Robert Porter of VDB Loi in Phnom Penh looks at the latest developments in Cambodia’s garment industry

The Garment industry is extremely important to the Cambodian economy, and employs over 600,000 people out of a total population of just over 15 million. Garment exports now exceed $6 billion annually, which represents over 15% of the country’s total GDP. It is estimated that there are over 600 factories, most of which are foreign-owned.

The majority of these factories produce garments from imported raw materials which remain the property of the offshore customer (often a related party or parent company); this is often referred to as the “Cut Make & Trim” (CMT) business model. Unfortunately the General Department of Taxation has always taken the view that the importer of record is the owner of such raw materials, and has therefore insisted that CMT companies file corporate income tax returns as if they are manufacturing on their own account (i.e. including purchases and inventory of raw materials, and sales of finished products). This is often referred to in Cambodia as the “Free on Board” (FOB) business model.

This requirement has always been inconvenient for CMT companies, causing additional accounting and administrative work, and being totally inconsistent with the commercial reality of their business. Now that most companies are required under the recently-issued Law on accounting and auditing, to have an external audit, this inconsistency will prove extremely problematic to audit firms.

The Garment Manufacturers Association of Cambodia (GMAC) has been campaigning for several years now to try to persuade the GDT to change their position, and recognize the CMT) model, rather than requiring CMT operators to file tax returns on the FOB basis.

Happily, during the last few weeks GMAC, with some technical support from VDB Loi, have succeeded in obtaining the agreement of the GDT to accept tax returns prepared on a CMT basis, subject to certain conditions. Although nothing formal has yet been issued, our understanding of the likely conditions is as follows:

  1. The company must have a written contract or agreement with its customer (even if the customer is the parent company);
  2. The company may need written confirmation from the Council for the Development of Cambodia (CDC) that CMT activities are permitted under the company’s license as a Qualified Investment Project (QIP). (CDC have actually confirmed to GMAC that CMT activity is permitted, so this requirement may be dropped);
  3. The GDT will require the company to be able to “prove” its income by reference to incoming bank transfer documents, and bank statements;
  4. The CMT fee is expected, unless there are abnormal circumstances, to be sufficient to cover direct costs plus overheads, and to provide a “reasonable” profit margin. (The GDT have not provided any guidance as to what they will consider to be reasonable, but did comment that if the fee is from a related party, they will apply Transfer Pricing principles to determine reasonableness).

In addition to these conditions, the GDT has agreed to allow revisions to and resubmission of Tax on Profit returns that have not yet been audited for 2013, 2014, and 2015. (Actually this is already a taxpayer’s right within the Law on Taxation, however the GDT wanted to emphasize that resubmission of the tax returns on a CMT basis is acceptable for the three years in question).

The GDT’s reference to transfer pricing principles is extremely interesting as Cambodia currently does not have specific transfer pricing regulations. It is our understanding that such regulations are now being drafted, although there is no news as to when these will be issued. We also hear that the regulations are based on those adopted by Malaysia and Indonesia (i.e. generally following OECD guidelines).

As part of its recent reform program, the GDT has recruited a considerable number of bright young graduates. From our contact with these officials it is clear that they are being given extensive transfer pricing training, and display an impressive understanding of the principles. This of course could be good or bad for taxpayers, depending on their pricing methods. One advantage for all taxpayers is hopefully that the newly trained tax officers will understand that acceptable transfer prices are not necessarily open market prices, but depend on the relative risk taken, and functions carried out by the related parties.

Companies with significant transactions with related parties, which is most of the garment industry, will need to start developing documentation to support the pricing methodology used in either setting the CMT fee, or material purchases and sales of finished goods for those companies operating on the FOB basis.


Robert Porter
Phnom Penh