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Capital gains tax delay – who stands to benefit?

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Land prices in Sihanoukville prior to Covid-19 rose over 100 per cent within five years on the back of Chinese investments. Today, many unfinished real estate projects have been left abandoned. YOUSOS APDOULRASHIM

Capital gains tax delay – who stands to benefit?

This property tax has been deferred for the third time in spite of moves to expand the tax base and revenue. But continued delays are eliciting questions as to its motive

Calls by the Ministry of Economy and Finance (MEF) to defer the Capital Gains Tax (CGT) on the sale or transfer of capital assets by individuals, particularly in the real estate sector has raised questions over the wisdom behind it.

Every year, the government enlarges the tax budget, whilst carrying out aggressive tax audits on a “reasonably small tax base”, experts say, with the hope of meeting, if not beating, the target. The General Department of Taxation (GDT) has exceeded the annual target collection several times in recent years.

Part of MEF’s revenue mobilisation strategy to expand the tax base and revenue is to introduce new tax policies, CGT being one it. It is also aimed at quelling speculations in the property market.

Hence, the reason why the postponement to January 1, 2024 may seem counter-intuitive.

To be sure, the CGT – a 20 per cent tax on capital gains as per Prakas 346 – has been delayed twice before, from its initial implementation date in July 2020 to January 1, 2021, and later to January 1, 2022.

Apart from real estate, the tax is imposed on capital gains from the sale or transfer of leases, shares and bonds issued by private entities, licences, intellectual property and foreign currency.

A range of transfer types are exempted from CGT including the sale of principal homes of five years, immovable properties between family members (except siblings-in-law), agricultural land (including one that is lived on by the farmer), and properties belonging to state, foreign missions and international organisations.

The 20 per cent flat tax rate might be unique to Cambodia, seeing that a majority of Southeast Asian countries tax capital gains as corporate tax or income tax.

However, Cambodian taxpayers are allowed to choose between two tax deductible methods – actual expense and determination-based – based on what they feel has a lesser tax obligation.

The second option, and probably more favourable for valuable properties, enables taxpayers to settle the CGT after deducting 80 per cent of the sale proceeds instead of paying tax on 100 per cent of the total revenue.

This method requires no proof of documentation, making it prone to false declaration or price manipulation.

Assuming a taxpayer made $100,000 from the sale of his property, under the determination-based deductible method, he can deduct $80,000 and pay CGT on the remaining $20,000.

That is, 20 per cent on $20,000 which amounts to $4,000. This calculation is similar to the four per cent stamp duty imposed on property transfers.

Although the real estate market is soft, experts are saying that a four per cent stamp duty might not impact first time home-buyers. The CGT, on the other hand, has the propensity to impact speculators.

If that’s the case, is the delay beneficial, and for whom?

The latest deferment is to facilitate the recovery of certain quarters that have yet to resume normal business, and need further support, ministry spokesman Meas Soksensan told The Post last week.

While Covid-19 has been the main reason for the move in the last two years, lobbying by the real estate sector and owners of high value properties have allegedly played a role.

Estate agents have previously said the four per cent stamp duty levied on property transfers was adequate, where together with rental tax rose over 110 per cent growth year-on-year, bumping up its contribution to 2019’s tax revenue.

But property tax or specifically, tax on immovable property, has done poorly in Cambodia, measuring only 0.1 per cent to gross domestic product (GDP), according a study by the International Monetary Fund in 2019.

“It is among the lowest collections by the GDT,” it read.

There are other forms of tax involving property, such as transfer tax, unused land tax and income tax, which are part of MEF’s revenue mobilisation strategy to widen the tax base.

However, the tax collection in the property sector has not been “perfect”, opined international economics director Hong Vannak of Royal Academy of Cambodia last September.

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Source: CBRE Cambodia

He learnt that the tax collection policies associated with real estate “lacked clarity and transparency”, so authorities should issue updates and other changes to provide a greater level of coherence.

GDT director-general Kong Vibol did not immediately respond to questions.

Weighing up the impact

The CGT has been sitting in the back burner for more than 10 years before it was approved in 2020, albeit lacking fanfare from real estate industry players.

“I think it is important that it is made clear who is actually impacted by CGT,” Clint O’Connell, partner and deputy managing director of legal, tax and investment advisory DFDL Cambodia, said.

Under the current CGT regime, those required to pay CGT include individuals and non-residents.

“Tax registered real estate developers should already be paying 20 per cent tax on income on gains that they make from sales. Individuals who sell property that they have lived in for at least five years or to close relatives are exempted from CGT,” he said.

Citing a recent National Bank of Cambodia report, he shared that house mortgages had increased by 37 per cent in 2021 despite Covid-19.

“So those impacted by the introduction of CGT would primarily be individuals who make profit from buying and selling real estate that does not constitute their primary place of residence,” said O’Connell, who is also head of tax practice in DFDL Cambodia.

What needs to be weighed up is the impact to the market of a CGT that practically “burdens” a seller who is selling property that does not involve their primary residence with a four per cent tax imposed on the sale versus the broadening of the current tax base.

The current tax base constitutes an additional tax revenue for the government for public spending and “potentially a reduction of property speculation” in the market.

