Cash & Liquidity ManagementCash ManagementPracticeCash Concentration and UK-UK Transfer Pricing

Cash Concentration and UK-UK Transfer Pricing

Readers may, by now, be aware of the lifting of the transfer pricing exemption for UK-UK transactions (which came into effect on 1 April 2004). Many groups should now be in the process of undertaking a review of intra-UK group transactions to identify arrangements and provisions of services where arm’s length pricing should be applied, and preparing documentation supporting the pricing arrangements. KPMG’s Transfer Pricing Group has identified several areas which UK groups need to focus on, such as the recharging of management charges (which may include accounting, tax, legal, HR and IT support services) and the charging of royalties on intellectual property owned by one member of the UK group but exploited by other companies within the group. However, it has come to our attention that the effect of the new rules on one particular type of arrangement, involving cash pooling, has not been fully appreciated by both UK groups and the banks offering cash concentrating schemes. As a result, many of these schemes currently in place will be incompatible with the new regime unless revisions are made to them. This is discussed in more detail below.

Cash concentration schemes operate to aggregate bank balances within a group of companies, providing an overall benefit to the participant group through the reduction of interest costs or concentration of surpluses to maximise investment returns. The tax implications of the operation of cash concentration schemes within one jurisdiction have, to date, been relatively straightforward. This is because, with no cross border cash movements, the issue of transfer pricing (that is, ensuring that all transactions are undertaken on arm’s length terms) has not generally been a concern. Provided that, on a group basis, income and expenditure is picked up in one of the participant companies, even if the allocation of any benefit between the participant companies in a particular territory is either not undertaken or not precise, tax authorities have not necessarily enquired into the arrangement.

The banks will often operate an ‘interest allocation’ formula, by which the benefit of the cash concentration is distributed around the group. However, in many cases, this is offered as an ‘extra’ for which the user group pays, or is not offered at all and is provided only at the group’s request. It is not uncommon for the participants in the cash concentration to continue to be charged/paid standard (that is, non adjusted) interest rates on deficits/surpluses, with the benefit from the concentration siphoned off into a separate ‘treasury’ account. Will the advent of single country transfer pricing rules require a change to such practices?

The new UK-UK transfer pricing rules

For UK groups within the scope of the new transfer pricing rules (which would include most groups for which a cash concentration structure would be feasible), transactions between related parties must be on arm’s length terms. The Revenue have indicated that they will not seek to audit this too rigorously where there is no significant UK tax loss at stake, but it is hard to assess whether this may or may not be the case until after the event when the actual pattern of cash balances and hence benefits can be determined. As UK companies are under an obligation to file tax returns which comply with arm’s length transfer pricing policies, the fact that the Inland Revenue may not rigorously police this requirement in respect of UK-UK transactions does not remove the need for UK companies to self assess accurately. That is, UK-UK transactions must be priced (for tax return purposes) on an arm’s length basis.

So, what should UK group companies with cash concentration structures do to ensure they meet the requirements? The first issue groups affected by the new rules should consider is whether their current cash concentration system does accurately allocate benefit between the participants, and whether it is arguably on an arm’s length basis. This may be a significant differentiator in deciding whether a new system needs to be set up and, if so, the terms of the arrangements. Our experience to date has shown that banks have not fully taken the issue on board and, whilst they are open to accommodate such data, they are still not integrating this feature as standard.

If no such allocation is made within the current scheme, the participants in a UK cash concentration structure should assess the degree of tax risk which could arise from the failure to allocate the benefits between the participants of the structure. The allocation appropriate for the structure in place should take into account issues such as the contribution of cash to or from the net position (whether by physical movement of cash or notional pooling), ‘back office’ type responsibilities undertaken by any of the participants and guarantees given by participants to cover the operation of the structure.

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