An Assessment of the Fiscal Policy in Cambodia. Valerie Mitchell Group Global. October 28, 2001

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1 Fiscal Policy - Cambodia Page 1 of 6 Interim Report to the Market Expansion Committee of General Electric Appliances - Asia An Assessment of the Fiscal Policy in Cambodia Valerie Mitchell Group Global October 28, 2001 Project The Market Expansion Committee (MEC) of general Electric Appliances Asia (GEAA), a division of General Electric (GE) has engaged Group Global to produce a strategic risk analysis on the feasibility of expanding its refrigerator product line of home appliances into Cambodia and Laos. GE maintains a strategic mission to attain a number one or two market position when entering a new market with any of their product lines (Friedman, 2000). Inasmuch, Group Global will endeavor to explore all potential market entry risks that could affect the successful attainment of this mission statement. GEAA currently has established offices and market positions in all countries surrounding or nearby Cambodia and Laos, except Myanmar (Burma), which include Thailand, Malaysia, Singapore, Vietnam, China, and others in the general region (About GE Appliances Asia, 2001). GEAA does not currently have a presence in Cambodia and Laos, thus generating the impetus to study the risk factors involved with entering these countries markets. This report is one of a series of reports to be issued in the ensuing weeks covering various risk focuses for market entry into Cambodia and Laos. The report will focus on the risk factors related to fiscal policy that should be considered relative to the plausibility of entry into the Cambodian market. This report will answer the question: What are the country s tax policies and how do they affect business operations? This report will also discuss the tax structure in the country and the categories of taxes that consumers and businesses must pay by discussing Cambodia s economic background and fiscal policy.

2 Fiscal Policy - Cambodia Page 2 of 6 Economic Background Cambodia, officially named Kingdom of Cambodia, experienced a drastic economic decline in The economic down fall was a result of the regional economic crisis, civil violence, and political infighting ( At the same time, foreign investment and tourism decreased. In 1998 the main harvest in the country, rice, corn and various vegetables, was destroyed by drought. Due to Cambodia's political instability and corruption within the government, foreign investment was discouraged and there was a delay in foreign aid from other countries. Cambodia's human resource levels are extremely low, especially in the poverty-ridden, rural areas where over 90 percent of the poor citizens reside ( The lack of adequate human resources puts a strain on Cambodia's economic development. Their wages and labor productivity remains low. It has been estimated that an annual gross domestic product (GDP) growth rate of 6 percent for 2001 to 2005 and an income of $320 per capita, from the current $271, would greatly reduce poverty in Cambodia. The government's plan is to significantly reduce poverty by the year Cambodia's long-term economic development is still a challenge for the government to uphold. In 2000, Cambodia was experiencing economic growth although macroeconomic stability was maintained. Cambodia's gross domestic product (GDP) increased by 5.4 percent, down from 6.9 percent the previous year. The economic decline was due to the decreased productivity in forestry, fishery and agriculture. Approximately 70 percent of the Cambodian population are employed in agricultural positions. In 2000, Cambodia lost approximately 100 million dollars as a result of a massive flood. The construction and textile industries grew dramatically during the time of rebuilding. However, the overall budget deficit increased from 1999 to The budget deficit increase was from 4.1 percent in 1999 to 6.0 percent in Surprisingly, this gap was financed almost in its entirety by loan agencies through loan and grant support, which was not the case 3 years earlier, in Fiscal Policy Fiscal policy is one of the tools that a national government utilizes to positively influence its domestic economy. Fiscal policy is a mechanism that is endorsed by the government and it

3 Fiscal Policy - Cambodia Page 3 of 6 also refers to the expenditure a government undertakes to provide goods and services. It is the way in which the government finances their expenditures. The Royal Government of Cambodia is responsible for effectively executing its financial policies. The Cambodian Investment Board (CIB) receives and evaluates investment proposals from the investors and submits them to the Council for the Development of Cambodia (CDC). In order to attract more foreign investors, the CIB has implemented promotional campaigns in major business centers. The advertising campaign was conducted worldwide. The CIB offers investors assistance for obtaining registration, authorizations or tax exemptions to facilitate the expedient setting up of their businesses in Cambodia. Cambodia offers the best business incentive package in Southeast Asia, which makes Cambodia attractive to investors. The Royal Government has an investment agency, the CDC, which is empowered to grant duty and tax free exemptions. The CDC approved Cambodia's investment law, which offers incentives to foreign and local companies wanting to do business in Cambodia. The incentives that Cambodia offers to these businesses include a corporate tax rate of 9%, up to eight years of tax holidays, no tax withholding on dividends, full import exemptions for export projects, free repatriation of profits and no nationalization and price control ( All imports to Cambodia are charged a tariff, which is based on the Harmonized System of Classification. The tariffs are determined on a cost-insurance-freight (c.i.f.) basis. There are only eight items in which the Ministry of Economy and Finance has established a fixed value. These items are cigarettes (important brands), beer, petroleum products, motor cycles, soft drinks, televisions, videocassette recorders, and radio cassette players. These eight items account for 60 percent of total imports and 78 percent of total import duty collections. The remaining import items are categorized under four main categories of 7, 15, 35, or 50 percent. The 7 percent category is for consumer goods and basic raw materials. The 15 percent category is for intermediate goods and machinery and equipment. The 35 percent category is for most consumer goods and building materials, and 50 percent is for luxury consumer goods, cigarettes and alcoholic beverages. GEAA's refrigerators will fall in the 35 percent category. There are a few items in the zero percent category, which are also exempt from consumption taxes; gold, silver and coins are 0.3 percent; diesel and lubricants are 20 percent; and petrol is 45 percent ( There are no exemptions for export taxes and the exemption categories

