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‘The devil is in the details’ – Tax versus incentives in new investment law

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A rice farmer transports his harvest to a mill in Chum Kiri district, Kampot. The rice sector has seen continuous growth in R&D investments that improve production. Hong Menea

‘The devil is in the details’ – Tax versus incentives in new investment law

Government incentives have been promising, even more so with the upcoming investment law. But as customs revenue slide with advancing trade agreements, the line between tax and incentives might start to blur

The new Law on Investment is expected to come into force next year, 10 years after the government embarked on a plan to repeal the existing statute, which was enacted in 1994, and amended in 2003.

The timing of the new law is crucial, as it falls in line with a clutch of trade agreements, which Cambodia is party to, taking effect.

In addition to Covid-19 eroding economic growth, government advisor Dr Sok Siphana said Cambodia’s World Trade Organisation (WTO) integration is also wearing off as ASEAN ascension deepens.

“We have a free trade agreement with China and soon with South Korea. Next year, there is the Regional Comprehensive Economic Partnership [RCEP]. The Chinese are coming in with their Belt and Road Initiative whereas Japan [has] its strategy for a free and open Indo-Pacific region.

“These are major trigger points for Cambodia to [get] started with the [new] investment law … hopefully it would be a catalyst to attract investments,” said Siphana, who was the lead negotiator in Cambodia’s ascension to WTO in 2003.

Official data has shown steady growth in investments in the last five years. While foreign direct investment (FDI) has been buoyant, with mainland China and Hong Kong representing a large portion in 2019, domestic investments have become seemingly formidable.

Last year, out of $7.5 billion worth of projects approved by the Council for the Development of Cambodia (CDC), nearly $3.9 billion was domestic investment, National Bank of Cambodia data showed.

It should also be noted that FDI rose 76.7 per cent to $3.6 billion from 2019, the second highest in five years after $3.8 billion recorded in 2018.

In the first quarter of 2021, NBC stated that $470.6 million out of $679.6 million approved was backed by domestic projects, owned by a mixture of Cambodian-owned firms as well as foreign investors who have set up locally-registered companies.

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Source: Cambodian authorities (Cambodia Economic Update, June 2021, World Bank)

Investments were mostly channelled into agriculture, industrial, energy, services and tourism projects, a slight shift from real estate and construction projects prior to Covid-19.

While experts are enthused over the relaxation of tax guidelines in the draft investment law, which will benefit qualified investment projects (QIPs) as these, greenlighting some incentives might be a tad unwieldy.

Investments are important in the current climate and Cambodia hopes to stand out amongst competition in the region with its draft law aimed at switching up the game and helping the small and medium enterprise (SME) industry grow.

But, continued slow economic growth will likely impact revenue collection, particularly with customs tax falling tremendously in recent years.

According to the World Bank, the authorities are pursuing a countercyclical fiscal policy with a continued social protection programme, while boosting public investment.

It said public debt and budget pressures have risen sharply and are likely to persist. As such, the authorities will need to consider options for restoring fiscal discipline once the recovery takes hold. One of which is to increase tax collection.

Presently, QIPs enjoy tax exemption between three and nine years. In the new law, another six years of tax exemption have been appended, albeit in a sliding scale.

New QIPs would likely benefit from this incentive where investors pay 25 per cent of tax for two years, 50 per cent in the following two years and 75 per cent in the final two years before acceding to a fully taxable schedule.

Having a sliding scale of tax incentives is competitive regionally, similar to Singapore’s three-year sliding incentive for investors who set up Singapore-based companies, said Anthony Galliano, president of American Chamber of Commerce (AmCham)in Cambodia.

In the past, the General Department of Taxation (GDT) has been encouraging the government to be competitive with tax incentives in the region or around the world, which he felt was a positive step to long-term tax incentives for major projects.

“It also encourages investors to pay tax because they get the tax incentive and are not discouraged by paying high taxes in the 21st century, at a reduced scale,” he said during a recent AmCham-organised online panel discussion on the draft investment law.

Pending approval by the National Assembly and Senate, the draft law targets incentives on priority sectors, especially high-tech sectors, innovation, research and development (R&D), digital infrastructure, new manufacturing, logistic supply chains and industries that serve the regional and global value chain, and environmental management and energy efficiency.

Galliano, also CEO of financial services firm Cambodian Investment Management Co Ltd, said among the tax incentives proposed is an investor option for exemption of income tax or capital expenditure offset through special amortisation.

“Income tax exemption is for the period of three to nine years. The period will trigger on the date when the first profit is disclosed, in contrast to the current law where such exemption is calculated based on a complicated trigger period – the three-year period following the trigger period, and the priority period.

“The second option focusses on the right to offset capital expenditure through special amortisation with the offset of [nearly] 200 per cent on other major expenditures for up to nine years along with other incentives,” he told The Post.

‘Don’t go in blindly’

That being said, it is not certain if the new incentive would be extended in the same form to existing QIPs, although Siphana, who was a panelist in that talk, offered that the government is likely to come up with a sub-decree addressing this.

“The devil is always in the details. When it comes to tax, it is a field of expertise that only tax people can handle. I won’t advise people to go in blindly [on their own]. For the last 10 to 15 years, I have been saying that as the years go by, tax is becoming more complicated.

“Let’s face it, 20 years ago we [could] do things ourselves [but] you can forget about that now because the complexity of the rules is mind boggling. It is you against the taxman. You [might] say you qualify for this [incentive] but the taxman would say ‘not sure’,” he shared.

Siphana said the government is challenged when it comes to balancing tax as it has to consider revenue growth for the state as well as ensure benefits for investors.

“You must bear in mind [that] customs revenue is coming down very fast. With all these free trade, revenue from customs is very negligible. Twenty years ago before we joined WTO, customs revenue was very high and tax was very low.