For a comparison, O’Connell explained, a purchaser of hard title land in Cambodia currently has to pay a four per cent registration tax to transfer the title to their name.

“This tax, which is an equivalent rate to the CGT that will be imposed on a seller, does not seem to have been raised as a factor that could affect the market post Covid-19,” he said.

Money to be made

One thing that has remained steady in the real estate market despite the pandemic is a continued interest in land investment, apart from gold.

Many parts of the country where development is touted, land prices have soared no less than 10 per cent pre-Covid-19, and over 100 per cent in five years in Sihanoukville, with land parcels selling like hot cakes for $3,000 to $4,000 per square metre.

At the time, prime areas in Phnom Penh in Chamkarmon, Daun Penh and 7 Makara districts registered price growth in commercial land of between $4,000 and $6,000 per square metre.

It was boom time for the property sector.

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

And in October – just one month – of that year, nearly $277 million was raised through property taxes including stamp duty.

According to CBRE Cambodia, land values in Phnom Penh have seen a 10-year compound annual growth rate of about 10 per cent in the central business district (CBD), inner city and inner suburbs, and over 20 per cent in the outer suburbs. Apart from the CBD area, land prices are forecast to rise this year.

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Estimated land prices in Phnom Penh. cbre cambodia

“A great deal of growth activity has been on the outer suburbs,” said CBRE Cambodia managing director Lawrence Lennon, noting that it was likely driven by developers’ growing interest to move into those areas, as well as infrastructure construction and improvement.

He expects infrastructure to resolve accessibility into those new locations, adding that land will carry on being a “very competitive investment opportunity for years to come”.

“The reason why we say it’s competitive is because in reality there aren’t many options for Cambodians to invest in and this is a big reason why land continues to be a vehicle for a majority of Cambodians to invest,” Lennon said in an event recently.

Could this buoy speculative activities? Possibly.

Anthony Galliano, CEO of financial services firm Cambodian Investment Management Co Ltd, believed that CGT would not eliminate market speculation.

“You can look at global stock markets as an example where speculation is prevalent and the majority of countries where markets have skyrocketed have capital gains tax,” he said.

Therefore, if there is “money to be made”, investors would participate and “factor in” the capital gains tax in their decisions on return.

However, the delay in the implementation of the CGT has not prompted a rush or panic to sell in order to avoid the tax, Galliano said based on his observation.

He is of the opinion that markets appeared to have “absorbed the reality” that the tax is imminent, reiterating that it would have been factored in.

“In reality with a maximum effective four per cent tax outlay, it is the high value end of the market impacted [involving] individuals as businesses are already taxed on capital gains.

“When you boil it down, it is not a material impact on a large scale, but indeed a very small segment of the population,” Galliano said, echoing O’Connell’s views.

‘Generous mechanism’

Accordingly, the CGT is a “monumental” step in broadening the

tax base through the inclusion of individuals and the assignment of a tax type, which has an embedded substantial tax revenue for the government “if harvested”.

While there are concerns about timing, given the present two-year period of economic hardship due to Covid-19, oversupply in the real estate market, and a potential rush of sellers in property to avoid the impending tax, Galliano felt that it was possible that the scale and impact of the CGT may have been misjudged.

On the face of it, there is a 20 per cent tax on the gain as a result of a sale or transfer of a capital asset but the tax can be “substantially mitigated” by employing the determination-based method.

“[This] is a generous mechanism that allows taxpayers to deduct 80 per cent of the revenue received from the sale or transfer of the immovable property, as the cost base, without having to provide supporting documentation.

“The maximum tax rate is effectively only four per cent to the seller of property, and considering the purchaser is required to pay four per cent stamp duty tax of the value of the sold property, it seems equitable and not an oppressive tax.

“The CGT can be further refined to exclude the first $50,000 to $100,000 in gains so as to ensure that the lower to middle income taxpayers are not impacted and the tax is focussed more on the wealthy end of society.

“Collection of the CGT will greatly contribute to the national treasury, diversify the tax base and tax categories, and reduce the dependency on the current tax base, without any material impact on the real estate market and foreign direct investment,” Galliano said.

Spreading the net

Overall, Cambodia has gradually adjusted to becoming a nation of taxpayers and progressive enforcement by the GDT has been a “well-executed strategy”, with property tax being an “excellent” example of slow and steady acceptance.

“It has taken decades for the tax to be widely applied and with education and enforcement, it is increasingly an accepted and honoured tax by property owners in its domain,” he commented.

He added that although Cambodia’s property taxes are among the lowest in the world, it is still a contributor to tax collection with scope for gradual increase.

Capital gains are likely to experience a similar cycle with gradual acceptance and enforcement, and over time become a substantial contributor to tax revenue.

“It is likely that the headline number of a 20 per cent tax rate gives angst, but in reality [the] determination-based method substantially reduces the tax rate to as low as an effective rate of four per cent rate,” he said.

Separately, Galliano commended the GDT for educating the population on property taxes and also digitalisation of collection.

However, in order to improve tax collection, he expressed that the “net will need to be spread further” to property owners outside major cities and soft title holders beyond the district level to further penetrate the base and increase tax revenues.

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