4 Fiscal Policy - Cambodia Page 4 of 6 consist of only 10 percent and 50 percent. The 10 percent category consists of livestock and wood, the 50 percent category consists of chemicals, flowers and extracts. Cambodia withholds a monthly tax from wages, salaries and fringe benefits. The tax applies to all wages received in Cambodia and wages received abroad by Cambodian nationals if the employer resides in Cambodia. The highest marginal tax rate is 20 percent. Additionally, tax paid abroad can be credited against tax paid in Cambodia. Citizens earning the equivalent of 3,500 U.S. dollars are exempt from taxes. For an annual income equivalent to $100,000 (U.S.), the average tax rate is less than 9 percent. There are no tax exemptions. Furthermore, deductions are contingent upon the number of children, in the household, under 18 years of age. Cambodia's rental property tax applies to all property owners except taxpayers who get less than $200 per month from all rental sources. Enterprises, taxed on an actual account basis are also exempt. There are no other exemptions. All incomes from the rental of property are covered by the tax, which is 10 percent. Cambodia assesses a monthly tax on the interest and capital gains of businesses. The monthly tax applies to businesses whose annual turnover is more than $ 77,000, service enterprises whose annual turnover is more than $ 38,500, import and export businesses, enterprises that have signed a contract with the State, enterprises that are covered by the Investment Law and hotels and restaurants. These businesses are required to keep accounts and pay accounts-based profit tax. All other enterprises estimate annual profits by estimating profit margins to turnover. Manufacturing and commercial businesses grossing more US$ 38,500 and service enterprises whose annual turnover is more than US$ 19,250, have to keep simplified accounts, including turnover. The Taxation Department assesses the turnover for the remaining businesses. Profit taxes are collected monthly but accounts-based profit taxes are paid by monthly installments equal to 0.5 percent of monthly turnover, the outstanding balance being payable in March of the following year. No refund is given in the case of a loss, but the tax already paid can be carried forward for 3 years ( There are no exemptions. However, under the Investment Law, exemptions can be granted to investors by the Council for the Development of Cambodia (CDC) for up to 8 years, beginning the year the investment project turns a profit. Interest paid and capital losses are deductible.

5 Fiscal Policy - Cambodia Page 5 of 6 Corporations are taxed at a flat rate of 20 percent instead of the progressive tax rate schedule, whose rate ranges from 10 to 30 percent, and which will continue to apply to the profits of individual and household businesses. The rate is 9 percent for projects approved by CDC under the Investment Law. Cambodia businesses also pay an annual registration (or license) fee. The base of the tax is the company's previous year's turnover. The annual rate for turnover between $154 and $1,925 is 0.5, 0.8 or 1.0 percent. Conclusion Cambodia's fiscal policy for 2000 entailed a broadened Value Added Tax (VAT) base, increased royalty payments from tourist service providers, improved customs and tax administration, and collection of arrears from telecommunications services and leases of state assets. On the expenditure side, while overall budgetary control and the allocation of funds for health, education, and rural development have improved, the program includes additional steps to raise the effectiveness of expenditure in reducing poverty. As with all countries, the effects of the World Trade Center disaster have been a declining factor in economic development. Even with these devastating circumstances, GEAA's intent to extend its refrigerator product line into Cambodia can be a successful endeavor. As stated above, Cambodia's wages and labor productivity are low. Entering into Cambodia would provide a more substantial income for the citizens to raise their families. In turn, the economic level will rise by providing jobs for some of the 70 percent of the agricultural employees who can not work when the floods destroy their crops. In conclusion, Cambodia has been striving to improve its economic stature. Although its political instability and corruption still exists, it has been decreasing. Both GEAA and Cambodia can reap the rewards of a refrigeration plant residing in Cambodia. The Cambodians will be able to continue working during flooding, they will earn substantial wages, and they will be educated on the refrigerator production and product line. With the assistance of the Royal Government, the Council for the Development of Cambodia and the Investment Board, GEAA and Cambodia can benefit from GEAA's market entry into Cambodia.

6 Fiscal Policy - Cambodia Page 6 of 6 References Cambodia-Business & Economy. [Online]. Available at: [October 20, 2001] Cambodia Country Brief. [Online]. Available at: [September, 2001] Friedman, T.L. (2000). The lexus and the olive tree. New York: Random House. Taxes on International Trade and Transactions. [Online]. Available at: [October 24, 2001] The World Bank and Cambodia, [Online]. Available at: [2000, May]