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Chapter 7. Raising Funds for the Future: The Case for an Integrated Revenue Mobilization Strategy

Author(s):
Olaf Unteroberdoerster
Published Date:
February 2014
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Tubagus FeridhanusetyawanThis chapter is a shorter version of “Revenue Mobilization in Cambodia: Challenges and Policy Priorities,” a background paper for the 2012 IMF Article IV Consultation with Cambodia, prepared by Tubagus Feridhanusetyawan (Asia and Pacific Department) in consultation with the IMF’s Fiscal Affairs Department. It is based on a number of technical assistance reports prepared by IMF technical experts for the Cambodian authorities covering administrative reform issues, tax policy reforms and recommendations involving the tax regime for individual economic sectors.

This chapter proposes a strategy for mobilizing domestic revenue, which is the key to rebuilding the fiscal space, as discussed in Chapter 6. It draws on the findings of recent IMF technical assistance missions to Cambodia and prioritizes recommendations into a set of achievable and well-sequenced measures. The strategy is three-pronged: improving revenue administration, reforming tax policy, and strengthening governance. Simultaneous implementation in these three reform areas is critical, because good progress in one area would create positive feedback to the others, making revenue mobilization more effective and self-sustaining.

Cambodia has made progress in reforming tax policies and administration to raise fiscal revenue. A series of comprehensive tax reforms took place during the past two decades to modernize the tax system. Substantial reforms also took place in the area of revenue administration, anchored by the establishment of the Large Taxpayer Department (LTD) in the General Department of Taxation (GDT) and the introduction of an automated system for customs clearance. As a result, domestic revenue increased to more than 10 percent of GDP in 2008 from 6½ percent of GDP in 2003; it stayed broadly flat during 2009–11 before increasing again in 2012, for reasons noted in the previous chapter.

Despite this progress, revenue mobilization in Cambodia remains low by most standards, limiting fiscal space available to meet its myriad development needs. As discussed in Chapter 6, Cambodia’s tax rates are competitive by regional standards, but revenue mobilization is constrained by excessive tax exemptions, low tax productivity, and weak collection. As a result, Cambodia’s tax-to-GDP ratio, around 11 percent on average during 2010–12, remained low compared with the 24 percent average of Vietnam, the 15 percent average of Lao P.D.R., and the 18 percent average in other low-income countries in Asia (Bangladesh, Bhutan, Mongolia, and Nepal). The task of increasing government revenues will likely become more challenging over time, since the contribution of trade taxes is likely to decline as Cambodia implements its commitments under the ASEAN Free Trade Area (AFTA) and transitions to middle-income country status, with grant disbursements (currently at 3½ percent of GDP) likely to fall. Meanwhile, greater mobilization of fiscal revenues is imperative in the near term to rebuild government deposits if difficult and undesirable spending cuts are to be avoided, and also in the long term to maintain fiscal sustainability and meet Cambodia’s vast development needs. In view of these challenges, the authorities have set an ambitious goal: to increase domestic revenue collection by ½ percent of GDP annually over the medium term.

In this chapter, we present a strategy to increase revenue collections over the medium term. We describe a comprehensive approach for mobilizing revenue and identifying specific policy priorities that can be implemented consistent with the findings of recent IMF technical assistance. We will distill and prioritize a long list of policy recommendations into a comprehensive set of achievable and well-sequenced measures. The first section will discuss the importance of pursuing a three-pronged strategy, with the other sections outlining specific policy priorities in each reform area.

A Three-Pronged Strategy

Cambodia’s revenue mobilization strategy should rely on a three-pronged strategy: improving revenue administration, implementing fair and efficient tax policies, and strengthening governance (Figure 7.1). Simultaneous implementation of these three reform areas is critical, for two reasons.

Figure 7.1Cambodia: Three-Pronged Approach of Revenue Mobilization Strategy

First, progress in one area of reform would create positive dynamic feedback to the other two areas. For example, developing a fair, efficient, and simple tax system would make it easier for revenue administration agencies to collect taxes and promote good governance and transparency. Experience from other countries shows that simplifying the tax system would reduce the burden of administration, prevent tax ambiguity, and reduce incentives for corruption (see Box 7.1). Meanwhile, improving revenue administration, for example by establishing good taxpayer services and collecting tax arrears, would make the tax system fairer and more efficient while at the same time improving compliance. Similarly, strengthening governance by promoting accountability and transparency would help the revenue administration collect taxes and ensure the efficiency and fairness of the tax system.

The second reason simultaneous reform is critical is in the same vein: a lack of progress in one area will hamper reform efforts in another. For example, without a mechanism to strengthen oversight and transparency, it would be difficult to enforce rules and improve tax compliance. Similarly, if the tax regime is not implemented consistently owing to administrative weaknesses, it would be hard to analyze the framework and the performance of the tax system.

