"The devil is in the details" – tax versus incentives in the new investment law
Government incentives have shown promise, especially with the upcoming investment law. But if tariff revenues decline as trade deals advance, the line between taxes and incentives could blur
The new investment law is expected to come into effect next year, 10 years after the government enacted a plan to repeal the existing law, enacted in 1994 and amended in 2003.
The timing of the new law is crucial as it is in line with a number of trade agreements to which Cambodia is a party to enter into force.
In addition to the erosion of economic growth from Covid-19, government adviser Dr. Sok Siphana, that Cambodia's integration into the World Trade Organization (WTO) is also waning as the rise of ASEAN deepens.
“We have a free trade agreement with China and soon also with South Korea. Next year there will be the Regional Comprehensive Economic Partnership (RCEP). The Chinese come with their Belt and Road Initiative, while Japan (has) its strategy for a free and open Indo-Pacific region.
"These are key trigger points for Cambodia to (re) start with the (new) investment law … hopefully it would be a catalyst to attract investment," said Siphana, who was chief negotiator for Cambodia's 2003 WTO rise.
Official data show a steady growth in investment over the past five years. While foreign direct investment (FDI) has been buoyant, with mainland China and Hong Kong accounting for a large proportion in 2019, domestic investment has seemingly gotten impressive.
Last year, of the $ 7.5 billion projects approved by the Cambodian Development Council (CDC), nearly $ 3.9 billion were domestic investments, data from the National Bank of Cambodia showed.
It should also be noted that FDI was up 76.7 percent from 2019 to $ 3.6 billion, the second highest in five years after $ 3.8 billion in 2018.
In the first quarter of 2021, NBC announced that $ 470.6 million of the approved $ 679.6 million was backed by domestic projects owned by a mix of Cambodian companies as well as foreign investors creating locally registered businesses to have.
Investments went mainly into agricultural, industrial, energy, service and tourism projects, a slight postponement of real estate and construction projects before Covid-19.
While experts are excited about the easing of tax requirements in the investment bill, which will benefit Qualified Investment Projects (QIPs) as such, approving some incentives could be a bit unwieldy.
Investment is important in the current climate, and Cambodia hopes to stand out from the competition in the region with its bill that aims to change the game and support the small and medium-sized enterprise (SME) industry.
However, persistently slow economic growth is likely to have an impact on revenue collection, especially as customs taxes have fallen dramatically in recent years.
According to the World Bank, the authorities are pursuing countercyclical fiscal policies with an ongoing social protection program, while stimulating public investment.
The national debt and budget pressure have risen sharply and are likely to continue. As a result, authorities need to consider options to restore fiscal discipline once the recovery takes hold. One of them is increasing the tax collection.
Source: Cambodian authorities (Cambodia Economic Update, June 2021, World Bank)
QIPs currently enjoy tax exemption for between three and nine years. In the new law, a further six years of tax exemption were added, albeit staggered.
New QIPs would likely benefit from this incentive if investors paid 25 percent of tax for two years, 50 percent in the next two years, and 75 percent in the last two years, before joining a fully taxable tariff.
A sliding scale of tax incentives is regionally competitive, similar to Singapore's three-year sliding incentive for investors starting Singapore-based businesses, said Anthony Galliano, president of the American Chamber of Commerce (AmCham) in Cambodia.
In the past, the General Department of Taxation (GDT) has encouraged the government to be competitive with tax incentives in the region or around the world, which it believes was a positive move towards long-term tax incentives for large projects.
“It also encourages investors to pay taxes because they get the tax incentive and don't get discouraged to go into the 21st century.
Pending approval by the National Assembly and the Senate, the bill aims to incentivize priority sectors, particularly high-tech sectors, innovation, research and development (R&D), digital infrastructure, new manufacturing, logistical supply chains, and industries serving the regional and global market serve the value chain as well as environmental management and energy efficiency.
Galliano, also CEO of financial services firm Cambodian Investment Management Co Ltd, said proposed tax incentives include an option for investors to be exempt from income tax or capital expenses offset by special depreciation charges.
“The income tax exemption is valid for a period of three to nine years. The period is triggered on the day the first win is announced, as opposed to applicable law, where such an exemption is calculated based on a complicated trigger period – the three year period after the trigger period and the priority period.
"The second option focuses on the right to offset investments through special depreciation at (nearly) 200 percent on other major expenses for up to nine years along with other incentives," he told the Post.
"Don't go in blind"
However, it is not certain whether the new incentive will be extended to existing QIPs in the same way, although Siphana, who was a panelist in that conversation, offered that the government will likely come up with a sub-decree on the matter.
“The devil is always in the details. When it comes to taxation, it is an area that only taxpayers can handle. I will not advise people to go in blind (alone). For the last 10 to 15 years I have been saying that taxes get more and more complicated as the years go by.
“Let's be honest, 20 years ago we (could) do things ourselves (but) you can forget that now because the complexity of the rules is unbelievable. You're against the tax officer. You (could) say you qualify for this (incentive) but the tax officer would say "not sure", "he said.
Siphana said the government is challenged when it comes to tax equalization as it needs to factor in income growth for the state and secure benefits for investors.
“You have to remember that customs revenue is falling very quickly. With all this free trade, the customs revenue is very negligible. Twenty years ago, before we joined the WTO, customs revenues were very high and taxes very low.
