is able to manage the overall tax reform, particularly in the face of heavy criticism by taxpayers on the overzealous audits by government auditors.

Content image - Phnom Penh Post

Granted, tax revenue has increased substantially year-on-year.

In fact, in the first half of 2020, the tax authority collected $1.7 billion in tax, an increase of 12 per cent from the corresponding period last year, and 60 per cent of its $2.9 billion full-year targets.

Many say this has been on the back of two to three audits conducted by auditors who are paid 10 per cent commission on top of their salaries.

“So we have a number of taxpayers that have been subjected to three different tax audits for the same tax year, so it is a painful process.

“It is true that within the tax department, different departments are competing for their own power struggle and the more revenue they make . . . auditors get to keep 10 per cent of the penalty and interests.

“I am not saying that people should not be compliant but the tax department sets a budget each year on the revenue it has to collect, and of course, the audit strategy will be geared around the budget,” the analyst said.

Moving on from here, there is no telling if the authorities will crack the whip on individual taxpayers but Cambodians are going to find out soon.