This three-pronged strategy is broadly in line with the lessons learned from successful tax reforms in many developing countries over the past two decades (Box 7.1; see IMF, 2011). Cross-country experience suggests that strengthened revenue administration, supported by strong political will and technical capacity, is critical to enhancing revenue mobilization. That said, estimating the revenue impact of administrative reforms alone could be difficult because the process is often complex, takes time, and involves other reforms. Past experiences also indicate the importance of simplifying tax laws, improving business processes, and segmenting the taxpayer population to better target administrative resources and improve compliance. However, challenges remain in strengthening human resources, improving coordination between domestic tax and customs administrations, reducing compliance costs, addressing noncompliance, and reducing corruption.

The priority should be on policy actions that would generate substantial additional revenue, create strong positive externalities, and be implemented without high cost. Cambodia has identified an extensive list of fiscal reforms, including policy actions to raise tax revenue. For example, the National Strategic Development Program and the Public Finance Management Reform Program have envisaged various measures to strengthen public financial management. Moreover, the IMF and other development partners have provided a long list of policy recommendations in recent years. However, policy actions need to be prioritized, sequenced, and implemented to make reforms more effective. The selection of measures should be based on their benefits (i.e., whether they are likely to generate additional revenue during the next three to five years), costs (i.e., practical implementation at the lowest cost possible), and strategic importance in supporting other reforms (i.e., creating positive externalities). Some measures are expected to produce an immediate revenue impact, while others are included because they are expected to sustain revenue performance in the medium term (Table 7.1).

Table 7.1Cambodia: Policy Priorities for Revenue Mobilization
Reform areaNear-term prioritiesMedium-term priorities
Revenue administrationCollecting tax debt and improving the performance of the Large Taxpayer Department.Reprioritizing reform plans toward revenue-generating activities; establishing taxpayer services; developing human resources and information technology; strengthening revenue forecasting.
Tax policyReforming value added and excise taxes.Focusing tax policy reforms on scaling back tax exemptions and incentives; limiting the estimated regime; rationalizing corporate and personal income taxes and property taxes.
GovernanceStrengthening oversight and accountability and promoting transparency to improve the performance and credibility of tax institutions.
Source: Various IMF technical assistance reports provided to the Cambodian authorities.
Source: Various IMF technical assistance reports provided to the Cambodian authorities.

Box 7.1Cross-Country Experiences in Improving Revenue Mobilization

This box provides a few examples showing how countries have managed to increase revenue collection in a short period through comprehensive tax reforms supported by strong political will and technical assistance.

El Salvador implemented tax reforms by simplifying the tax regime and broadening the tax base during 2004–10. The reforms included restricting value added tax (VAT) zero-rating to exports; eliminating exemptions on interest earned in banks licensed abroad and on income from the interest and capital gains of individuals; establishing a tax on the registration of new vehicles; broadening the income tax withholding base for nonresidents; introducing a mixed (ad valorem and specific) system of excises on tobacco and alcoholic and other beverages, replacing the previous system of ad valorem rates to ensure that a reasonable tax is paid even on the least expensive products; introducing provisions to deal with transfer pricing, previously absent, and rules addressing thin capitalization; eliminating export subsidies; and increasing the tax on lottery prizes from 5 to 15 percent, partly to counter money laundering. These simplifications reduced the burden on tax administration and, as a result, tax revenue increased to 13.4 percent of GDP in 2010 from 10.9 percent of GDP in 2004.

Tanzania raised revenue collection without increasing tax rates by strengthening tax administration. The reform was guided by five-year plans of the semiautonomous Tanzania Revenue Authority and supported by development partners. Key reforms included introducing a common taxpayer identification number for all taxes; creating a large taxpayers department; consolidating VAT and income tax administration into the single, functionally structured Domestic Revenue Department; allocating geographical groups of taxpayers to specific teams with clear performance targets; and improving assistance to small taxpayers in understanding and complying with their obligations. A new income tax law (2004) introduced self-assessment and rationalized small taxpayer administration and an increase in the VAT threshold to focus on high-yield taxpayers. Policy reforms also simplified the personal income tax (PIT), including reducing the brackets and the top marginal rates, increasing the exempt amount under the PIT, and adjusting the presumptive income tax rates to reduce inconveniences to small-scale businesses. Customs reforms focused on interfacing operations with domestic revenue operations; better risk management; and introducing web-based customs clearance. These reforms helped raise tax collections to 15.3 percent of GDP in 2009 from 9 percent of GDP in 2000.