“Now we see that the tax revenue is much higher than the customs revenue because according to ASEAN, the Chinese and Korean FHA and the RCEP (customs) for most items is zero. So where do you want the revenue to come from? It comes from taxes and consumption taxes, ”he claimed.
The 2020 tax collection by the GDT was above budget due to its “excellent job” in managing tax revenues in a “most challenging and difficult environment” in decades and since reaching low-middle-income status, Galliano said.
While customs revenue is expected to decline, the law is intended to encourage investment in the kingdom, which in the long term would increase tax collection.
"The proposed changes are designed to help collect tax revenue through increased investment not only in large foreign investment projects, but also in local industries and SMEs, which are increasingly becoming the engine of the Cambodian economy, with over 90 percent of businesses being SMEs," he added .
Tax law, investment law
Siphana advised members to consult tax specialists to help them manage the intricacies of the incentives and also reminded them of the Double Tax Avoidance Agreements (DTAs) with Singapore, China, Japan and Thailand. "This is only beneficial if you have the right advice."
With DTAs accelerating, of which there are nine now, including one with Hong Kong and two more expected in the next year, investors looking to avoid double taxation might consider investing through a holding company or base in To build Cambodia.
Through the DTA, QIPs wishing to pay dividends to a non-resident pay a lower tax of currently 14 percent, said Jay Cohen, partner and director of regional law firm Tilleke & Gibbins (Cambodia) Ltd.
Unfortunately, the dividend tax was not taken into account in the draft investment law during the tax vacation.
“The way the Investment Act (works) is, it establishes all tax exemptions. However, you really have to look at the tax law, then the tax law, which optimizes tax law.
“If you just read the investment law and stop there, you won't fully understand how investment law interacts with tax laws. You really have to immerse yourself in the tax laws, because there are many details there too.
"Where investment law provides a great framework and valuable incentive, you have to look at tax law and see how it interacts with the law," he said during the webinar on investment law.
Similarly, the length of the tax exemption varies for different industries as it is determined by the size of the investment, while for certain specialized projects the government would provide different incentives, Cohen said.
"Stacked up in a van"
In the meantime, the government has created new incentives for QIPs, such as the ability to offset taxes of up to 150 percent for employee training, which in turn benefits the economy.
Reflecting on this, Siphana said, "What the government is saying is, 'Wait a minute, we have to take care of our workers and enable them to live better and more dignified (standard) lives". Hence the subsidy of 150 percent (to cover the) costs for kindergarten, catering and better transport.
Source: Economic and Monetary Statistics, May 2021 (National Bank of Cambodia)
“(We saw) driving past the airport, the street (with) the clothing industry, how Cambodian workers pile up in a van on the way home at the end of the day (and) crammed in the morning.
“I don't want to (use) the word inhuman, but I think it is time (for) the government to say that we are going to give incentives (for investors). . . to provide better transportation, dining facilities, etc., ”said Siphana.
He emphasized that further training is another aspect in order to improve working conditions and to get out of the segment of the clothing industry.
“You probably heard me say (that) 20 years ago that we don't want to work in the clothing industry forever …).
"At some point we have to move up the value chain, and that is exactly what this (investment) law is about – to enable more added value," he said.
It is also intended to help integrate medium-sized companies into the regional and global supply chain, especially when RCEP comes into force.
Currently the local input is only five percent, which makes RCEP a big trigger point given its size. It would be the main driving force directing economic activities such as relocation of industries to find the next source of growth and take advantage of the rule of origin.
Many Chinese companies would come to Cambodia through the RCEP because Cambodia had access to the US, not as a Chinese company but as a Cambodian company because of trade tensions, Siphana said.
What the RCEP would do is open up Cambodia to companies focused on R&D, which is currently lacking as most of the local companies are "just satellites" of another company.
“We just produce. This new incentive will (attract) more companies e.g. B. in the fintech sector or start-ups, as there are many components in research. If they spend money on research and development, they could write off 150 percent of their costs. . . it's a good start.
"I don't think companies will start R&D right away, but over time you will see the effects of this policy," said Siphana, adding that the incentives could encourage CEOs running companies in Cambodia to increase.
“That's why we see under incentives. . . it's all about new industries (those) doing R&D or embracing the fourth industrial revolution. It is (a) new trend, which is why I would put all my money into implementing RCEP here. It's a lot of trade diversion, ”he said.
Outdated SEZ models
David Van, Senior Associate Public-Private Partnership at Platform Impact Co Ltd, said that while it took the government a decade to draft the revised investment law, it has been carefully considered, including examining innovative aspects of new tax incentives to encourage future-oriented sectors.
However, he stressed that in order to take advantage of the RCEP, Cambodia must improve its competitiveness in goods and services, as well as production and logistics costs, regardless of new incentives.
He also pointed out that the concept of Special Economic Zones (SEZ) appears "out of date" as more countries move to free zone models as consumer trends have changed.
People demand ethically produced goods that include the protection of workers' welfare and the use of clean or renewable energy by factories.
"As a result, the conventional SEZ (model) is out of date, especially in Cambodia, where the government does not provide anything, just facilitates the documentation process and (provides) the basic road infrastructure," he said.
In order to attract foreign direct investment, rapid adaptation and provision of new formats of cluster production facilities, such as the novel SME cluster of the WorldBridge Group, are of crucial importance.
"It is a pioneer of this concept and is fully supported and supported by the government as an example of how conventional SEZs need to change their modus operandi or reinvent their business model," he said.