By Tim Watson and Phyllis Lye, who work in Phnom Penh for
PricewaterhouseCoopers, specializing in Cambodian taxation.
ALTHOUGH not currently considered a major tax issue, Cambodia's taxation law contains
some fairly aggressive transfer pricing provisions. Given the high profile of transfer
pricing internationally, and Cambodia's now visible efforts to improve its fiscal
performance, these provisions should not be ignored by the foreign investment community.
What is Transfer Pricing?
There is no universal definition of transfer pricing. However, transfer pricing generally
refers to any transaction, between countries or within a country, for which the level
of the transaction pricing might be viewed as being artificially high or low.
To the extent the pricing is artificial, the transaction will effectively shift income
or expenditure between the participants of the transaction. Tax authorities around
the world are therefore concerned with the capacity for transfer pricing to shift
profits (and so taxes) out of their tax net.
Take the simple example of Parentco Ltd located in country X. Country X imposes corporate
tax at the rate of 30%. Parentco Ltd sells widgets to the public at $100 each.
The widgets are, however, manufactured by Subsidiaryco which is located in country
Y, and which imposes corporate tax at the rate of 50%. It also costs Subsidiaryco
$40 to make each widget.
The question is at what price should Subsidiaryco sell the widgets to Parentco?.
If sold at $40 then the group's profit of $60 is earned entirely in country X and
is taxed at 30%. If transferred at $100 than the $60 profit is earned entirely in
country Y and taxed at 50%.
Of course, the role of foreign tax credits, taxation of dividends and many other
factors mean the issue is much more complicated in real life. However, the principle
is the same in that foreign groups will have an incentive to seek to transfer profits
to the country with the lowest tax rate.
What conditions are relevant?
Conditions necessary for transfer pricing to occur will typically include:
- A transaction between parties who are somehow related (there is obviously no
point shifting profits to unrelated parties). For instance, companies which are members
of the same corporate group will generally be considered related;
- An incentive for these parties to transact at other than the market price. Incentives
are typically tax related (ie low tax country vs high tax country) but could include
other factors such as currency convertibility, political risks or profit remittance
- The Remedy?
With the globalisation of world commerce, transfer pricing is probably the most
significant international tax issue of recent times.
Governments tend to counter the activity by giving their tax officials wide, often
discretionary, powers to adjust inter-company pricing to what they view as being
Often the taxpayer is left with the obligation of trying to demonstrate that their
price is the correct market price. As can be imagined, the room for dispute is considerable,
particularly as inter-company transactions often involve components of corporate
products, for which a ready market price is not available.
Cambodia's current transfer pricing provisions are set out at articles 18 and 19(4)
of the 1997 Law on Taxation. Article 18 provides the tax authorities with wide powers
to "redistribute" income and deductions between companies under "common"
ownership in order to prevent the avoidance or evasion of taxes.
Common ownership is set at a quite low level of 20%. The powers are exercisable to
the extent the tax authorities deem necessary. It is also not clear how a taxpayer
may challenge such pricing adjustments.
Article 19(4) operates to simply deny a tax deduction on losses incurred on the sale
of property between "related" persons. In this case, companies are related
where there is at least a 61% common interest. This provision also operates automatically,
that is, its operation is not subject to the discretion of the tax authorities.
Cambodia's tax profile
Cambodia is a low-taxing country with many foreign investors enjoying a 9% corporate
tax rate. It may be thought therefore that the incentive to transfer profits out
of Cambodia is not significant and so transfer pricing should not be widespread.
However at least three factors still make transfer pricing an issue the authorities
will seek to monitor. These are:-
- That foreign groups often set up holding companies in tax havens, many of which
have nil or very low corporate tax rates. Transfer pricing on transactions involving
these tax haven companies may still be attractive;
- For group's with more than one Cambodian subsidiary it is currently not possible
to transfer losses between the subsidiaries should, say, one subsidiary be in profit
while the other is in loss. The tax authorities may be wary of whether loss transfers
are otherwise being achieved through inter-company transactions; and
- For more complicated reasons, corporate group's may prefer to pay tax in their
home jurisdictions even if the rate is higher than Cambodia's. This may be because,
in some countries, only home country tax can be credited to shareholders.