Vietnam implemented sweeping tax reforms by simplifying tax policies and strengthening tax administration guided by a five-year Tax Reform Plan (2005–10). The corporate income tax has been strengthened by unifying the rate structure, removing some incentives, permitting deductions, and transferring unincorporated businesses to the PIT. The VAT has been improved by restricting zero-rating to exports, eliminating the discrimination between domestic and imported products, and reducing exemptions. The PIT has also undergone comprehensive changes, such as introducing a tax on capital income, broadening the tax brackets, and lowering the top marginal rate. A new tax administration law was enacted in 2006 to combine all administrative procedures and broaden the powers of the General Department of Taxation (GDT) to administer the tax system. The GDT’s headquarters and its network of tax offices were reorganized into functionally based units and connected by computer network, and a broad range of electronic applications were implemented. Steps have also been taken to upgrade staff skills; these actions have been supported by the creation of a tax college within the GDT. Reflecting these reforms, tax revenue averaged 23.7 percent of GDP during 2005–08, compared with 19.6 percent of GDP during 2001–04.

Source: IMF (2011).

The remainder of this chapter will discuss specific policy priorities for each reform area to help focus and sequence reform implementation. It first focuses on revenue administration, which has lagged behind in reform progress but also has the largest potential to increase revenue in the near term. The discussion then turns to necessary reforms of tax policy and finally outlines some measures to strengthen governance.

Improving Revenue Administration and Forecasting

A stable and modern tax administration in Cambodia should be based on several key standards that guide revenue collecting agencies around the world. First, a proper legal framework is needed that provides an appropriate balance between the rights of taxpayers and the power of the tax agency, supported by efficient organizational and staffing arrangements. The framework should put in place a system of self-assessment, supported by streamlined collection systems and procedures, with the objectives of fostering voluntary taxpayer compliance, reducing compliance cost, and focusing enforcement efforts on taxpayers who pose a higher risk of evasion. Second, a service-oriented approach should be taken by the tax administration, whereby it operates as a trusted advisor and educator to help taxpayers meet their obligations voluntarily and is supported by risk-based audit and verification as well as dispute resolution mechanisms. Third, human resources management and information technology practices should be adopted: the former to provide incentives for high performance and ethical behavior of tax officials and the latter to promote the extensive use of a computerized system to help process taxpayer information effectively. Finally, a modern tax administration should have a mechanism to adopt ongoing institutional change for improvement, supported by an environment of integrity and good governance to ensure transparency and accountability. Although this chapter focuses on tax and customs revenue, improvements in nontax administration would also support revenue performance, albeit from a smaller base.

Near-Term Priorities

Cambodia faces a number of challenges in strengthening administration, which must be prioritized to maximize revenue collections (Table 7.2). The stock of tax debt including arrears is large, estimated at about half of the annual tax collection. At the same time, this figure is based on Cambodian tax officials’ unilateral assessments, and lack of supporting evidence and accurate records on accumulated penalties and interest on old debt make the obligation difficult to collect. A task force should be set up to undertake forceful but professional collection activity against some of the worst offenders. For example, the task force could select some debts that are recent, significant, and uncontested, and secure the advance agreement from relevant senior officials to use appropriate collection measures for these cases.

Table 7.2Cambodia: Priorities for Improving Revenue Administration
Priority areasPolicy measures
Near term
Debt collection: Start collecting large tax debts. Even a small proportion would generate significant additional revenue.(1) Establish a task force to start addressing the most significant debt cases; (2) Develop protocols to delegate powers from relevant senior officials; (3) Develop tax installment payment arrangements; (4) Strengthen audit capacity.
Large Taxpayer Department (LTD): Strengthening the performance of LTD, which provides about 80 percent of tax collection, would raise overall revenue.(1) Create a team within LTD to develop and maintain an understanding of every large taxpayer and risks; (2) Include the LTD arrears cases in the debt collection task force coverage; (3) Develop large taxpayer compliance strategy including service initiatives; (4) Relocate all large taxpayer risk assessment and audit functions to LTD.
Medium term
Taxpayer services: A comprehensive strategy is needed to pull together the various elements of service delivery in order to improve taxpayers’ compliance.(1) Draw up action plans to ensure the implementation of the Department for Tax Services and Tax Arrears (DTSTA) operational work plan; (2) Continue seeking development partners to design and roll out a comprehensive taxpayer service strategy and allocate sufficient resources to taxpayer services functions. (3) Provide public information about avenues of appeal available to taxpayers.
Planning: Tax institutions have limited planning capacity and limited progress has been made in implementing action plans.(1) Review the operational plans to prioritize activities and tasks, identify the resource needs, and set realistic targets. (2) Establish central reform office in tax institutions to implement and monitor reform programs.
Human resource development: Staff are skewed toward low-value activities, partly due to large number of small taxpayers and manual procedures. Meanwhile important functions like taxpayer services and debt collection are understaffed.(1) Reorganize staff allocation by prioritizing revenue mobilization functions; (2) Allocate staff particularly at headquarters to strengthen governance, performance management, and monitoring; (2) Reform recruitment process to quickly fill vacancies.
Information technology (IT): The IT system is inadequate, procedures are predominantly manual and paper-based. Taxpayer information is unreliable and is not easily processed, consolidated, and shared, while the number of IT support staff is inadequate.(1) Establish a business process and an IT reform program, including a dedicated full-time team and seek support from development partners. (2) Discuss funding option, including donor support, to develop IT infrastructure.
Revenue forecasting: Limited capacity of revenue analysis due to resource constraints and absence of automated systems and integrated database.Strengthen revenue forecasting capacity at the Ministry of Economy and Finance (MEF) and all tax collecting agencies and improve coordination in setting and monitoring revenue targets.
Source: Various IMF technical assistance reports provided to the Cambodian authorities.
Source: Various IMF technical assistance reports provided to the Cambodian authorities.

