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Ernst & Young director of tax and advisory services Brendan Lalor, photographed at his office last week.
Ernst & Young director of tax and advisory services Brendan Lalor, photographed at his office last week. Kali Kotoski

Business Insider: Transfer pricing rules retooled

With the General Department of Taxation (GDT) recently introducing transfer pricing rules that aim to shore up the Kingdom’s tax base and align regulations with international standards, The Post’s Kali Kotoski spoke with Brendan Lalor, director of tax and advisory services at Ernst & Young, about how the new laws will impact businesses.

Can you broadly describe the government’s new transfer pricing rules?
The rules in the new prakas have the full weight of the law behind it and the prakas is based on the Arm’s Length Principle, which does not translate directly into Khmer. Regardless, the Arm’s Length Principle is the Organisation for Economic Cooperation and Development’s (OECD) recognised principle, which requires taxpayers to set the inter-company price on their inter-company transactions as if they were dealing with third parties. By basing the prakas on the OECD guidelines, the GDT is aligning Cambodia’s transfer pricing rules with international standards as most of the countries in the world, both developed and developing, have adopted the Arm’s Length Principle as the basis for their transfer pricing rules.

What is the purpose of the transfer pricing rules?
The main reason the OECD introduced its transfer pricing guidelines is to prevent profit shifting through non-arm’s length pricing on offshore, related party transactions so as to reduce the tax base in higher taxing jurisdictions by moving profits to lower taxing jurisdictions. Multinational groups that operate in countries without transfer pricing rules could lower their overall effective group tax rate by shifting profits from higher taxing jurisdictions to lower taxing jurisdictions through non-arm’s length pricing. It took some time for governments to react to this when they started seeing companies moving profits around, but the first transfer pricing rules were adopted in developed countries as far back as the late 1960’s.

How will these impact businesses operating in Cambodia?
The compliance requirements of the new prakas will have a big impact on businesses in Cambodia with regards to offshore and related party transactions to ensure taxpayers are compliant. From a cost perspective, these relate to the need to prepare and maintain documentation in support of the arm’s length nature of the company’s inter-company transactions. What we typically see with larger multinational companies is that they have dedicated in-house tax teams that assist their affiliates and subsidiaries in smaller jurisdictions with the preparation of localised transfer pricing documentation. As the General Department of Taxation becomes more sophisticated the compliance burden on local taxpayers will increase to the point where they may consider hiring their own in-house transfer pricing specialists, although this will likely be some years away.

Does the government have the capacity to enforce the transfer pricing rules?
The GDT certainly has the capacity and weight of law behind it to enforce the provisions in the new prakas although they will face a number of challenges including resource and technical constraints. The authorities have told us that they have set up a dedicated transfer pricing team, which is a good step because this allows them to focus on improving the skill set of the auditors in this team. I would think that one of the first steps the GDT should consider is setting up a risk assessment programme to identify which sectors of the Cambodian economy represents the most risks from a transfer pricing compliance perspective, as opposed to randomly selecting certain taxpayers for audits.

How should the government set up its risk assessment tools?
There are a number of ways that other countries have adopted tools. But usually it comes at looking at the economy on a macro level and looking at industries that are attracting the most foreign direct investment and comparing the margins earned by independent companies versus members of multinational groups. This type of approach helps revenue authorities to decide where the risks are and then focus on these industries.

What is the difficulty in benchmarking operations?
The challenge to benchmarking an arm’s length price from both the GDT and taxpayers perspective is in identifying independent companies that are comparable to the taxpayer in terms of functions, assets and risks, and being able to access the independent companies financial statements. It is well known in Cambodia that financial data of independent companies is not readily accessible. So, taxpayers may have to search for regional and independent companies and access their financial statements for benchmarking their own performance. The GDT has yet to indicate its intended approach to benchmarking.

Is the garment sector a good place for transfer pricing rules to start seeing that is still a simple manufacturing industry?
I would say yes because it is an industry that the GDT has the most knowledge about and also it is a less complex industry. That makes it easier for them to risk assess this industry from a transfer pricing perspective.

How does implementing transfer pricing rules help Cambodia?
Cambodia’s transfer pricing rules should not be seen as a determent to foreign investment, but from an international tax compliance perspective, the new prakas should help to close loopholes.

This interview has been edited for length and clarity.

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