Circular 1707 (Notification on the Treatment of Interest-Free Loans and Non-Market Rate Loans), recently issued by the General Department of Taxation (“GDT”), has very important implications on Cambodian taxpayers and may have ripple effects on the costs of doing business in Cambodia.  We provide below a summary of the Circular and a brief analysis on who can potentially benefit from this Circular and who may be adversely impacted.

What is in Circular 1707?

The most important matters covered by Circular 1707 are:

  • No deemed withholding on loans with zero or lower than market interest rates.  The Circular effectively restrains government tax examiners from applying deemed interest and corresponding withholding tax liabilities to loans that provide zero or lower than market interest rates. 
  • No deemed income to borrowers.  The Circular also restrains the tax examiners from treating the above non-market loans as subsidies that result in deemed income for the borrowers.
  • An additional limit on interest expense deductions.  Circular 1707 provides benchmark market rates.  For foreign loans, the benchmark is the Singapore Interbank Offered Rate (SIBOR) plus 6%.  For domestic borrowings, the deemed market rate is the annual average interest rate of the National Bank of Cambodia.    

Taxpayers are now able to deduct interest expenses only to the extent that they do not exceed these benchmark rates. 

This applies whether or not the parties to the loan are related.  It is applied per loan and is in addition to the total interest deduction cap under Article 12 of the Law on Taxation which prohibits interest deductions above the sum of the borrower’s interest income plus 50% of its net non-interest income for the applicable tax year.

  • Strict documentation requirements.  The Circular requires that :
    • loan contracts be duly certified by lawyers of the lenders and the borrowers;
    • evidence of the loan amounts having actually been received by the borrowers be maintained; and
    • proper entries regarding the loan be made in the borrowers’ books of account.

Failure to comply with the above requirements would lead to the loan being considered as income of the borrower.  This exposes the loan principal to the 20% Tax on Profit.

Winners and Losers under Circular 1707

Winners.  The obvious beneficiaries of the policies adopted by the Circular are multinational companies and foreign investors which are able to or have the policy of providing low or zero interest loans to their Cambodian subsidiaries.  These low interest loans are often provided to local subsidiaries which are still in their startup phase or which are not seen to turn a profit within the term of the loans.

In the past, these low interest loans exposed the borrowers to additional withholding tax liabilities for the deemed interest (for zero interest loans) or for the difference between the market rates and the actual interest rate under the loans.  This Circular eliminates this risk.*    

The Circular makes it cheaper for the above entities to finance their operations in Cambodia. 

Losers.  The cap on the deductibility of interest expense applicable to specific loans may potentially make debt financing more expensive for Cambodian businesses that are unable to gain access to cheap loans.  Interest rates on business to business loans are often set according to the specific risk profiles or the profit potential of the borrowers.  Some borrowers with riskier business models or who do not have a long track record of success often accept interest rates higher than the average lending rates provided by banks or other non-bank lenders.  With the adoption of the policies under the Circular, these businesses will have to absorb the portion of their interest expense beyond that calculated using the benchmark rates.  This effectively raises the borrowing costs of these businesses.       

The cap imposed by the Circular also limits to a certain extent the benefits of debt financing of Cambodian OpCos by multinationals or foreign investors. 

DFDL can provide you more information about this Circular and how it can affect your business.

* We note however that foreign lenders may still need to closely examine the transfer pricing rules in their own jurisdictions.  These transfer pricing rules may lead to deemed interest income in their jurisdictions.