The task force should maintain full records of all contacts with taxpayers and the actions taken and results, updated on a regular basis. Further efforts to strengthen the capacity of the LTD would also generate more revenue in the near term. The LTD contributes to more than three-fourths of revenue collection, but its performance has reached a plateau in recent years and further efforts are needed to enhance its capacity. For example, the LTD should be given full responsibility for all interactions with its taxpayer base, including oversight of the audit program. Improving the LTD’s capacity to identify and address the major risks of noncompliance posed by its different types of taxpayers would help focus its limited resources on the least compliant taxpayers. In addition, since the service needs of large taxpayers are different from those of other taxpayers, the LTD needs to develop its own taxpayer service strategy. For instance, a range of tailored service initiatives, including improved relationship management for large taxpayers, could be established to develop respect and trust and encourage greater compliance.

In addition, rigorous audit activities are needed to support revenue collection. So far, audit activities have been fragmented, and efforts to investigate cases of serious tax fraud have been limited, partly because of capacity constraints. In view of this, it would be a good start to assign all audit activities relating to taxpayers registered with the LTD to the department’s staff. For other taxpayers, the Department of Enterprise Audit should have the full responsibility for designing and coordinating audit activity (including selection and audit guidelines) for all of the GDT’s audit teams (except those within the LTD). This would involve developing audit selection processes to better address noncompliance across the small- and medium-sized taxpayer segments and consolidating risk assessment activities in one central unit. It is also important to develop a standard audit manual which should cover routine audit procedures, and to design a system to record and transmit audit results to the appropriate departments, agencies, and units so that the risk assessment process, including information-sharing procedures, can be improved.

Medium-Term Priorities

Turning to medium-term priorities, the development of a comprehensive taxpayer service strategy would pave the way for sustained revenue collection. In Cambodia, basic taxpayer services are still lacking, such as providing taxpayers access to continuous tax education and written materials and alerting them to advisories, rulings, and dispute resolution processes. Therefore, a taxpayer services strategy is needed as a major component of the overall plan for improving taxpayers’ compliance. This strategy, if formulated properly, would address what services could best assist taxpayers to comply with their obligations and how such services could be organized and delivered, including staffing and skill requirements. Sufficient resources for central and field-level taxpayer services would need to be reallocated to ensure successful delivery.

Concerning organization and planning, reorienting tax institutions’ operations toward revenue-generating activities remains the top priority. With no organizational separation between tax policy and tax administration, the work on policy and legal issues has often drawn valuable resources away from revenue-generating activities. The work on legal initiatives should also be focused on areas that will improve revenue yield, such as reducing the “gray” areas to improve tax compliance. The GDT Strategic Plan 2011–14 is a good starting point, but more prioritization is needed, particularly in aligning the planned activities with the overall strategic direction and resource availability. For example, taxpayer services feature prominently in the technical assistance supported by development partners, but it has not received full recognition as a strategic priority. Therefore, the tax institutions need to reorient themselves toward the identified priorities for generating and sustaining revenue collection, such as improving taxpayer services, where limited resources are currently deployed.

Efforts to strengthen human capital should focus on reallocating staff toward high-value activities that generate revenue. The limited number of skilled and experienced staff is currently skewed toward low-value activities, partly because of the structure of the tax system (large numbers of small taxpayers) and procedures, which are predominantly manual. The most qualified staff are also stretched by numerous tasks, such as participating in ad hoc policy teams, leaving limited resources for operational work. Meanwhile, functions that ought to have a higher strategic value, such as taxpayer services and debt collection, have been understaffed. More staff are needed to work on governance, performance management, and monitoring roles to strengthen oversight of tax institution performance. Finally, a program to strengthen human capital should be supported by improvements in the recruitment process to quickly bring in new staff once a vacancy arises.

The information technology (IT) systems are currently inadequate. Developing effective and efficient IT systems may take time, but it is critical to sustain revenue mobilization over the medium term. At present, procedures are predominantly manual and paper-based and taxpayer information is not easily processed, shared, or consolidated. The lack of IT systems also contributes to face-to-face tax assessments that create opportunities for corruption. Without substantial improvement in the IT systems, progress in improving core tax administration procedures (taxpayer registration and services, returns filing, revenue collection, and arrears management) will be limited. However, significant investment is required to obtain and implement a good IT system as well as the resources to manage and sustain the system. Therefore, the priorities should be on developing and implementing an IT reform agenda within the overall reform program, and establishing a dedicated, full-time team charged with improving business processes and IT systems. Further support from development partners will be needed to advance these efforts and maintain full transparency and accountability in developing the IT systems.