“Now we see that tax revenue is way higher than customs revenue because under ASEAN, the China and Korean FTA, and the RCEP, [tariff] for most of the items is zero. So, where will the revenue come from? It is from tax and excise,” he asserted.

Tax collection in 2020 by the GDT was above budget due to its “excellent job” in navigating tax revenue generation in what was the “most challenging and difficult environment” faced in decades and since achieving lower middle-income status, Galliano said.

While the reduction in customs revenue is anticipated, the intent of the law is to stimulate investment in the Kingdom, which would increase tax collection in the long-term.

“The proposed amendments are expected to support tax revenue collection with increased investment not only in major foreign investment projects but also local industries and SMEs, which are increasingly becoming the engine of Cambodia’s economy as over 90 per cent of enterprises are SMEs,” he added.

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Source: Economic and Monetary Statistics, May 2021 (National Bank of Cambodia)

Tax law, investment law

Advising members to reach out to tax specialists to handle the intricacies of incentives, Siphana also reminded them of the Double Tax Avoidance [DTA] treaties with Singapore, China, Japan, Thailand. “This is only beneficial if you have the right advise.”

With the acceleration of DTA agreements, where there are currently nine including one with Hong Kong and another two expected next year, investors who want to avoid double taxation could consider investing through a holding company or setting up a base in Cambodia.

Through the DTA, QIPs that want to pay dividend to a non-resident will pay a lesser tax to the current 14 per cent, said Jay Cohen, partner and director of regional legal firm Tilleke&Gibbins (Cambodia) Ltd.

Unfortunately, dividend tax during tax holiday has not been addressed by the draft investment law.

“So, the way the Law on Investment [works, is that] it sets out all of the tax exemptions. However, you really have to look at the Law on Taxation, then at the Law on Financial Management, which tweaks the tax law.

“If you only read the investment law and stop there, you don’t fully appreciate how the law of investment interacts with the tax laws. You really have to dig into the tax laws as well because there is a lot of details there as well.

“Where the investment law is a great framework and it provides some valuable incentives, you have to look at the tax law and see how that interacts with the law,” he explained during the webinar on the investment law.

Similarly, the length of tax exemption varies for different industries as it is determined by the size of the investment whereas certain specialised projects would see the government crafting a different set of incentives, Cohen said.

‘Piled up in a van’

Meanwhile, the government has included new incentives for QIPs such as the ability to offset tax up to 150 per cent for staff training, which will in turn benefit the economy.

Musing over this, Siphana said, “What the government is saying is, ‘wait a minute, we got to care for our workers, and give them a better and more dignified living [standard]’. Hence, the allowance of 150 per cent [to cover the] cost for nursery, catering facility and better transport.

“[We have seen] when driving past the airport, the road [with] garment industries, how Cambodian workers are piled up in a van at the end of the day going home [and] back in the morning all stuffed.

“I don’t want to [use] the word inhumane but I think it is time [for] the government to say we will give incentives [to investors] . . . to provide better transport, eating facilities, et cetera,” Siphana said.

He stressed that upskilling is yet another aspect to improve work conditions and a way to move out of the garment industry segment.

“You have probably heard me say [this] 20 years ago [that] we don’t want to be working in the garment industry forever … but right now we have to because it is a gradual process to graduation [from least developed country status].

“At some point, we have to move up the value chain, and that’s what this [investment] law is all about – to enable more value addition,” he said.

It is also to help plug in the SME sector into the regional and global supply chain, particularly when RCEP comes into effect.

Currently, local input is only five per cent, which makes RCEP a big trigger point, given its scale. It would be the main driving force, directing economic activities such as relocation of industries to tap on the next source of growth and how to take advantage of the rule of origin.

Many Chinese companies would come into Cambodia through the RCEP because Cambodia has access to the US but not as a Chinese company, rather as a Cambodian company due to the trade tension, Siphana said.

What the RCEP would do is that it would open up Cambodia to companies focussing on R&D, which is currently lacking as most local firms are “just satellite operations” of another company.

“We just produce. This new incentive will [attract] more companies, for instance in fintech or start ups as there are a lot of components on research. If they spend money on R&D, they could write off 150 per cent of their costs . . . it is a good start.

“I don’t think that companies will immediately rush to start R&D but over time you will see the effect of this policy,” Siphana said, adding that the incentives could motivate CEOs who are running companies in Cambodia to upscale.

“That’s why we see under incentives . . . it is all about new industries [doing] R&D or embracing the fourth industrial revolution. It is [a] new trend, which is why I would put all my money to implement RCEP here. It is a lot of trade diversion,” he said.

Outdated SEZ models

David Van, senior associate public-private partnership of Platform Impact Co Ltd, said though the government took a decade to draw up the revised investment law, it was carefully studied, including looking at innovative angles on new tax incentives to promote pioneering sectors.

But, he stressed, to take advantage of the RCEP, Cambodia needs to enhance its competitiveness in goods and services and production and logistics cost irrespective of new incentives provided.

He also pointed out that the concept of special economic zones (SEZs) appeared “outdated” as more countries moved to free trade zone models, seeing that consumer trends have changed.

People demand for ethically-produced goods which include workers’ welfare protection and the usage of clean or renewable energy by factories.

“Thus, the conventional SEZ [model] especially in Cambodia where the government doesn’t provide anything but only facilitate the documentation process and [provide] basic road infrastructure, is becoming outdated,” he said.

To lure FDI, rapid adaptation and provision of new formats of cluster production facilities, like WorldBridge Group’s novel SME cluster, are critical.

“It is a pioneer of that concept and is fully encouraged and supported by the government as an example of how conventional SEZs need to change their modus operandi or re-invent their business model,” he said.

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