Instruction no. 10979.GDT on the required documents for related party loan.
There has been a substantial amount of back and forth regarding the tax position on a related party loan, as detailed in the below list.
- Before 2014 – Interest-free loan was not allowed by the GDT
- Jan 2014 – Interest-free loan was allowed by the GDT
- Oct 2017 – To follow arm-length rate
- Mar 2019 – Lower interest/interest-free is allowed if the required conditions are fulfilled
- May 25, 2022 – Instruction no. 10979
From October 2017, a related party loan is generally required to follow the arm’s length rate. However, a taxpayer can opt to use a related party loan with a lower/zero interest rate provided that they can fulfil the below four required conditions based on the Instruction no. 4909 GDT dated 18 March 2019:
- Loan agreement with a specific loan period
- Business plan in relation to the loan
- Document(s) on interest rate determination base
- Board of directors’ resolution (For Enterprise other than single-member private limited Enterprise)
The conditions (2) and (3) above are not defined, creating difficulty/uncertainty for a taxpayer to fulfil. For example, is a simple business plan only showing how the loan is used acceptable? It is understood in practice that there is an inconsistent position adopted by the General Department of Taxation (GDT) concerning these two conditions.
Therefore, the GDT has issued Instruction no. 10979 dated 25 May 2022 to provide clarification on these two required conditions and other concerns regarding funds from related parties as detailed below.
I. An enterprise having a related party loan transaction CAN determine its interest rate as agreed. It shall be exempt from the arm’s length principle if an Enterprise possesses the following supporting documents:
- Loan agreement with a specific loan period and repayment
- Business plan or “current and forecasted financial statements” and the purpose of borrowing together with an explanation
- Board of Directors’ resolution (for an Enterprise that is not a single member private limited Enterprise)
Our comments: This condition no. (2) is the combination of the conditions (2) and (3) in Instruction no. 4909. In addition, this condition no. 2 is practical to implement as it is usually the case for long-term borrowing to have forecasted financial statements as the supporting document/reference for the group to review before approving the requested loan. These forecasted financial statements should illustrate a shortage of funds, which is why to borrow from the group. For short-term funding, please refer to item no. 3 below.
II. When an Enterprise borrows money from its related parties, the interest rate shall not exceed the market interest rate during the borrowing. The market interest rate is the average interest rate of at least five local commercial banks, which the GDT annually issues.
Our comments: This limitation is the condition for related party loans from 2014 to 2017, as shown in the above graph. Hence, reintroducing such limitation should technically impact an entity having its source of funds mainly from a group loan. Luckily, the market interest rate in Cambodia is generally higher than in other countries, so there should not be much impact for reintroducing this limitation, as related party loans tend to have lower interest rates than the market interest rate as defined above.
However, as you may be aware, from 2020 onwards, the interest expense, which is not allowed as an expense during the year, is currently allowed to be carried forward for only five years. The carryforward period was indefinite for the prior year, 2020.
Therefore, if your Enterprise has significant loan transactions, we suggest you revisit your tax planning.
III. An Enterprise with a cash advance transaction from the related party with less than a one-year period, counting from cash receipt to actual payment date, shall not be considered a loan transaction and be exempt from the arm’s length principle implementation.
Our comments: It should be the case that there is financial difficulty, especially during this Covid-19 pandemic, that an Enterprise needs funds from its related party to support its operation. However, tax matters can be considered as one barrier to this matter. This provision eliminates such a barrier.
Is a short-term revolving advance considered a new advance under this provision when rolled over? It is very subjective, but we would think that it is possible to have such an arrangement.
Can this tax provision be used on short-term advances for prior periods? As no effective date is indicated in this Instruction, it might be argued that such provision can be used for previous periods.
The Instruction no. 4909 GDT dated 18 March 2019 on the supporting documents for related party loan interest are replaced by the current provisions and no longer apply.
Contact our teams for expert support and further information about accounting & tax requirements in Cambodia to ensure you are compliant in the market.