Along with the development of these systems, the management of tax registration should continue to be improved. Taxpayer registration has not kept up with business development nationwide, evidenced by the fact that the number of registered business taxpayers is much smaller than the number of registered business establishments. At a minimum, the ongoing process of cleansing the existing registration databases should proceed together with centralizing national registration responsibilities under the Department of Taxpayer Services and Tax Arrears. Meanwhile, the authorities should develop a plan to broadly expand the taxpayer base, with appropriate resources and development partner support, aimed at creating a single, automated, registration database for all taxpayers. Expanding the number of registered taxpayers requires improving control systems to be able to handle new registrants effectively.

Revenue forecasting needs to be strengthened to help establish appropriate revenue targets in annual budgets and medium-term frameworks. The capacity for forecasting revenue remains limited owing to human resource constraints and the absence of integrated and automated systems to capture and process data. For example, various performance statistics, including audit results and arrears stocks, are held by each department and by the tax branches, but they are not consolidated centrally on a regular basis. The Ministry of Economy and Finance recently started a program to enhance the revenue forecasting capacity of its Fiscal Policy Department, supported by technical assistance from the IMF. This important initiative should include establishing effective coordination between the ministry, GDT, and the General Department of Customs and Excise to improve revenue analysis, set revenue targets, and monitor performance.

Good progress has been made in customs revenue collection, and the challenge is to sustain strong performance going forward. The collection of customs duties, export taxes, import VAT, and other trade taxes has been improved since 2009 by implementing reforms in customs procedures and techniques, including the implementation of the Automated System for Customs Data. Despite this progress, more efforts are needed to strengthen the customs intelligence and antismuggling functions, both at headquarters and in provincial branches, to detect fraud and reduce smuggling. Steps should also be taken to continue strengthening capacity in import valuation and post clearance audits.

In addition, reform priorities should include preparing the development of the Cambodia National Single Window (i.e., processing trade documents at a single location or agency) and the implementation of the regional priority “Asia cargo highway” (i.e., trade facilitation initiatives to create seamless flows of goods) by 2015. Improving customs administration would also be critical in offsetting the potential customs revenue losses from the implementation of AFTA.

Implementing Efficient and Fair Tax Policies

Cambodia could improve its tax regimes by following standard principles of efficiency, equity, and simplicity (IMF, 2010). The efficiency principle means that taxes should interfere as little as possible with relative prices and resource allocations, creating minimal distortion in the economy. The equity principle ensures that taxpayers under a similar situation should pay similar taxes and that the individual tax burden should reflect the ability to pay. The simplicity or ease-of-implementation principle means that taxes should be designed to minimize taxpayers’ cost of compliance and tax institutions’ cost of administering taxation. Based on these principles as well as cross-country experiences, reforming indirect taxation, such as the VAT and excise taxes, would generate a more immediate impact on revenue collection. Meanwhile, reforming direct taxation, such as profit and income taxes, will also be critical to sustain tax collection in the long run. The priorities for tax policy reforms are presented in Table 7.3.

Table 7.3Cambodia: Priorities for Strengthening Tax Policy
Priority areasPolicy measures
Near term
Value added tax (VAT): Revenue productivity is low due to narrow tax base, weak enforcement, and little information on taxpayers of the estimated regime because they are not registered.(1) Apply one threshold to all types of taxpayers; (2) Make registration with tax ID mandatory for all taxpayers; (3) Eliminate exemptions for electricity; (4) Adopt partial exemptions system for financial institutions by establishing rules to define the different kinds of financial services.
Excise tax: Low collection due to small amount of tax on standard excisable products. Restructuring the excise system would generate immediate revenue impact.(1) Rationalize the list of imported goods taxed; (2) Increase the number of petroleum products taxed; (3) Consolidate the ad valorem and additional taxes on fuels into one specific, indexed, tax; (4) Increase excise tax and customs duty on diesel to equal the rates on gasoline; (5) Tax tobacco with specific, indexed, excise tax.
Medium term
Tax incentives: Profit tax collections are low partly owing to various tax incentives that are unnecessary as Cambodia’s tax rate is low and competitive.(1) Limit tax holidays to specific industries for certain periods with no extensions; (2) Phase out tax holidays, grandfathering existing investors for specified time period.
Estimated tax regime: The process is labor intensive and the collection is low. The presumptive tax is determined by the GDT after verification, consultation, and negotiation with taxpayers.(1) Replace the negotiation system with simple, transparent, and consistent procedures for determining profits to improve governance and transparency.
Personal income tax: The collection is low due to narrow base, low compliance, and weak enforcement.(1) Address low compliance through strong enforcement. (2) Refrain from changing tax policies without any efforts in strengthening administration; (3) Streamline the PIT from five to three rates (for example, 0, 10, and 20 percent) and reduce deductions.
Capital income tax: Highly uneven statutory rates on different sources of capital income and no tax on capital gains.(1) Tax interest income with a standard rate of 15 percent. (2) Introduce uniform taxation on individual capital income consistent with the principle of dual income tax. (3) Prepare the introduction of a capital gains tax.
Property tax: The introduction of property taxation in urban areas is a positive step, and consistent and transparent implementation of property taxation across the country would provide additional source of revenue.(1) Review the implementation of property taxation to ensure it works effectively before expanding it across the country. (2) Strengthen property valuation procedures, including reassessment every five years and provide independent dispute resolution.
Source: Various IMF technical assistance reports provided to the Cambodian authorities.
Source: Various IMF technical assistance reports provided to the Cambodian authorities.

