On 3 August 2018 the Ministry of Economy and Finance issued Prakas 741, entitled “Rules and Procedures for the Implementation of Tax on Income and Other Taxes Related to the Cut, Make and Trim Activities of Qualified Investment Projects”. On 6 September 2018 the General Department of taxation (“GDT”) issued Notification 12802, entitled “Textile and Garment Enterprises’ Voluntary Amendment of Accounting Books and Tax Returns, and Obligation to Submit Independent Audit Reports”.
Both these pronouncements are specific to the garment, footwear, bags and hat manufacturing industries, and follow-on from the draft Prakas of late 2016, which resulted from extensive discussions between the GDT and the Garment Manufacturers Association of Cambodia concerning the GDT’s previous unwillingness to recognize the Cut, Make and Trim (“CMT”) model, under which companies provide fee-based manufacturing services on raw materials, the ownership of which remains with the customer. The GDT’s historical position was that the importer of record of the raw materials must be the owner, and therefore had insisted that manufacturers prepare financial statements, and file tax returns in which raw materials are accounted for as inventory and cost of goods sold. This often is not consistent with the commercial terms agreed between the manufacturers and their customers, and has led to many difficulties and disputes over the years.
Prakas 741 is thus a positive development, as manufacturers will be able to maintain their accounting records, and file their tax returns on a basis consistent with the commercial reality of their business arrangements. As always however, there are conditions and a few areas of potential confusion. Let’s take a look at what the Prakas and notification say.
Who does it apply to?
According to Article 3, the Prakas applies only to qualified investment projects (“QIPs”) engaged in the manufacturing of garments, textiles, footwear, carry bags, handbags, and hats in the Kingdom of Cambodia and who provide, under a contract, CMT services for such goods that are exported.
The Prakas does not apply to companies providing supporting goods or services to these manufacturers.
Article 4 provides definitions of terms used in the Prakas as follows:
- CMT refers to the supply of manufacturing services to the owner of raw materials whereby they are converted into finished products for export
- Owner of raw materials means a non-resident person who enters into a CMT contract
- CMT raw materials refers to the imported raw materials and/or accessories that are delivered to the CMT service provider, the ownership of which remains with the non-resident customer
The CMT service provider must:
- Notify the GDT within 30 days of signing a CMT contract, and provide a copy of the contract, which must contain details of the scope of work, the service fees, and the payment terms
- Maintain accounting records in accordance with Cambodian International Financial Reporting Standards (“CIFRS”) and the tax laws
- Retain the supporting documents specified in Article 9 of the Prakas
Article 6 of the Prakas confirms that CMT activities are treated as manufacturing for the purposes of the incentives available to QIP companies.
Income tax and VAT
Article 7 requires a CMT service provider to submit a monthly analysis of revenue, showing income from CMT fees, sales of rejects or excess material, and other non-export-related income.
The article confirms that Prepaid Tax on Income and Minimum Tax, where applicable, will be based on the total of these income components. It also confirms that CMT fees will be zero-rated for VAT purposes.
Under Article 8, a CMT service provider must maintain detailed records of the raw materials supplied by its customers. The records must include the quantities of materials received, processed, damaged, and exported, supported by goods received notes, and other documents and vouchers. The GDT must be notified of damaged or excess materials that will be scrapped seven days before disposal so that the GDT can witness the disposal or destruction.
Article 8 also requires that an “audited inventory report” be submitted each year with the annual Tax on Income return.
In addition to requiring CMT service providers to maintain accounting records in accordance with CIFRS, Article 9 of the Prakas makes it clear that a CMT service provider may also have non-CMT transactions, but requires that the accounting records identify these separately. In such cases only one Tax on Income return needs to be filed.
Per paragraph 3 of Article 9, CMT providers are expected to amend their previously filed tax returns to reflect the reality of their business. It states: “In case the enterprise supplying CMT services has declared taxes so far not reflecting the actual transactions, the enterprises shall amend their TOI returns for the previous 3 years. The outcome of the amendment which leads to additional taxes due shall be exempt from penalties and interest. The time limit for the amendment will be determined by the notification of the GDT.” We will review the contents of this notification later in this alert.
Paragraph 4 of Article 9 lists the supporting documents that the CMT service provider must retain, which includes the CMT contract, import and export documentation, etc.
The notification was issued primarily to impose a deadline on the amendment of previously-filed Tax on Income returns as provided for in Article 9 of the CMT Prakas. The deadline has been set as 31 March 2019. The GDT has taken the opportunity to observe that some businesses have not yet amended their previously filed “improper” tax returns; this seems to indicate an expectation on its part that more businesses should do so.
Thankfully, the Prakas and notification are generally clear as to meaning; however, there are one or two points which may need further clarification. The requirement to submit an “audited inventory report” will be an additional cost to taxpayers, and audit firms asked to prepare such a report will produce something called an “agreed-upon procedures report” which will provide limited assurance that the inventory report contains no material errors. Will this satisfy the requirement?
Some of the language used in the notification gives the impression that the GDT believes that a significant number of businesses in the industry have been filing inaccurate tax returns, and therefore should file amended returns. If you have been filing what you consider to be accurate returns, what should you do? Our view is that you should not file unnecessary amendments, and if you wish to switch to a CMT basis of reporting, follow the requirements of the Prakas and move forward.
Businesses operating in other industry sectors that may also wish to adopt the CMT model will be disappointed that the Prakas does not apply to them; perhaps the GDT will consider expanding the scope of the Prakas in future.
Those of you operating in industries within the scope of this Prakas have decisions to make, and possibly work to do before 31 March 2019! Not only do you need to have transfer pricing documentation by that date, but you also have to decide whether to amend prior tax returns, and whether to adopt the CMT method.
If you would like to discuss the content of this alert in more detail, or if you need assistance with implementing any of the required changes, please contact the undersigned, or your usual VDB Loi adviser.
VDB Loi is a network of leading law and tax advisory firms with offices in Cambodia, Indonesia, Laos, Myanmar and Vietnam. We provide the highest quality solutions for transactions and taxation. Our general areas of practice are corporate, finance, licensing and disputes. Our principal specialized areas of practice are energy, infrastructure, real estate and construction, telecom, and taxation.
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