Cambodia has two tax regimes for business taxpayers: the real regime and the estimated regime. The real regime centers on the VAT and the standard income tax and is focused on larger taxpayers, while the estimated regime is anchored by a 2 percent turnover tax and a profits tax, mainly to bring smaller taxpayers into the system. Tax collected from the estimated regime is very small, but the number of estimated taxpayers is large in comparison to those subject to the real regime, with current estimates placing them at more than 40,000. Despite this, low compliance and weak enforcement have contributed to poor revenue collections from this group. Little information exists on taxpayers in the estimated tax regime, since they are monitored mainly by the district offices and are not registered and assigned tax ID numbers, which creates opportunities for tax evasion.

Near-Term Priorities

As a first priority, tax policy reforms should focus on unifying the VAT thresholds for all taxpayers and registering all taxpayers, including in the estimated regime, with tax ID numbers. The VAT is the largest single source of tax revenue in Cambodia, but tax productivity remains low owing to a narrow tax base and weak enforcement. At present, VAT taxpayers are primarily large taxpayers, contributing about 90 percent of the domestic VAT. However, several VAT thresholds exist depending on the type of businesses, and this increases collection costs and creates opportunities for tax evasion. The highest threshold (US$125,000 a year for businesses providing goods) is relatively high compared with the threshold commonly applied in countries in the region (US$50,000), while the lowest threshold (US$31,250 for unincorporated government contractors) is too low. Unifying the thresholds to the level comparable to the regional average would simplify the tax regime and increase revenue substantially.

The system of negotiation in determining tax in the estimated regime should be removed. The estimated regime is essentially a presumptive tax, and the amount of tax is determined by tax officials after verification and consultation with the taxpayer. This system of negotiation is resource-intensive and open to abuse, leading to potential revenue leakage. Removing the system of negotiation would improve transparency and help taxpayers meet their tax obligations. For example, the regulations could be modified to clearly define the profit margins with simple rules, which could be made publicly available and applied consistently to all taxpayers. The simplified profit margins would also make the tax system simpler and more transparent, reduce opportunities for abuse, and free up GDT resources that could be focused on more revenue-generating tasks. It is also important to undertake a comprehensive study of the taxpayer population under the estimated tax regime, using the results of the economic census, to gauge the revenue potential of these taxpayers. Formulating new strategies for bringing more of them into the tax net, for example by strengthening enforcement and audit activities, would raise revenue collection.

Restructuring the current excise system could have an immediate revenue impact. Although Cambodia levies excise taxes on services such as telecommunications, hotel accommodations, and motor vehicles, its revenue collection is low mainly owing to the small amount of tax on standard excisable products such as tobacco, carbonated and alcoholic beverages, and diesel fuel. In almost all of these categories, the tax rates in Cambodia are about one-half to one-third the rates in neighboring countries. As a start, the reference prices used to calculate taxes and the ad valorem tax rates could be raised and, at a later stage, these ad valorem taxes could be replaced by specific taxes with indexation. Rationalizing the list of imported goods subject to tax would also ensure that all standard goods, including all petroleum products such as liquefied petroleum gas and kerosene, are properly taxed. In addition, raising the excise tax on diesel to the rate applied to gasoline and eliminating the differential taxation of domestic and imported tobacco products could raise revenue in the near term.

Medium-Term Priorities

Another priority is to scale back tax incentives, including income tax holidays and exemptions on the VAT, import duties, and excise taxes. Tax incentives involve a loss of current and future revenue and create different tax treatments between and within sectors, leading to distorted resource allocation. Moreover, they create opportunities for tax abuse and corruption and tend to attract footloose firms that leave as soon as the incentive expires. In fact, taxes are not the only important factor in investment decisions, and the benefits of tax incentives may be reversed if a foreign investor is from a country that taxes its residents on a worldwide basis. There are also other concerns specific to Cambodia that need to be addressed, mainly a lack of effective monitoring to prevent abuse and revenue leakage; uncertainty for both taxpayers and administrators about the treatment of companies with multiple Qualified Investment Projects; and a lack of cost and benefit analyses of the incentives.

By and large, tax incentives in Cambodia are unnecessary given the country’s competitive tax regime. As discussed in Chapter 6, the VAT rate is 10 percent; the corporate tax rate is 20 percent; and the highest PIT rate is 20 percent—each lower than the typical rates for other low-income countries in the region. Therefore, tax holidays should be phased out in the medium term to prevent more revenue losses. If incentives are to be granted for investment, then accelerated depreciation or investment tax credits should be provided. If tax incentives are to be provided in Special Economic Zones, they should not include income tax incentives, but be restricted to import duties and VAT on exports with close monitoring. However, removing these incentives and their harmful effects may be politically challenging in the near term. Therefore, during the transition period, tax holidays could be limited by applying them to a few specific sectors with clear criteria and for a period of no more than three years with no extensions (grandfathering existing investors for the remaining period of their time-bound incentives). The granting of tax incentives should rest with one agency, such as the Council for the Development of Cambodia, and the laws granting them should be consolidated into one law, preferably the Law on Taxation, and with sunset clauses adopted in all other laws containing tax incentives.

Personal income taxation. Broadening the PIT base through stronger enforcement has large revenue potential. The PIT base is currently very narrow, with only an estimated 1½ percent of the urban employed liable. Reduction in the threshold for zero tax rates may generate more collections, although the cause of low revenue is likely weak enforcement. Therefore, changes in tax policy should not be made without other reforms aimed at improving revenue administration, including strengthening enforcement through a salary withholding tax.

Capital income taxation. Continued reforms in streamlining capital income taxation would sustain revenue collection over the medium term. Currently, Cambodia’s capital tax has highly uneven statutory rates on the different sources of capital income received by individuals. For example, interest income is taxed at final withholding rates of 4, 6, or 15 percent, depending on whether the interest is paid by banks or by nonbanks. The large variation in the taxation of personal capital income has a number of undesirable effects. First, the disparity in effective tax rates has efficiency costs by distorting portfolio choices of individuals. Second, it opens up loopholes by inviting tax arbitrage by providing incentives to invest in assets that generate lightly taxed or nontaxable returns, such as capital gains. Finally, current policies for taxing capital income violate equity considerations by allowing lower effective rates on income accruing mainly to the better-off segments of the population.

To address these issues, over the medium term Cambodia should adopt the principles of the dual income tax to prevent tax arbitrage, taxing all interest income and other capital income, such as dividends, at a low uniform rate of 10–15 percent. In the longer run, a capital gains tax should be introduced as an integral part of the PIT.

Property taxation. The introduction of property taxation in the urban areas in 2011 was a positive step and should help pave the way for countrywide implementation over the medium term. However, a review of its implementation needs to be done to ensure that it is working effectively before expanding it across the country. Based on existing reviews, the law could be strengthened by requiring property valuations to be reassessed at least every five years and by indexing property values—for example, to the consumer price index—in the interim. In addition, ensuring clear procedures for valuation and providing an independent dispute resolution process are important. In the longer term, the tax rate could be increased to at least 0.5 percent of the assessed property value, providing that local authorities, who are responsible for assessing, collecting, and enforcing the tax, have some discretion to set rates within a small range determined by the central government. At the same time, consideration could be given to repealing the tax on unused land and reducing the rate of the property transfer tax, which may discourage investment.

Resource-based taxation. Although Cambodia does not rely on resource-based revenue, formulating a resource-based tax regime is important to ensure that Cambodia gets the most benefit from the extraction of its mining, petroleum, gas, and other natural resources. Because of the specific characteristics of resource projects, the resource-based taxation regime is generally separated from the general taxation regime. For example, an exploration project could be lengthy and risky, the amount of capital to develop a mine could be lumpy, and capital could be captive and not transportable. In addition, revenues and costs can be volatile, driven by mineral and fuel prices, and it takes time to recoup a large upfront investment. Therefore, an appropriate resource-based tax regime should strike a balance between maximizing tax collection from the rents and providing an incentive for companies to invest in mining activities. The instruments of the mining regime include direct taxes, such as the corporate income tax and the profit tax, and indirect taxes, such as royalties, export duties, and import duties. Other nontax instruments can also be used, such as production-sharing arrangements and state equity participation.

Before a resource-based fiscal regime is established, Cambodia should follow a cautious approach in signing agreements on resource extraction projects that include tax and nontax provisions. While agreements on prospecting licenses for exploration could be granted based on the current mineral laws, agreement on mining leases for extraction should be prepared carefully to ensure that Cambodia gets the most benefits. Mining and petroleum agreements are complex and often difficult to implement and oversee. These agreements determine how profits are divided between the government and investors and how their costs are to be paid or recovered. In view of these factors, the government should consider hiring truly independent experts to help formulate and evaluate the contracts. In addition, contracts and regulatory matters should be disclosed publicly, including by participating in the Extractive Industries Transparency Initiative, to promote transparency in the process and the accountability of public officials.1

International taxation. Finally, Cambodia needs to strengthen its international taxation regime as its economy develops and becomes more internationally integrated. The provisions on international taxation are currently limited. For example, Cambodia has no double tax agreements (DTAs), which play an important role in determining the taxation rights of a country in which income is sourced. However, because reforming international taxation may take time and require substantial capacity building in formulating and implementing complex taxation regimes, it should be viewed as a medium-term priority. Nonetheless, the ongoing efforts to formulate DTAs with countries that are close trading partners or are significant sources of foreign direct investment should continue. In the process, the interaction between DTAs and tax incentives should not be overlooked, because these incentives, as currently structured in Cambodia, render the benefits of DTAs virtually ineffective. A foreign country would have less incentive to consider signing a treaty on DTAs with Cambodia if its own companies were not subject to tax in Cambodia because of the incentives. In addition, developing transfer pricing rules and improving the capacity to administer them would help strengthen Cambodia’s international tax regime.

Strengthening Governance

Effective revenue mobilization requires strong political commitment supported by accountable and transparent institutions. Political commitment is essential for successful reforms. Lasting reforms require deep institutional change across all dimensions—policies, procedures, systems, human resources, and organizational behavior. Strong accountability and transparency—both internally (management) and externally (governance and oversight)—would improve the performance and increase the credibility of tax institutions, thereby raising the public’s perception of and confidence in the tax system. In this context, Cambodia’s priorities for improving governance are presented in Table 7.4.

Table 7.4Cambodia: Priorities for Strengthening Governance
Priority areasPolicy measures
Oversight: Limited oversight of the General Department of Taxation’s (GDT) and General Department of Customs and Excise’s (GDCE) operations and performance.Create the political will to strengthen oversight and accountability of GDT and GDCE, and within the GDT and GDCE.
Transparency: Officials have considerable discretion in the application of tax laws due to weaknesses of management systems, process, and controls, and limited information and assistance to taxpayers.(1) Create systematic programs for taxpayer education, advice, and interpretation of the laws; (2) Remove the complex system of tax negotiation and abolish informal taxpayer-facing activities; (3) Strengthen management and supervisory controls.
Source: Various IMF technical assistance reports provided to the Cambodian authorities.
Source: Various IMF technical assistance reports provided to the Cambodian authorities.

Strengthening the oversight and accountability of tax institutions is the key to improving governance. The GDT and GDCE are responsible to the Ministry of Economy and Finance and are required to obtain its approval for a wide range of actions, but the ministry’s oversight of these departments’ overall operations and performance remains a challenge. Meanwhile, within tax institutions, the headquarters’ oversight of organizational performance and individual tax officials is also limited, partly because of capacity constraints and system weaknesses. This hinders effective enforcement and opens the door for rent-seeking behavior. Therefore, strong oversight and accountability are needed, which could be provided by the Ministry of Economy and Finance directly or by an independent governance board, as is the case in many other countries. Strengthening oversight and accountability should be the core of governance reform, drawing from inside and outside the government, including from the private sector.

Cambodia has much scope to improve transparency in tax policies and administration. For example, the provision of information, assistance, and advice to taxpayers is generally limited. There are no systematic programs to inform taxpayers about their rights and obligations and enable them to obtain greater certainty in managing and paying their taxes. The dispute resolution process contained in the law has not been implemented effectively, and current processes are inadequate. At the same time, and partly as a result of weak oversight, officials have considerable discretion in the application of procedures. This discretion creates a high risk of informality, particularly in taxpayer-tax official interactions, and threatens the integrity of the tax system and the reputation of tax institutions.

In view of these shortcomings, continued efforts to improve transparency will play a critical role in strengthening tax institutions’ governance. Creating systematic programs for taxpayer education, advice, and interpretation of the laws would be a good start to improve taxpayers’ confidence and perception. Removing the complex system of tax negotiation, particularly in the estimated tax regime, and abolishing informal taxpayer-tax official interactions would go a long way toward improving taxpayers’ confidence in an even-handed and fair system. Automation and stronger management controls and oversight are crucial for this. Establishing processes for independent reviews of GDT and GDCE decisions and for dispute resolutions would also boost transparency. Finally, better governance of tax institutions would help enhance the progress made so far in reforming tax policies and administration.

References

    International Monetary Fund (IMF)2010From Stimulus to Consolidation: Revenue and Expenditure Policies in Advanced and Emerging Economies,IMF Policy Paper (Washington).

    International Monetary Fund (IMF)2011Revenue Mobilization in Developing Countries,IMF Policy Paper (Washington).

The EITI is a global standard that promotes revenue transparency and accountability in the extractive sector by monitoring and reconciling company payments and government revenues from oil, gas, and mining at the country level (see www.eiti.org).

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